MONOPOLISTIC COMPETITION

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MONOPOLISTIC COMPETITION

• Chapter 17

2
The Spectrum of Market Structures
3
The Spectrum of Market Structures
4
Types of Imperfectly Competitive Markets

• Monopolistic Competition
• ä Many firms selling products that are similar
  but not identical.
• Oligopoly
• ä Only a few sellers, each offering a similar
  or identical product to the others.

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Monopolistic Competition

• Markets that have some features of competition
  and some features of monopoly.

6
Attributes of Monopolistic Competition

• Many sellers
• Product differentiation
• Free entry and exit

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Many Sellers

• There are many firms competing for the same group
  of customers.
• ä Product examples include books, CDs, movies,
  computer games, restaurants, piano lessons,
  cookies, furniture, etc.

8
Product Differentiation

• Each firm produces a product that is at least
  slightly different from those of other firms.
• Rather than being a price taker, each firm faces
  a downward-sloping demand curve.

9
Free Entry or Exit

• Firms can enter or exit the market without
  restriction.
• The number of firms in the market adjusts until
  economic profits are zero.

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Monopolistic Competition in the Short Run

• In the short run, the monopolistically
  competitive firm follows a monopolists rule for
  profit maximization.
• ä Produce the quantity where MR MC.
• ä Price should be greater than average total
  cost.

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Monopolistic Competition in the Short Run
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Monopolistic Competition in the Short Run
Price
0
Quantity
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Monopolistic Competition in the Short Run
Price
Demand
MR
0
Quantity
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Monopolistic Competition in the Short Run
Price
MC
ATC
Demand
MR
0
Quantity
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Monopolistic Competition in the Short Run
Price
MC
ATC
Price
Demand
MR
Profit-
0
Quantity
maximizing quantity
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Monopolistic Competition in the Short Run
Firm Makes a Profit
Price
MC
ATC
Price
Demand
MR
Profit-
0
Quantity
maximizing quantity
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Monopolistic Competition in the Short Run
Firm Makes a Profit
Price
MC
ATC
Price
Average total cost
Demand
MR
Profit-
0
Quantity
maximizing quantity
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Monopolistic Competition in the Short Run
Firm Makes a Profit
Price
MC
ATC
Price
Average total cost
Demand
Profit
MR
Profit-
0
Quantity
maximizing quantity
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Monopolistic Competition in the Short Run
Price
MC
ATC
Demand
MR
0
Quantity
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Monopolistic Competition in the Short Run
MC
Price
ATC
Demand
MR
0
Quantity
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Monopolistic Competition in the Short Run
MC
Price
ATC
Price
Demand
MR
0
Quantity
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Monopolistic Competition in the Short Run
Firm Makes Losses
MC
Price
ATC
Price
Demand
MR
0
Quantity
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Monopolistic Competition in the Short Run
Firm Makes Losses
MC
Price
ATC
Average total cost
Price
Demand
MR
0
Quantity
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Monopolistic Competition in the Short Run
Firm Makes Losses
MC
Price
ATC
Losses
Average total cost
Price
Demand
MR
0
Quantity
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Monopolistic Competition in the Short Run

• Short-run economic profits encourage new firms to
  enter the market. This
• ä Increases the number of products offered.
• ä Reduces demand faced by incumbent firms.
• ä Incumbent firms demand curves shift to the
  left.
• äDemand for the incumbent firms products
  fall, and their profits decline.

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Monopolistic Competition in the Short Run

• Short-run economic losses encourage firms to exit
  the market. This
• ä Decreases the number of products offered.
• ä Increases demand faced by the remaining
  firms.
• ä Shifts the remaining firms demand curves
  to the right.
• äIncreases the remaining firms profits.

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The Long-Run Equilibrium

• Firms will enter and exit until the firms are
  making exactly zero economic profits.

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Two Characteristics of Long-Run Equilibrium

• As in a monopoly, price exceeds marginal cost.
• ä Profit maximization requires marginal
  revenue to equal marginal cost.
• ä The downward-sloping demand curve makes
  marginal revenue less than price.

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Two Characteristics of Long-Run Equilibrium

• As in a competitive market, price equals average
  total cost.
• ä Free entry and exit drive economic profit to
  zero.

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A Monopolistic Competitor in the Long Run
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A Monopolistic Competitor in the Long Run
Price
0
Quantity
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A Monopolistic Competitor in the Long Run
Price
MC
ATC
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Quantity
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A Monopolistic Competitor in the Long Run
Price
MC
ATC
Demand
MR
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Quantity
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A Monopolistic Competitor in the Long Run
Price
MC
ATC
Demand
MR
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A Monopolistic Competitor in the Long Run
Price
MC
ATC
Demand
MR
0
Quantity
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A Monopolistic Competitor in the Long Run
Price
MC
ATC
Demand
MR
0
Quantity
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A Monopolistic Competitor in the Long Run
Price
MC
ATC
0
Quantity
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A Monopolistic Competitor in the Long Run
Price
MC
ATC
Demand
MR
0
Quantity
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A Monopolistic Competitor in the Long Run
Price
MC
ATC
Demand
MR
0
Quantity
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A Monopolistic Competitor in the Long Run
Price
MC
ATC
Demand
MR
0
Quantity
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A Monopolistic Competitor in the Long Run
Price
MC
ATC
Demand
MR
0
Quantity
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A Monopolistic Competitor in the Long Run
Price
MC
ATC
Demand
MR
0
Quantity
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A Monopolistic Competitor in the Long Run
Price
MC
ATC
Demand
MR
0
Long-run Profit-maximizing quantity
Quantity
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Monopolistic versus Perfect Competition

• There are two noteworthy differences between
  monopolistic and perfect competitionexcess
  capacity and markup.

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Excess Capacity

• There is no excess capacity in perfect
  competition in the long run.

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Excess Capacity

• Free entry results in competitive firms producing
  at the point where average total cost is
  minimized, which is the efficient scale.

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Excess Capacity

• There is excess capacity in monopolistic
  competition in the long run.

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Excess Capacity

• In monopolistic competition, output is less than
  the efficient scale of perfect competition.

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Excess Capacity
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
Quantity
Quantity
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Excess Capacity
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
ATC
MR
Demand
Quantity
Quantity
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Excess Capacity
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
ATC
ATC
P MC
P MR (demand curve)
MR
Demand
Quantity
Quantity
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Excess Capacity
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
ATC
ATC
P
P MC
P MR (demand curve)
MR
Demand
Quantity
Quantity
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Excess Capacity
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
ATC
ATC
P
P MC
P MR (demand curve)
MR
Demand
Quantity
Quantity
Quantity produced
Quantity produced
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Excess Capacity
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
ATC
ATC
P
P MC
P MR (demand curve)
Demand
Quantity
Quantity
Quantity produced
Efficient scale
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Excess Capacity
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
ATC
ATC
P
P MC
P MR (demand curve)
Excess capacity
Demand
Quantity
Quantity
Quantity produced
Efficient scale
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Excess Capacity

• Unlike a competitive firm, a monopolistically
  competitive firm could increase the quantity it
  produces and lower the average total cost of
  production.

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Markup Over Marginal Cost

• For a competitive firm, price equals marginal
  cost.
• For a monopolistically competitive firm, price
  exceeds marginal cost.

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Markup Over Marginal Cost

• Because price exceeds marginal cost, an extra
  unit sold at the posted price means more profit
  for the monopolistically competitive firm.

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Markup Over Marginal Cost
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
ATC
Quantity
Quantity
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Markup Over Marginal Cost
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
ATC
ATC
P MR (demand curve)
MR
Demand
Quantity
Quantity
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Markup Over Marginal Cost
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
ATC
ATC
P
P MC
P MR (demand curve)
MR
Demand
Quantity
Quantity
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Markup Over Marginal Cost
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
ATC
ATC
P
P MC
P MR (demand curve)
MR
Demand
Quantity
Quantity
Quantity produced
Quantity produced
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Markup Over Marginal Cost
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
ATC
ATC
P
P MC
P MR (demand curve)
Marginal cost
MR
Demand
Quantity
Quantity
Quantity produced
Quantity produced
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Markup Over Marginal Cost
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
Markup
ATC
ATC
P
P MC
P MR (demand curve)
Marginal cost
MR
Demand
Quantity
Quantity
Quantity produced
Quantity produced
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Monopolistic Competition and the Welfare of
Society

• Monopolistic competition does not have all the
  desirable properties of perfect competition.

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Monopolistic Competition and the Welfare of
Society

• There is the standard deadweight loss of
  monopolistic competition caused by the markup of
  price over marginal cost.
• However, regulating the pricing of all firms that
  produce differentiated products would be
  impractical.

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Monopolistic Competition and the Welfare of
Society

• The variety of products in the market can be too
  large or too small to be socially efficient. That
  is, there may be too much or too little market
  entry.

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Monopolistic Competition and the Welfare of
Society

• Externalities of entry include product-variety
  externalities and business-stealing
  externalities.
• Because the inefficiencies are subtle, hard to
  measure, and hard to fix, there is no easy way
  public policy can improve the market outcome.

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Quick Quiz!

• List the three key attributes of monopolistic
  competition.

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Quick Quiz!

• Draw and explain a diagram to show the long-run
  equilibrium in a monopolistically competitive
  market.

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Advertising and Brand Names

• Product differentiation leads to advertising and
  brand names.
• Some critics of advertising and brand naming
  contend that they exploit consumers and reduce
  competition.

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Advertising and Brand Names

• Defenders argue that advertising provides
  information and increases competition by offering
  a greater variety of products and prices.

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Advertising and Brand Names

• Firms that sell highly differentiated consumer
  goods typically spend between 10 and 20 percent
  of revenue on advertising.

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Advertising and Brand Names

• Overall, about 2 percent of total revenue, or
  over 100 billion a year, is spent on advertising.

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Conclusion

• Monopolistically competitive markets are
  characterized by many firms each producing a
  differentiated product with freedom of market
  entry and exit.

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Conclusion

• In long-run equilibrium, monopolistically
  competitive markets produce with some excess
  capacity and each firm charges a price above
  marginal cost.

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Conclusion

• The selling price of a monopolistically
  competitive market results in some deadweight
  losses and resource misallocations that
  regulations cannot practically remedy.

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Conclusion

• Product differentiation leads to advertising and
  brand names.

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MONOPOLISTIC COMPETITION

• End of Chapter 17

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Figure 17-1a
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Figure 17-1b
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P ATC
Figure 17-2
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(a) Monopolistically Competitive Firm
(b) Perfectly Competitive Firm
Price
Price
MC
MC
Markup
ATC
ATC
P
P MC
P MR (demand curve)
Excess capacity
Marginal cost
MR
Demand
Quantity
Quantity
Quantity produced Efficient scale
Quantity produced
Efficient scale
Figure 17-3