Transcript Document

Monopolistic Competition
Topic 7(a)
Contents
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2.
3.
4.
5.
Characteristics of MC
Short run profit maximisation
Long run equilibrium
Assessment of MC
Product differentiation and Advertising
Characteristics of MC
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Large number of small firms
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Differentiated products
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so individual decisions have little or no
impact on other firms’ decisions
similar but not identical
Low barriers to entry
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low economies of scale
low set-up costs
Price and Output Determination
The Firm’s Demand Curve in MC is:
 Highly elastic, Why?
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More close substitutes than a pure monopolist
Not perfect substitutes (as is the case with
perfect competition)
Elasticity depends on
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number of rivals
degree of product differentiation
Short-Run Price and Output
Determination
Rules for Profit maximization same as
under Perfect Competition
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MR = MC (where MC cuts MR from below)
Short Run: P ≥ AVC
Long Run : P ≥ ATC
Short-Run Price and Output
Determination: Short-Run Profits
Price and Costs
P
MC
Economic
Profits
AC
D
MR
Q
Q
Short-Run Price and Output
Determination: Short-Run Losses
MC
Price and Costs
P
ATC
Losses
D
MR
Q
Q
Long Run
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How much to produce?
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MR = MC
Firms tend to break even, i.e. normal
profit
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Tangency solution: profit-maximising firm will
produce an output when its demand curve is
at a tangent to its ATC curve
When ATC = Price
Long run Equilibrium
Long-Run Equilibrium
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Why do monopolistically competitive firms
tend to break even in the long run?
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Profits attract new entrants
Losses encourage exits
Some complications
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Some product differentiation
Some entry is partially restricted
Some economic losses may be tolerated by
firms in the long run
Assessment of MC (vs. PC)
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Higher price, lower
output
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P > MC
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No allocative eff.
P = AC
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lower consumer
surplus
like monopoly
like PC but
P ≠ min AC
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No productive eff.
Monopolistic Competition &
Economic Efficiency
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Productive inefficiency: Minimum ATC
is not necessarily chosen
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Allocative inefficiency:
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excess capacity
price does not necessarily equal MC
Good feature
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product variety
Non-price Competition
(ie. competition not based on price)
Product differentiation:
Real and/or perceived differences created by factors such as:
quality, brands, service, location, advertising and packaging
Advantages
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More choice
Innovation => Better products
Avoid price war
Disadvantages
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Too much choice?
Superficial product changes – waste of resources
Non-price Competition Advertising
Firm
Advantages of Advertising
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influences consumer preferences (the power of
persuasion)
makes demand more price inelastic
Increases market power, market share
Disadvantages of Advertising
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Increases cost of production
Non-price Competition –
Advertising (cont.)
Society
Advantages of Advertising
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Provides information
Promotes competition
Advertising revenue – cheaper media (television,
newspapers etc) for users
Disadvantages of Advertising
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Misleading or false information
Waste of resources if overall market demand stays
constant
Creates barriers to entry (financial, brand loyalty)
Media bias towards advertisers