Transcript Monopolistic Competition

Monopolistic Competition: Outline
What is monopolistic competition?
Characteristics of monopolistic competition
Equilibrium in SR and the LR
Implications of Monopolistic Competition
for social welfare
Advertisement and brand names- do they
have any social value?
Monopolistic Competition
Monopolistic Competition is a market
structure in which many firms sell products
that are similar but not identical
Characteristics of Monopolistic Competition
Many sellers
Product differentiation (down-ward sloping
demand curve)
Free entry
Monopolistic Competition in the SR
and LR
Monopolistically Competitive firm in the
short run follows the monopolist’s rule for
profit maximization and produces the
quantity that maximizes its profits
In the LR, when existing firms are making a
profit:
New firms have an incentive to enter
Existing firms experience a downward shift in
their demand curve
Monopolistic Competition in the LR
In the LR, when existing firms are making a
loss:
Existing firms have an incentive to exit
The remaining firms experience an upward shift
in their demand curve
Process of entry and exit continue up to the
point until all the firms in the market are
making zero economic profit. This is the
market equilibrium
Monopolistic Competition in the LR
Graphically, the market equilibrium occurs at
the point where the firm’s demand curve is
tangent to its ATC curve (Recall: Profit=
Price-ATC)
Characteristics of LR equilibrium:
Similar to monopoly, monopolistic competitive
market has price exceeding MC
Similar to a competitive market, monopolistic
competitive market has P=ATC and therefore
has zero economic profit
Monopolistic Competition VS Perfect
Competition in the LR
Equilibrium in the Monopolistic competition
in the LR differs from equilibrium in perfect
competition in the LR on two accounts:
Excess capacity
Markup over MC
Monopolistic Competition and Welfare
Sources of inefficiency:
Markup of price over MC resulting in a
deadweight loss
Public policy cannot lower prices since
monopolistic competitors are already making zero
economic profit (or a subsidy would be required)
Monopolistic Competition and Welfare
Sources of inefficiency:
Entry and exit may not ensure that the ideal
number of firms exist in the market
The presence of ideal number is difficult to
ensure because of the externalities associated with
the entry of a new firm
Product variety externality- positive for consumers
Business stealing externality- negative for existing firms
Monopolistic Competition and
Advertising
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Critique
Defense: information, promotes competition
Advertisement is a sign of quality
Brand names
Critique
Defense