ECO 3104

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ECO 3104

• Lecture 20

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Price Searchers in the Long Run

• Can distinguish between two types of price
  searching firms
• closed-market price searchers
• new firms cannot enter, even in the long run
• existing firms have greater flexibility in choice
  of inputs, but otherwise long-run is the same as
  the short run

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Price Searchers in the Long Run

• Can distinguish between two types of price
  searching firms
• open-market price searchers
• in the long-run, new firms can enter
• still price searchers if product or location
  differences exist
• economic profit driven to zero

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Open-Market Price Searchers or Monopolistic
Competition

• Characteristics
• many firms
• free entry and exit
• differentiated product

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Open-Market Price Searchers or Monopolistic
Competition

• The amount of monopoly power depends on the
  degree of differentiation.
• Examples of this common market structure include
• Toothpaste
• Soap
• Cold remedies
• Breakfast cereal

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Open-Market Price Searchers or Monopolistic
Competition

• Toothpaste
• Crest and monopoly power
• Procter Gamble is the sole producer of Crest
• Consumers can have a preference for
  Crest---taste, reputation, decay preventing
  efficacy
• The greater the preference (differentiation) the
  higher the price.

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A Monopolistically CompetitiveFirm in the Short
and Long Run
/Q
/Q
Short Run
Long Run
Quantity
Quantity
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A Monopolistically CompetitiveFirm in the Short
and Long Run

• Observations (short-run)
• Downward sloping demand--differentiated product
• Demand is relatively elastic--good substitutes
• MR lt P
• Profits are maximized when MR MC
• This firm is making economic profits

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A Monopolistically CompetitiveFirm in the Short
and Long Run

• Observations (long-run)
• Profits will attract new firms to the industry
  (no barriers to entry)
• The old firms demand will decrease to DLR
• Firms output and price will fall
• Industry output will rise
• No economic profit (P AC)
• P gt MC -- some market power

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Comparison of Price-Taker and Open-Market Price
Searcher Equilibria
Price-Taking Firm
Open-Market Price Searching Firm
/Q
/Q
Quantity
Quantity
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Open-Market Price Searchers or Monopolistic
Competition

• Monopolistic Competition and Economic Efficiency
• market power (due to product heterogeneity)
  yields a higher price than perfect competition.
  If price was lowered to the point where MC D,
  total surplus would increase by the yellow
  triangle
• welfare loss even though profit 0

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Open-Market Price Searchers or Monopolistic
Competition

• Monopolistic Competition and Economic Efficiency
• Although there are no economic profits in the
  long run, the firm is still not producing at
  minimum AC and excess capacity exists
• if number of brands was reduced, output per brand
  would go up, lowering AC
• fewer brands means less consumer choice, so
  apparent excess capacity may simply be the cost
  for product variety

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End of Lecture 20