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PowerPoint Lectures for Principles of
Microeconomics, 9e By Karl E. Case, Ray C. Fair
Sharon M. Oster

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(No Transcript)
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Monopolistic Competition
PART III MARKET IMPERFECTIONS AND THE ROLE OF
GOVERNMENT
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Prepared by
Fernando Yvonn Quijano
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MonopolisticCompetition
PART III MARKET IMPERFECTIONS AND THE ROLE OF
GOVERNMENT
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CHAPTER OUTLINE
Industry Characteristics Product Differentiation
and Advertising How Many Varieties? How Do Firms
Differentiate Products? Advertising Price and
Output Determination in Monopolistic
Competition Product Differentiation and Demand
Elasticity Price/Output Determination in the
Short Run Price/Output Determination in the Long
Run Economic Efficiency and Resource Allocation
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Monopolistic Competition
? FIGURE 13.2 Characteristics of Different
Market Organizations
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Industry Characteristics
monopolistic competition A common form of
industry (market) structure in the United States,
characterized by a large number of firms, no
barriers to entry, and product differentiation.
TABLE 15.1 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 2002 TABLE 15.1 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 2002 TABLE 15.1 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 2002 TABLE 15.1 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 2002 TABLE 15.1 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 2002 TABLE 15.1 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 2002 TABLE 15.1 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 2002 TABLE 15.1 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 2002 TABLE 15.1 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 2002 TABLE 15.1 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 2002

Industry Designation Four LargestFirms Four LargestFirms Four LargestFirms Eight Largest Firms Eight Largest Firms Twenty Largest Firms Twenty Largest Firms Number ofFirms Number ofFirms
Travel trailers and campers 38 38 45 58 733
Games, toys 39 39 48 63 732
Wood office furniture 34 34 43 56 546
Book printing 33 33 54 68 560
Curtains and draperies 17 17 25 38 1,778
Fresh or frozen seafood 14 14 24 48 529
Womens dresses 18 18 23 48 528
Miscellaneous plastic products 6 6 10 18 6,775

Source U.S. Department of Commerce, Bureau of the Census, 1997 Census of Manufacturers, Concentration Ratios in Manufacturing. Subject Series EC92m315, June, 2001. Source U.S. Department of Commerce, Bureau of the Census, 1997 Census of Manufacturers, Concentration Ratios in Manufacturing. Subject Series EC92m315, June, 2001. Source U.S. Department of Commerce, Bureau of the Census, 1997 Census of Manufacturers, Concentration Ratios in Manufacturing. Subject Series EC92m315, June, 2001. Source U.S. Department of Commerce, Bureau of the Census, 1997 Census of Manufacturers, Concentration Ratios in Manufacturing. Subject Series EC92m315, June, 2001. Source U.S. Department of Commerce, Bureau of the Census, 1997 Census of Manufacturers, Concentration Ratios in Manufacturing. Subject Series EC92m315, June, 2001. Source U.S. Department of Commerce, Bureau of the Census, 1997 Census of Manufacturers, Concentration Ratios in Manufacturing. Subject Series EC92m315, June, 2001. Source U.S. Department of Commerce, Bureau of the Census, 1997 Census of Manufacturers, Concentration Ratios in Manufacturing. Subject Series EC92m315, June, 2001. Source U.S. Department of Commerce, Bureau of the Census, 1997 Census of Manufacturers, Concentration Ratios in Manufacturing. Subject Series EC92m315, June, 2001. Source U.S. Department of Commerce, Bureau of the Census, 1997 Census of Manufacturers, Concentration Ratios in Manufacturing. Subject Series EC92m315, June, 2001. Source U.S. Department of Commerce, Bureau of the Census, 1997 Census of Manufacturers, Concentration Ratios in Manufacturing. Subject Series EC92m315, June, 2001.
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Product Differentiation and Advertising
How Many Varieties?
product differentiation A strategy that firms
use to achieve market power. Accomplished by
producing products that have distinct positive
identities in consumers minds.
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Product Differentiation and Advertising
How Do Firms Differentiate Products?
horizontal differentiation Products differ in
ways that make them better for some people and
worse for others.
behavioral economics A branch of economics that
uses the insights of psychology and economics to
investigate decision making.
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Product Differentiation and Advertising
How Do Firms Differentiate Products?
commitment device Actions that individuals take
in one period to try to control their behavior in
a future period.
vertical differentiation A product difference
that, from everyones perspective, makes a
product better than rival products.
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An Economist Makes Tea
Product Differentiation and Advertising
How Do Firms Differentiate Products?
Bottled iced tea is a classic example of a
monopolistically competitive market. None of the
brands are exactly alike. Nor are the teas priced
the same.
Goldman and Nalebuff discovered that sugar beyond
some point adds little taste, yet comes at a
health costmore calories. Given consumers new
awareness of healthy and natural foods, Honest
Tea became an overnight success.
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Product Differentiation and Advertising
Advertising
TABLE 15.2 Total Advertising Expenditures in 2006 TABLE 15.2 Total Advertising Expenditures in 2006 TABLE 15.2 Total Advertising Expenditures in 2006
Billions of Dollars Billions of Dollars
Newspapers 49.0
Television 66.8
Direct mail 59.6
Yellow pages 14.4
Internet 15.0
Radio 19.1
Magazines 24.0
Total 247.9
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Product Differentiation and Advertising
Advertising
TABLE 15.3 Domestic Advertising Spending by Category in 2006 in Billions of Dollars TABLE 15.3 Domestic Advertising Spending by Category in 2006 in Billions of Dollars TABLE 15.3 Domestic Advertising Spending by Category in 2006 in Billions of Dollars TABLE 15.3 Domestic Advertising Spending by Category in 2006 in Billions of Dollars TABLE 15.3 Domestic Advertising Spending by Category in 2006 in Billions of Dollars
Rank Rank Category 2006 2006
1 Automotive Automotive 19.8
2 Retail Retail 19.1
3 Telecommunications Telecommunications 11.0
4 Medicine remedies Medicine remedies 9.2
5 General services General services 8.7
6 Financial services Financial services 8.7
7 Food, beverages, candy Food, beverages, candy 7.2
8 Personal care Personal care 5.7
9 Airlines, hotels, car rental, travel Airlines, hotels, car rental, travel 5.4
10 Movies, recorded video, music Movies, recorded video, music 5.4
11 Restaurants Restaurants 5.3
12 Media Media 5.1
13 Government, politics, religion Government, politics, religion 3.5
14 Insurance Insurance 3.5
15 Real estate Real estate 3.1
16 Apparel Apparel 2.9
17 Computers, software Computers, software 2.5
18 Home furnishings Home furnishings 2.2
19 Beer, wine, liquor Beer, wine, liquor 2.1
20 Education Education 1.9
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Product Differentiation and Advertising
Advertising
The Case for Advertising
The advocates of spirited competition believe
that differentiated products and advertising give
the market system its vitality and are the basis
of its power. They are the only ways to begin to
satisfy the enormous range of tastes and
preferences in a modern economy. Product
differentiation also helps to ensure high quality
and efficient production, and advertising
provides consumers with the valuable information
on product availability, quality, and price that
they need to make efficient choices in the
marketplace.
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Product Differentiation and Advertising
Advertising
The Case Against Product Differentiation and
Advertising
The bottom line, critics of product
differentiation and advertising argue, is waste
and inefficiency. Enormous sums are spent to
create minute, meaningless, and possibly
nonexistent differences among products.
Advertising raises the cost of products and
frequently contains very little information.
Often, it is merely an annoyance. Product
differentiation and advertising have turned the
system upside down People exist to satisfy the
needs of the economy, not vice versa.
Advertising can lead to unproductive warfare and
may serve as a barrier to entry, thus reducing
real competition.
Open Questions
There are strong arguments on both sides of the
advertising debate, and even the empirical
evidence yields to conflicting conclusions.
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Can Information Reduce Obesity?
Product Differentiation and Advertising
Advertising
Policy makers have been working to increase the
level of information that consumers have about
products. In the early 1990s, the Food and Drug
Administration passed rules requiring most
processed foods sold in grocery stores to carry
nutrition labels. The current hot topic in the
labeling area involves restaurant meals. With
growing obesity in the United States, many policy
makers think that one way to fight the problem is
to require calorie and fat labeling in
restaurants.
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Price and Output Determination in Monopolistic
Competition
Product Differentiation and Demand Elasticity
? FIGURE 15.2 Product Differentiation Reduces
the Elasticity of Demand Facing a Firm
The demand curve that a monopolistic competitor
faces is likely to be less elastic than the
demand curve that a perfectly competitive firm
faces. Demand is more elastic than the demand
curve that a monopolist faces because close
substitutes for the products of a monopolistic
competitor are available.
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Price and Output Determination in Monopolistic
Competition
Price/Output Determination in the Short Run
? FIGURE 15.3 Monopolistic Competition in the
Short Run
In the short run, a monopolistically competitive
firm will produce up to the point MR MC. At q0
2,000 in panel a, the firm is earning short-run
profits equal to P0ABC 2,000. In panel b,
another monopolistically competitive firm with a
similar cost structure is shown facing a weaker
demand and suffering short-run losses at q1
1,000, equal to CABP1 1,000.
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Price and Output Determination in Monopolistic
Competition
Price/Output Determination in the Long Run
? FIGURE 15.4 Monopolistically Competitive Firm
at Long-Run Equilibrium
As new firms enter a monopolistically competitive
industry in search of profits, the demand curves
of profit-making existing firms begin to shift to
the left, pushing marginal revenue with them as
consumers switch to the new close substitutes.
This process continues until profits are
eliminated, which occurs for a firm when its
demand curve is just tangent to its average total
cost curve.
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Economic Efficiency and Resource Allocation
Because entry is easy and economic profits are
eliminated in the long run, we might conclude
that the result of monopolistic competition is
efficient. There are two problems,
however. First, once a firm achieves any degree
of market power by differentiating its product
(as is the case in monopolistic competition), its
profit-maximizing strategy is to hold down
production and charge a price above marginal
cost. Second, the final equilibrium in a
monopolistically competitive firm is necessarily
to the left of the low point on its average total
cost curve.
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REVIEW TERMS AND CONCEPTS

• monopolistic competition
• product differentiation
• vertical differentiation

behavioral economics commitment device horizontal
differentiation