Revenue Cost Nature
1. Revenue Cost (Demand curve): Monopolist competition has elements of both monopoly and competition. Therefore the average revenue curve or the demand curve faced by a firm by monopolistic competition is neither as steep as it is under monopoly nor is it parallel to the X-axis as it is under perfect competition. Generally under monopolistic competition due to product differentiation a firm faces downward sloping demand curve.
The main differences being under monopolistic competition AR and MR curves are more elastic. It means that when a monopolistic competition raises the prices of the proportionate fall in its demand will be more. It is so because in a monopolistic competitive market goods have their substitutes and buyers are equally attracted towards them. If one firm raises the price of its product the buyers will shift their demand to the substitute product whose price remains unchanged. Thus if a firm raises prices demand for its product will fall substantially and conversely. If it lowers the price demand for its product will raise considerably.
2. Cost Curves: As stated above a firm's cost curves are independent of the market structure in which it has to operate: cost is the function of physical aspects of production; cost behavior is determined by the law of variable proportions.
In the short run a firm under monopolistic competition will have average fixed cost, average variable cost, average cost and marginal cost. It is however sufficient to take only AC and MC even in the short period.
Dominent firm model: in the dominent firm type of leadership one firm produces major portion of the output of the industry. The other smaller firms together produce the balance of the output. None of these small firms produce enough output to have any determinate effect of price. The result is that the dominent firm fixes the price which other firms accept. If the smaller firms charge a higher price above the price below the price set by the dominent firm, they do not secure any advantage as they could easily dispose of all their output at the price of the dominent firm. Therefore, the average revenue curve (ARC) for the follower firms is a horizontal line parallel to the X-axis, they are are required to adjust their output to the point at which their marginal cost is equal to the price determined by the dominent firm. Generally their marginal cost is equal to the price determined by the dominent firm. Generally prices are uniform if the products are physically homogeneous. If the products are differentiated, prices can be uniform to a given pattern of differentials. The price leader makes price changes from time to time.
Smaller firms follow suit with motives ranging from fear to convenience, to laziness. The smaller firms believe that profit will be greater in the long run under price leadership that could be obtained under alternative pricing arrangements.
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