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Economics For Business: Monopolistic Competition Assessment Answer



The main motive of a firm is to maximise the profit. The product differentiation is a procedure of the firm to ensure its customer that its product has slightly different characteristics than its close substitutes. The product differentiation helps to achieve greater economic profit to the firm. Economic profit is the difference between the revenue of a firm and economic or opportunity cost of inputs used in the production process. There is product differentiation because some firms cannot imitate the product of the rival firm. This is due to several laws are there regarding copyrights, trademarks and patents. In a perfect competition market, there may be a super-normal profit in the short run. However, in the long run, there is only a normal profit. Similarly, almost the same things happen in the case of the monopolistic competitive market. However, perfect competition market deals with homogeneous product and monopolistic competition mainly deal with the differentiated product. In the case of a market for the differentiated product, a price is greater than marginal cost (Novshek, 2014). Therefore, the output of the monopolistically competitive market is not socially optimal or Pareto efficient. However, in the monopolistic competition, the consumer gains more satisfaction and welfare for consuming differentiated product than consuming a homogenous product. However, there is a positive externality for the consumer by increasing the type of variety of the product, and a negative externality to the firms by reducing their profit. To increase the welfare of the people, government intervention plays a crucial role to increase the efficiency in production and distribution of output. However, it is evident that product differentiation causes higher profit to the firms making a once-off expenditure in it

(Brander, & Spencer, 2015).

Analysing the behaviour of the product differentiating and profit-maximizing firm, here is a consideration of monopolistically competitive market.  Monopolistically competitive firm sells the differentiated product. The firm faces a negatively sloping or downward sloping demand curve. The consumer has a love of variety and ideal variety for a product. As a monopolistically competitive firm increases its price than its rival firm producing a close substitute, it may not lose its all the consumer. Some of its consumers attach high value for that firm’s product. Every product of the monopolistically competitive firm has it distinct features (Grigolon & Verboven, 2014). If the rival or competitive firm increases their price then there is an increase in the demand for the product of the given firm. If the firms are selling almost the same product, then there is an increase in the elasticity of demand. Monopolistically competitive firm is different from the oligopolistic firm. Because in the monopolistic competitive firm does not consider the price or quantity strategy of the rival firm. In real life, there is a large number of businesses in a single industry. Therefore, the effect of price change or change in demand of the rival firm has a relatively small effect (Varian, 2014).

The product- differentiated firm is choosing a profit maximising output. Profit maximisation occurs where marginal cost is exactly equal to its marginal revenue. This condition is same as the monopolist. In the monopolistic ally competitive market, the condition of free entry and exist drives the super normal profit to zero and in the long run the demand curve tangent to the average cost curve for every firm. In the following diagram, there is a discussion of it (Becchetti et al. 2014).

Figure 1: equilibrium in monopolistic market

(Source: created by author)

In this diagram (1), the demand or the average revenue curve and marginal revenue curve is downward slopping. Average revenue curve is a U-shaped curve. Marginal cost is upward rising and intersects the average cost curve at the minimum point (Grigolon, & Verboven, 2014).

In this diagram, dead weight loss in the gray-shaded portion. P* is the socially optimal price charge in the competitive market, and socially optimal quantity is Q*. However, the charged price of the monopolistically competitive firm is P and the Q is the quantity. If the price is equal to the marginal cost, then it may be a loss- making firm. If the government wants to increase the output to attain a socially optimal level, then it should provide subsidy to the firm. Consumer gains satisfaction for having a different variety of goods. If there is a reduction in some available goods in the market, this may cause a reduction in the consumer welfare. This reduction in consumer surplus is the deep shaded grey triangle. In a monopolistically competitive firm generates a consumer surplus by introducing new product. In case of monopolistically competitive firm, the demand curve and the marginal revenue curve is downward slopping, profit maximising condition holds where that marginal cost is equal to marginal revenue. However, the demand curve is lying above the marginal revenue curve. Therefore, the price is greater than the marginal revenue. In this market, every firm has some good numbers of consumers of its product. Therefore, the demand curve is less elastic. This ensures relatively higher profit for the monopolistically competitive firm than the competitive firm. Therefore, if a firm interested in producing the differentiated product then it definitely ensures higher economic profit in the future. Higher opportunity cost results in diversion of inputs from the production. The product-differentiating firm has different cost structure than its rival firm. Including an ideal variety of features in the product consistent of the consumer needs may ensure a higher profit to the firm. Therefore, once-off expenditure for a differentiating product is very important in the case of achieving the higher profits in the future (Woo et al.2014).

In conclusion, it is evident that a monopolistically competitive firm always tries to attain higher profit. By varying its product and adding new features to its product, monopolistically competitive firm ensures greater profit. Therefore, product differentiation is very important factor in the monopolistically competitive. If a firm adds different characteristics to a product, it ensures an ideal match of its product to its customer. Attaching higher value to the product by the consumer makes the demand curve of the monopolistically competitive firm less elastic. This inelastic demand results in higher price and higher profit for the monopolistically competitive. Therefore, the firm has to initiate a product differentiation to ensure a higher profit in the future (Zhelobodko et al. 2012).


There are various rates of wages prevailing in the economy. There are different wage rate in different sectors. Wage rates vary from country to country, industry to industry and sectors to sectors.  This variation is in between and within the occupation and industry. Economists face difficulty in explaining the variation of these wage rates differential within and across the occupation and industry. There are various factors causing the variation in the wage rate in across and within the occupation, industry. These are the age and working capacity of the labor, qualification of education, working experience of the labor, health hazards and risk involve in work, possibilities of promotion, the prevailing or on-going wage rate of the society, employment stability, job security and stability in the employment, the product demand and earning surplus and profit by the business organization.  Moreover, it is very difficult to measure the endowed capability in the human being. If the employer can trace the potential of the labour or employee, then the employer takes a decision to increase the wage of the labour. The employer can apply various screening method to know the potentiality of the labour. However, this potentiality of labour is difficult to measure (Blau, 2016).

However, there is problem or difficulty in evaluating the possible reasons behind the wage rate differentiations in across and within the industry and occupations. In the next section of discussion, there is an analysis of reasons behind the difficulties in explaining the wage differentials in the economy (Dix-Carneiro, & Kovak, 2015).

In the economy, labour is one of the most important inputs of production. Any production activities need sufficient amount of labours to produce output efficiently. There is a different rate of wage in various sectors and industry. The wage rate is a function of unions of labour, expectation about the future rate of wage, living cost, various rules and regulation of government, ability to pay of the employer, labour demand and supply and most importantly productivity of the labour. Therefore, the reason behind the variations of the wage rate may cause due to the variation or differentiation in the above mention factors. However, different countries have different quality of labour. Age structure differs across the different countries. Some countries have a greater number of young labours than the others (Romano & Meneses, 2016).. Therefore, their working capacities are relatively higher than the old labourers. In some industries, there are productions of same goods using either labor-intensive technique or capital-intensive technique. Capital abundant economy uses capital-intensive technique and relatively low numbers of labour. There is a need for skilled labour to operate the physical and financial capita efficiently. Those economies have higher number of labour and applying labour intensive technique faces a problem of low wage. However, this is not always true. Sometimes, there is a problem in evaluating the quality of labour. There is a judgment of the quality of labour regarding productive efficiency (Guvenen, Kuruscu & Ozkan, 2013). The increase in the productive efficiency is due to either for the skill of the labour or the experience of the labour. Similarly, some industries prefer educated and qualified labour; however, some prefer the experienced labour. There are differences in the wage rate due to the different perspective of the employer of the organisation. There are different preferences of the employer to employ a labor. Different industries have different cost structures to produce a product. It completely depends on the employer of the organisation to determine the factors of different wage rate. There is no individual rule for different industry or occupation to follow for setting the wage structure. Therefore, there exists wide variation of wage rate across the occupation and industry (Katz  & Krueger, 2012).

To determine the factors causing wage variation within the industry or occupation depends on the outlook of an employer. The value attachment to the employee by the employer may be the reason of differentiating wage within the industry or organisation. However, there is a difficulty in judging the employer outlook to the different employee. If the cause of wage differentiation is due to several variables as per the discussion, still there are some cases where variation in wage is not for any of the above-mentioned reason. This creates a problem. Even economists cannot give any convincing reasons for the wage differentiations in within and across the industry. There is no given rule for the variation of the wage differentials. There are various rules set by the government; these rules regarding the wage rate differs from country to country. However, government changes its rule time to time according to the needs of the labor and for various other reasons. Therefore, to explain the effect of the different rules and regulation of the on the variation in the rate of wage is very difficult (Lindley & Machin, 2013). Even quality of labour is quantifiable. Therefore, an increase in productivity cannot be the only indicators of judging the quality of labour. Providing proper skill and guidance can increase the quality of labour at any time; therefore, it is very difficult to say wage variation occurs due to the increase in the quality of labour. Some jobs have risk association in it. This risk may cause to health hazards. However, measuring the amount of risk associated with that job is sometime difficult to measure. Therefore, a serious problem or difficulty arises in explaining the variation in the wage differentials across and within the occupations and industry (Manacorda, Manning & Wadsworth, 2012).

In stating a conclusion, it is clear from the above analysis that there is no such explanation is there for the variation of wage rates across and within the occupation and industry. There are some reasons behind the wage differentials of the labour. However, to discuss or explaining the economic reasons behind this is very difficult to analyse. From, the above discussion, it is evident that there is no uniform rule for explaining the wage variation. It completely depends on upon some factors that have qualitative features. There is a difficulty in judging the qualitative variables in a quantitative measurement (Lindley & Machin, 2013).


Becchetti, L., Palestini, A., Solferino, N., & Tessitore, M. E. (2014). The socially responsible choice in a duopolistic market: A dynamic model of “ethical product” differentiation. Economic Modelling, 43, 114-123.

Blau, F. D. (2016). Gender, inequality, and wages. OUP Catalogue.

Brander, J. A., & Spencer, B. J. (2015). Intra-industry trade with Bertrand and Cournot oligopoly: The role of endogenous horizontal product differentiation. Research in Economics, 69(2), 157-165.

Depalo, D., Giordano, R., & Papapetrou, E. (2015). Public–private wage differentials in euro-area countries: evidence from quantile decomposition analysis. Empirical Economics, 49(3), 985-1015.

Dix-Carneiro, R., & Kovak, B. K. (2015). Trade liberalization and the skill premium: A local labor markets approach. The American Economic Review,105(5), 551-557.

Grigolon, L., & Verboven, F. (2014). Nested logit or random coefficients logit? A comparison of alternative discrete choice models of product differentiation.Review of Economics and Statistics, 96(5), 916-935.

Guvenen, F., Kuruscu, B., & Ozkan, S. (2013). Taxation of human capital and wage inequality: A cross-country analysis. The Review of Economic Studies, rdt042.

Katz, L. F., & Krueger, A. B. (2012). Changes in the Structure of Wages in the Public and Private Sectors. 35th anniversary retrospective, 721-756.

Lindley, J., & Machin, S. (2013). Wage inequality in the Labour years. Oxford Review of Economic Policy, 29(1), 165-177.

Manacorda, M., Manning, A., & Wadsworth, J. (2012). The impact of immigration on the structure of wages: theory and evidence from Britain.Journal of the European Economic Association, 10(1), 120-151.

Nagurney, A., & Li, D. (2015). A supply chain network game theory model with product differentiation, outsourcing of production and distribution, and quality and price competition. Annals of Operations Research, 226(1), 479-503.

Novshek, W. (2014). Equilibrium in simple spatial (or differentiated product) models. Noncooperative Approaches to the Theory of Perfect Competition,3, 199.

Romano, P. P. O., & Meneses, E. G. (2016). WHY ARE THE WAGES OF THE MEXICAN IMMIGRANTS AND THEIR DESCENDANTS SO LOW IN THE UNITED STATES?. Estudios Económicos, 31(2), 305-337.

Varian, H. R. (2014). Intermediate Microeconomics: A Modern Approach: Ninth International Student Edition. WW Norton & Company.

Woo, C. K., Sreedharan, P., Hargreaves, J., Kahrl, F., Wang, J., & Horowitz, I. (2014). A review of electricity product differentiation. Applied Energy, 114, 262-272.

Zhelobodko, E., Kokovin, S., Parenti, M., & Thisse, J. F. (2012). Monopolistic competition: Beyond the constant elasticity of substitution.Econometrica, 80(6), 2765-2784.


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