Page 192 - DECO101_MICRO_ECONOMICS_ENGLISH

Unit 12: Monopolistic Competition

Notes
Figure 12.6: Reduction in Demand Elasticity due to Elasticity

Figure 12.6 shows the effect of advertising on demand elasticity. The new demand curve facing
Everest is a little steeper and less elastic. Less elastic demand means that buyers are less inclined
to change their quantity demanded with a price change. Given this, Everest is able to charge a
slightly higher price for the same quantity of packets sold. It can now charge a price of ` 5.95 for

each of the 6 packets sold at the profit-maximising level of production.

There are, however, a couple of things that a monopolistically competitive firm should take care
of. They are:

1. First, firms cannot maximise profit in the inelastic range of demand as in this range
marginal revenue is negative. This would mean that the marginal cost would also have
to be negative. This is not possible. In case the advertising is so successful that demand
becomes inelastic, then the fi rm will have to raise the prices until it moves back into the
elastic range. Quite sensibly so, when it is not possible to garner profits in the inelastic

range, the firms move back to the elastic range to boost profi t.

2. Second, advertising involves a lot of cost. The revenue generated by advertising must be
compared against the cost of the advertising. In Everest’s case, demand might increase
and become less elastic, but average and marginal costs are also likely to increase.

Case Study Maruti facing Tough Competition
he key issue for Maruti today is to sell at least the number of cars it sold last year
(1998-99). Insiders in the company admit that it can’t. The reason: Hyundai, Daewoo
Tand Telco all plan to hawk 60,000 cars by end of next April. And all of them are
targeting the Zen or the Maruti 800, the two monopolists, and not the crowded luxury
segment. And with the market expected to stagnate, by simple logic the newcomers will
be grabbing a share only from Maruti.
The threat from the new car makers is not an empty one. For instance, Hyundai plans to
follow the policy of “enrichment” of the Zen. It intends to price its air conditioned model
slightly lower than the Zen VX and top it by pricing the higher end model with power
steering and windows just ` 10,000-15,000 more than the Zen VX.
Contd...

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