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Monopolistic Competition

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Title: Monopolistic Competition


1
13A
CHAPTER
Monopolistic Competition
2
After studying this chapter you will be able to
  • Define and identify monopolistic competition
  • Explain how output and price are determined in a
    monopolistically competitive industry
  • Explain why advertising costs are high in a
    monopolistically competitive industry

3
PC War Games
  • Globalization brings enormous diversity in
    products and thousands of firms seek to make
    their own product special and different from the
    rest of the pack.
  • Dell, Hewlett-Packard, Lenovo, Acer, and Toshiba
    accounted for one half of the global market of
    60 million PCs in 2006.
  • Firms in these markets are neither price takers
    like those in perfect competition, nor are they
    protected from competition by barriers to entry
    like a monopoly.
  • How do such firms choose the quantity to produce
    and price?

4
What Is Monopolistic Competition?
  • Monopolistic competition is a market with the
    following characteristics
  • A large number of firms.
  • Each firm produces a differentiated product.
  • Firms compete on product quality, price, and
    marketing.
  • Firms are free to enter and exit the industry.

5
What Is Monopolistic Competition?
  • Large Number of Firms
  • The presence of a large number of firms in the
    market implies
  • Each firm has only a small market share and
    therefore has limited market power to influence
    the price of its product.
  • Each firm is sensitive to the average market
    price, but no firm pays attention to the actions
    of the other, and no one firms actions directly
    affect the actions of other firms.
  • Collusion, or conspiring to fix prices, is
    impossible.

6
What Is Monopolistic Competition?
  • Product Differentiation
  • Firms in monopolistic competition practice
    product differentiation, which means that each
    firm makes a product that is slightly different
    from the products of competing firms.

7
What Is Monopolistic Competition?
  • Competing on Quality, Price, and Marketing
  • Product differentiation enables firms to compete
    in three areas quality, price, and marketing.
  • Quality includes design, reliability, and
    service.
  • Because firms produce differentiated products,
    each firm has a downward-sloping demand curve for
    its own product.
  • But there is a tradeoff between price and
    quality.
  • Differentiated products must be marketed using
    advertising and packaging.

8
What Is Monopolistic Competition?
  • Entry and Exit
  • There are no barriers to entry in monopolistic
    competition, so firms cannot earn an economic
    profit in the long run.
  • Examples of Monopolistic Competition
  • Figure 13.1 on the next slide shows market share
    of the largest four firms and the HHI for each of
    ten industries that operate in monopolistic
    competition.

9
What Is Monopolistic Competition?
  • Figure 13.1 shows examples.
  • The 4 largest firms.
  • Next 4 largest firms.
  • Next 12 largest firms.
  • The numbers are the HHI.

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11
Price and Output in Monopolistic Competition
  • The Firms Short-Run Output and Price Decision
  • A firm that has decided the quality of its
    product and its marketing program produces the
    profit-maximizing quantity at which its marginal
    revenue equals its marginal cost (MR MC).
  • Price is set at the highest price the firm can
    charge for the profit-maximizing quantity.
  • The price is determined from the demand curve for
    the firms product.

12
Price and Output in Monopolistic Competition
  • Figure 13.2 shows a short-run equilibrium for a
    firm in monopolistic competition.
  • It operates much like a single-price monopoly.

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14
Price and Output in Monopolistic Competition
  • The firm produces the quantity at which marginal
    revenue equals marginal cost
  • and sells that quantity for the highest possible
    price.
  • It makes an economic profit (as in this example)
    when P gt ATC.

15
Price and Output in Monopolistic Competition
  • Profit Maximizing Might be Loss Minimizing
  • A firm might incur an economic loss in the short
    run.
  • Here is an example.
  • In this case, P lt ATC.

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17
Price and Output in Monopolistic Competition
  • Long Run Zero Economic Profit
  • In the long run, economic profit induces entry.
  • And entry continues as long as firms in the
    industry make an economic profitas long as (P gt
    ATC).
  • In the long run, a firm in monopolistic
    competition maximizes its profit by producing the
    quantity at which its marginal revenue equals its
    marginal cost, MR MC.

18
Price and Output in Monopolistic Competition
  • Figure 13.4 shows a firm in monopolistic
    competition in long-run equilibrium.
  • If firms incur an economic loss, firms exit to
    achieve the long-run equilibrium.

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21
Price and Output in Monopolistic Competition
  • Markup
  • Firms in monopolistic competition operate with
    positive mark up.
  • Again, the downward-sloping demand curve for
    their products drives this result.

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Price and Output in Monopolistic Competition
  • In contrast, firms in perfect competition have no
    excess capacity and no markup.
  • The perfectly elastic demand curve for their
    products drives this result.

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25
Price and Output in Monopolistic Competition
  • Is Monopolistic Competition Efficient
  • Because in monopolistic competition P gt MC,
    marginal benefit exceeds marginal cost.
  • So monopolistic competition seems to be
    inefficient.
  • But the markup of price above marginal cost
    arises from product differentiation.
  • People value variety but variety is costly.
  • Monopolistic competition brings the profitable
    and possibly efficient amount of variety to
    market.

26
Product Development and Marketing
  • Innovation and Product Development
  • Weve looked at a firms profit-maximizing output
    decision in the short run and the long run of a
    given product and with given marketing effort.
  • To keep making an economic profit, a firm in
    monopolistic competition must be in a state of
    continuous product development.
  • New product development allows a firm to gain a
    competitive edge, if only temporarily, before
    competitors imitate the innovation.

27
Product Development and Marketing
  • Advertising
  • Firms in monopolistic competition incur heavy
    advertising expenditures.
  • Figure 13.6 shows estimates of the percentage of
    sale price for different monopolistic competition
    markets.
  • Cleaning supplies and toys top the list at almost
    15 percent.

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30
Product Development and Marketing
  • Advertising costs might lower the average total
    cost by increasing equilibrium output and
    spreading their fixed costs over the larger
    quantity produced.
  • Here, with no advertising, the firm produces 25
    units of output at an average total cost of 60.

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Product Development and Marketing
  • The advertising expenditure shifts the average
    total cost curve upward.
  • With advertising, the firm produces 100 units of
    output at an average total cost of 40.
  • The firm operates at a higher output and lower
    average total cost than it would without
    advertising.

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34
Product Development and Marketing
  • Selling Costs and Demand
  • In Figure 13.8(a), with no advertising, demand is
    not very elastic and the markup is large.
  • In Figure 13.8(b), advertising makes demand more
    elastic, increases the quantity and lowers the
    price and markup.

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36
THE END
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