Introduction
Monopolistic competition is a market structure where there are many firms selling a differentiated product and entry barriers are low. This structure gives rise to particular firm behaviour and performance. The behaviour of a firm pertains to price and output determination, manner of competition and tendency to engage in R&D. The performance of a firm is measured in terms of the extent to which productive, allocative and dynamic efficiencies are achieved, variety of products and choice are provided and equity of income distribution promoted. To examine whether the model of monopolistic competition best explains firm behaviour and performance in Singapore, there is a need to consider whether the model can explain firm behaviour and performance better than other models in terms of whether industries in Singapore fit this market structure and whether firms exhibit the behaviours and performances that are predicted by this model. This would entail taking into account the various type of industries found in Singapore.
Body
Thesis:
Monopolistic competition best explains firm behaviour and performance in Singapore
There are markets in Singapore which are structured like in monopolistic competition and thus behave and perform like a monopolistic competitive firm.
- E.g. retail, food and beverage (F&B), personal services industries have many firms due to low entry barriers. E.g. low start-up cost and limited EOS. These firms produce slightly differentiated products, giving them some degree of market power as represented by them facing a downward sloping demand curve for their product.
- Profit maximising behaviour in price and output determination:
As profit maximisers, these firms would produce the output level at which MR=MC. This is because as long as MR>MC, producing at additional unit would add more to TR than TC thus enabling total profits to rise. On the other hand, when MR<MC, producing an additional unit would add more to TC than TR thereby lowering total profits. The highest level of total profits is thus attained where MR=MC, which occurs at point Qm in the diagram below. The firm will then charge the highest price possible for that output, Pm (price-setting). As long as TR>TVC in the short-run, the firm will produce the equilibrium or profit maximising output and TR must at least equal TC in order to induce the firm to stay on in the industry in the long-run.
Evaluation:
As there are many firms in Singapore (a market economy) which are privately-owned and are hence profit-maximising, the monopolistic competition model would be a relevant model for explaining firm behaviour in S’pore.
This behaviour gives rise to the following performances
- Productive efficiencyThe existence of competition and profit motive would drive the firm to produce at least cost.
- Allocative inefficiencyThe price, Pm, > MC. This is because as long as firms have some degree of market power, the MR will be lower than AR (or P) and hence at the profit- maximising output, P > MC.This underproduction causes welfare loss as the additional Qs-Qm units would have caused a net gain of welfare for society since the TB of the Qs-Qm units > the TC of the Qs-Qm units. This net gain is given by area hse.
Evaluation:
As all firms in Singapore have some degree of market power and are hence price setters, since perfectly competitive market conditions do not exist in the real world, the monopolistic competition model’s explanation of firm’s performance is thus relevant for explaining firms’ performance in Singapore.
- Behaviour of price and non-price competition
Firms in retail, food and beverage, personal services industries engage in
– Price competition
Prices of hawker food at hawker centres for instance are very competitive. Similar dishes are often priced at the same price, as low as they possibly can. This happens because firms face a very price elastic DD as barriers to entry are low (e.g. set up cost for a hawker stall is not very high) so consumers may switch to the other substitutes when any firm increases the price.
Some firms may even charge lower than the rest. E.g. In the same hawker food centre, 1 noodle stall could be charging $3 a bowl while another could be charging only $2.50 a bowl. The firms in these industries dare to engage in price competition because there are many competitors and the effect on them is diluted when 1 firm charges a lower price. They thus do not retaliate with counter price cuts.
Evaluation:
This lack of rival consciousness is a characteristic of monopolistic competition, thus making this model a suitable model for explaining firm behaviour in Singapore for industries like retail, food & beverage.
This behaviour gives rise to the following performances
- Low degree of allocative inefficiency
The presence of competition that drives firms to charge prices close to MC mean that although P>MC, the difference is not as great as if they had more market power and faced rather inelastic demand.
- Equity between firms and consumers in the market because firms are not earning too much profit at the expense of high prices for consumers.
– Non-price competition
Differentiated products are found in a wide variety of industries, particularly in the retail, F&B and personal services industries. As barriers to entry are quite low for firms in this industry, these firms rely on the differences in their goods to grant them the little market power that they have. For example, in the personal services industry like hair salons, the firms distinguish themselves based on their provision of service with professionalism or the personal touch, serving tea and coffee while having a haircut.
This behaviour gives rise to the following performance –
– Choice and variety for consumers that cater to the myriad of tastes and preferences.
Antithesis:
Monopolistic competition does not best explain firm behaviour and performance in Singapore.
- Not all industries are structured like monopolistic competition.
- Various industries in Singapore consist of only a few firms or are dominated by a few firms. That is, oligopoly. This is because of the existence of high entry barriers.
E.g.
Oil-refining and electronics industries – High MES (due to substantial technical EOS) relative to market demand.
Pharmaceuticals – Patents
Public transport – Govt licenses (for taxi, bus, MRT) + high MES (for bus/MRT) Certain consumer goods like breakfast cereals – High MES and persuasive advertising
Oligopolies are common for the manufacturing industries and even in certain service industries in Singapore given
- Singapore’s increased focus on more knowledge, technology and capital intensive manufacturing activities. This means firm size needs to be big in order to survive global competition.
- The large presence of foreign firms in Singapore and her openness to imports and dependence on exports. This means that various industries are dominated by large MNCs and local firms will have to be big to survive global competition (e.g. merger of banks in Singapore).
- These oligopolistic firms are usually selling differentiated products and are profit- maximising just like in monopolistic competition and, with their market power, are also allocative inefficient like monopolistic competitive firms.
- However, this different structure gives rise to behaviour and performance that are either not found or differ from that of monopolistic competitive firms.
- Rivalrous behaviour
– Collusive behaviour
E.g. In the petrol industry when 1 firm, usually Shell, changes its price, the rest will follow. In the taxi industry, following Comfort-Delgro’s (the market leader with 65% market share) raising of the starting meter price from $2.50 to $2.80, many other taxi companies followed suit.
The implication for performance is that of
- possibly productive inefficiency since firms are not competing in terms of price.
- Greater allocative inefficiency in oligopoly rather than monopolistic competition since colluding firms would be behaving like a monopoly given price fixing.
– Competitive behaviour
E.g. Rivalrous behaviour is also seen in the counter provision of bundle packages for consumers in terms of mobile plans provided by telco companies.
- Supernormal profits
The existence of high entry barriers means that firms in such oligopolistic industries are able to preserve their supernormal profits in the long-run. This contrasts with firms in monopolistic competition where the earning of supernormal profits will cause firms to enter and this lowers the market DD for the incumbent firms eventually to the point where each firm earns only normal profits (explain with ref to diagram). The easy entry of firms is commonly seen in the F&B industry, where start-up cost is relatively low and knowledge of production easily available. When a successful new type of restaurant eventually attracts new firms, the amount of supernormal profits will be dissipated.
The implication for performance is that
- Firms in oligopolies contribute to income distribution inequity in Singapore.
- Firms in monopolistic competition operate their plant at excess capacity rather than at optimum capacity.
- Persuasive advertising
Although firms in retail, F&B and personal services industries do engage in advertising, these are usually cheap forms like distribution of flyers or use of classified ads. Firms in industries in Singapore that are structured like oligopoly engage in large scale mass media advertising. As Singapore is closely integrated with global markets, being a trade-reliant economy, the local firms, e.g. a soft drinks manufacturer would have to advertise extensively to compete successfully against well-established international brands like Coca Cola. The purpose of advertising is to make the demand facing the firm more price inelastic in order to gain more market share and market power and also creates entry barriers to new firms who would be deterred by the high cost of advertising required.
The implication for performance is that consumers benefit from the informative aspects of the advertising but the persuasive advertising could well lead to wastage of resources since they don’t meet consumers’ needs and wants.
- Research and development
- Firms in both monopolistic competition and oligopoly engage in innovation but for the latter, they have both the incentive and ability to engage in costly R&D to lower marginal costs of production and come up with revolutionary improved products. Their ability to preserve any supernormal profits obtained from innovation provides them with the incentive to engage in R&D while their ability to obtain the funding provides them with the ability to engage in R&D.
- The implication for performance is that the rate of technological advancement is higher in an industry like pharmaceuticals than in an industry like F&B.
- The profit-maximization assumption of monopolistic competition model does not necessarily hold
Firms are not necessarily profit maximisers
- E.g. retail stores periodically have sales for selected items. This means it won’t be producing where MR=MC.
Evaluation
However, this is usually a marketing ploy that can’t be sustained in the long term. This means, the monopolistic competitive model is still relevant.
- Firms do not necessarily produce where MR=MC and charge according to the DD curve for this output. This is because they may lack info on MR and MC. Most firms simply engage in ‘cost plus’ pricing, i.e. determine AC and add a profit margin to arrive at the price.
- Alternative theories of the firm
- In big firms where functions are divided, the shareholders are not the managers of the firm and the firms’ managers may actually exhibit profit-satisficing behaviour rather than profit-maximizing behaviour of a monopolistic competitive firm. (Elaborate)
- However, small firms operating in markets that are structured like monopolistic competition are usually managed by the owner himself and his aim of engaging in business would be profit-motivated. Thus, the principle of profit-maximisation (as found in the model of monopolistic competition) is still applicable.
Evaluation
This means the monopolistic competition model remains a useful model for explaining firm behaviour in industries that comprise of small firms.
- Government regulation
- This apply to natural monopolies like utilities and MRT which having substantial economies of scale where MES is high relative to the market demand. In the utilities industry, the high start-up cost of laying cables or pipes results in falling marginal cost and average cost across the whole range of the market demand curve such that it is not possible for more than 1 firm to produce the product profitably. However, as it is a necessity, the government intervenes by regulating the price that PUB charges for water. This means the industry may not be allocative inefficient (a feature of monopolistic competition).
Evaluation
The model of monopolistic competition is thus more useful for explaining firm behaviour and performance when firms are allowed to pursue their profit motive.
Synthesis and Conclusion
Which model of market structure can best explain firm behaviour and the resulting performance in Singapore, depends very much on the nature of the industries that are in question. For industries with low barriers to entry and where choice and variety are valued such as the personal service industries, or the F&B industries, the monopolistic competition model does explain firm behaviour and performance to a large extent. However, for other industries with high barriers to entry such as those in manufacturing and transport, the behaviour exhibited by oligopoly and monopoly firms would better explain the behaviour of firms in such industries. Furthermore, due to the small and open nature of the economy of Singapore, the dependence on imports, exports and FDI means that there is the presence of many big multi-national companies in Singapore with large domestic market share, hence the monopolistic competitive model may not best explain firm behaviour and performance in Singapore.