Simulations and Games in Economics Education - Example in Monopolistic Competition

Example in Monopolistic Competition

Through a simulation game, students may participate directly in a market by managing a simulated firm and making decisions on price and production to maximize profits. An excellent review of the use of a successful market simulation is given by Motahar (1994) in the Journal of Economics Education.

A monopolistic competition simulation game can be used as an example in the standard economics classroom or for experimental economics. Economic experiments using monopolistic competition simulations can create real-world incentives that may be used in the teaching and learning of economics to help students better understand why markets and other exchange systems work the way they do. An explanation of experimental economics is given by Roth (1995).

Assumptions of monopolistic competition

A simulation game in monopolistic competition needs to incorporate the standard theoretical assumptions of this market structure, including:

• Many buyers and sellers
• Easy entry and exit
• Some degree of product differentiation
• Zero economic profits in the long-run

In a simulation of monopolistic competition, each firm must be small in size, and should not be able to influence the direction of the overall market. Yet each firm has some control over price owing to product differentiation. To be consistent with economic theory, the simulation model should allow entry of new firms to occur as long as profits are greater than normal, and economic profits exist. The entry of new firms will decrease the market price, and eventually cause economic profits to return to zero (see Baye, 2009).

Controllable decisions in monopolistic competition

To simulate monopolistic competition, the controllable firm decisions of the participants (students) must include, at a minimum, those specified in the standard theoretical model, including (see Baye, 2009):

• Firm price
• Advertising
• Firm production
• Plant Size

Simulation game experience

From an educational point of view, students will have an “opportunity” to learn by their own observations and experience through participation in a simulation game (see Schmidt, 2003). Consistent with the theoretical model of monopolistic competition (see Baye, 2009), student participants would observe and experience that their pricing decisions are controlled by the market. They would “experience” that in the simulation they would have to lower their firm’s price to be competitive as new firms entered the market. In the long-run, they would see the impact of changing plant size. They would observe that the successful firms would take advantage of economies of scale, but would also be careful not to incur diseconomies of scale in the long-run. Students would experience that economic profits cannot be maintained in the long-run. They would see, first hand, that their accounting profits will inevitably decline and move closer to normal profits. This experience provides students an opportunity to learn (as a supplement to the lecture and readings) the economic messages of monopolistic competition.