Market Structures: Monopolistic Competition

1
Market Structures Monopolistic Competition
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Imperfect Competition

• The spectrum of competition
• Perfect Comp. -------------? Monopoly
• Monop. Comp.-- Oligopoly
• Assumptions underlying Monopolistic Competition
• Differentiated products
• Differentiated products leads to some market
  power over price or a downward slping demand
  curve
• Many buyers and sellers
• Free entry and exit
• Perfect knowledge

3
Short-run Vs. Long-run Supply Decisions

• In the short-run, the firm is able to set prices
  like a monopolistic. PgtMR so MRMC implies that
  PgtMC. A firm can make profits, breakeven or make
  losses.
• In the long-run, free entry and exit will
  eliminate economic profits or losses.
• In either case, the monopolistically competitive
  firm produces a level of output where LRAC are
  greater than LRAC minimum or the efficient scale
  and sets price above MC.

4
Monopoly Competition and Economic Welfare

• Compared to competitive markets, monopolistic
  competition results in an output level where
  there is
• Excess capacity LRAC gtLRAC min
• PgtMC - or MBgtMC
• So, Deadweight Welfare Loss exists
• Welfare loss is due to product differentiation
• If differentiation is real, the welfare is small
• If differentiation is the result of advertising
  which does not contribute anything to consumer
  satisfaction, it represents welfare loss

5
Advertising

• Advertising is costly, the question is - does it
  add anything of value to the consumer?
• informative advertising which contributes to
  competition
• Advertising aimed at creating perceived
  differences or brand loyalty
• Breakfast cereals and kids versus supermarket ads
• Advertising and the prisoners dilemma
  self-canceling ads.