Transcript Monopolistic Competition

Monopolistic
Competition &
Advertising
Copyright©2004 South-Western
Mods
67-68
Imperfect Competition
• Imperfect competition refers to those market
structures that fall between perfect competition
and pure monopoly—monopolistic competition
and oligopoly.
Copyright © 2004 South-Western
One Type of an Imperfectly
Competitive Market
• Monopolistic Competition
• Markets that have some features of
competition and some features of
monopoly.
• Attributes of Monopolistic Competition
•
•
•
•
•
Many sellers
Differentiated (similar but different)
Relatively Easy entry and exit
Some amount of Price-setting power
Considerable non-price competition (Advertising)
Copyright © 2004 South-Western
Monopolistic Competition
• Many Sellers
• There are many firms competing for the same group
of customers.
• Product examples include books, CDs, movies, computer
games, restaurants, piano lessons, cookies, furniture, etc.
Copyright © 2004 South-Western
Monopolistic Competition
• Product Differentiation
• Each firm produces a product that is at least slightly
different from those of other firms.
• This makes their product, however slightly unique,
a market of 1—so there is no larger market graph
• Therefore, like a monopoly, they are the market for
their good, so each firm faces a downward-sloping
demand curve.
Copyright © 2004 South-Western
Monopolistic Competition
• Free Entry or Exit
• Firms can enter or exit the market without
restriction.
• The number of firms in the market adjusts until
economic profits are zero.
Copyright © 2004 South-Western
Monopolistic Competition—
the “bare bones” graph
Price
MC
Price
Demand
MR
0
Profitmaximizing
quantity
Quantity
Copyright
© 2004 South-Western
Copyright©2003
Southwestern/Thomson Learning
Monopolistic Competition in the Short Run—Profit scenario
Firm Makes Profit
Price
MC
ATC
Price
Average
total cost
Demand
Profit
MR
0
Profitmaximizing
quantity
Quantity
Copyright©2003 Southwestern/Thomson Learning
MC Firm earning Profits—what
happens?
• Short-run economic profits encourage new
firms to enter the market. This:
•
•
•
•
Increases the number of products offered.
Reduces demand faced by firms already in the market.
Incumbent firms’ demand curves shift to the left.
Demand for the incumbent firms’ products fall, and their
profits decline.
Copyright © 2004 South-Western
Monopolistic Competitors in the Short Run—Loss Scenario
Firm Makes Losses
Price
MC
ATC
Losses
Average
total cost
Price
MR
0
Lossminimizing
quantity
Demand
Quantity
Copyright©2003 Southwestern/Thomson Learning
MC Firm earning Losses—
What Happens?
• Short-run economic losses encourage firms to
exit the market. This:
•
•
•
•
Decreases the number of products offered.
Increases demand faced by the remaining firms.
Shifts the remaining firms’ demand curves to the right.
Increases the remaining firms’ profits.
Copyright © 2004 South-Western
A Monopolistic Competitor in the Long Run
Price
MC
ATC
P = ATC
Demand
MR
0
Profit-maximizing
quantity
Quantity
Copyright©2003 Southwestern/Thomson Learning
The Long-Run Equilibrium
• Firms will enter and exit until the firms are
making exactly zero economic profits.
• As in a competitive market, in the long run,
price equals average total cost.
Copyright © 2004 South-Western
Monopolistic versus Perfect Competition—
Long Run Equilibrium
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
ATC
ATC
P
P = MC
P = MR
(demand
curve)
Marginal
cost
MR
0
Quantity
produced
Demand
Quantity
0
Quantity produced
Quantity
Copyright©2003 Southwestern/Thomson Learning
Monopolistic versus Perfect Competition
• There are two noteworthy differences between
monopolistic and perfect competition—excess
capacity and markup.
Copyright © 2004 South-Western
Monopolistic versus Perfect Competition
• Excess Capacity
• For PC firms, free entry in response to market
conditions produces a LR Equilibrium that has the
firm producing where MR=MC=ATC. This is the
efficient scale for the firm.
• For MC firms, LR Equilibrium has firm producing
where DARP =ATC, but this is not at ATC’s lowest
point, so output is less than the efficient scale of
perfect competition.
Copyright © 2004 South-Western
Monopolistic versus Perfect Competition
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
ATC
ATC
P
P = MC
MR
0
Quantity
produced
Efficient
scale
P = MR
(demand
curve)
Demand
Quantity
0
Quantity produced =
Efficient scale
Quantity
Excess capacity
Copyright©2003 Southwestern/Thomson Learning
Monopolistic versus Perfect Competition
• Markup Over Marginal Cost
• For a PC firm, price equals marginal cost.
• For an MC firm, price exceeds marginal cost.
• Because price exceeds marginal cost, an extra unit
sold at the posted price means more profit for the
monopolistically competitive firm.
• This is just like monopoly, but because Monopoly
firms are true “one-of-a-kind” products, they will
always “markup” to the DARP curve.
• Due to competition, MC firms may vary their
markup
Copyright © 2004 South-Western
Monopolistic versus Perfect Competition
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
ATC
ATC
Markup
P
P = MC
P = MR
(demand
curve)
Marginal
cost
MR
0
Quantity
produced
Demand
Quantity
0
Quantity produced
Quantity
Copyright
© 2004 South-Western
Copyright©2003
Southwestern/Thomson Learning
Monopolistic versus Perfect Competition
Monopolistically Competitive Firm
Perfectly Competitive Firm
Price
Price
MC
MC
ATC
ATC
Markup
P
P = MC
P = MR
(demand
curve)
Marginal
cost
MR
0
Quantity
produced
Efficient
scale
Demand
Quantity
0
Quantity produced =
Efficient scale
Quantity
Excess capacity
Copyright©2003 Southwestern/Thomson Learning
Monopolistic Competition and the Welfare of Society
• Monopolistic competition does not have all the
desirable properties of perfect competition.
Copyright © 2004 South-Western
Monopolistic Competition and the Welfare of Society
• Deadweight loss
• Just like monopoly pricing, MC’s have deadweight
loss caused by the markup of price over marginal
cost.
• However, the administrative burden of
regulating the pricing of all firms that produce
differentiated products would be overwhelming.
• We see this DW loss as the “cost of variety”
Copyright © 2004 South-Western
Monopolistic Competition and the Welfare of Society
• Another way in which monopolistic
competition may be socially inefficient is that
the number of firms in the market may not be
the “ideal” one. There may be too much or too
little entry.
Copyright © 2004 South-Western
Monopolistic Competition and the Welfare of Society
• Externalities(side effects) of entry include:
• product-variety externalities.
• business-stealing externalities.
Copyright © 2004 South-Western
Monopolistic Competition and the Welfare of Society
• The product-variety externality:
• Because consumers get some consumer surplus
from the introduction of a new product, entry of a
new firm conveys a positive externality (or side
effect) on consumers.
• The business-stealing externality:
• Because other firms lose customers and profits from
the entry of a new competitor, entry of a new firm
imposes a negative externality (or side effect) on
existing firms.
Copyright © 2004 South-Western
ADVERTISING
(Non-Price Competition)
• When firms sell differentiated products and
charge prices above marginal cost, each firm
has an incentive to advertise in order to attract
more buyers to its particular product.
Copyright © 2004 South-Western
Product Differentiation
Product differentiation
is the attempt by firms to
convince buyers that
their products are
different from those of
other firms in the
industry.
Copyright © 2004 South-Western
Product Differentiation
Ways to Differentiate:
•REAL physical
appearance/qualities
•Location
•Services
•Perceived Differences
Copyright © 2004 South-Western
ADVERTISING
• Firms that sell highly differentiated consumer
goods typically spend between 10 and 20
percent of revenue on advertising.
• In 2014, about $.5 Trillion spent on advertising
Copyright © 2004 South-Western
ADVERTISING
• The Critique of Advertising:
• Firms advertise in order to manipulate people’s
tastes.
• Advertising impedes competition by implying that
products are more different than they truly are.
• Brand names also cause consumers to perceive
differences between products that don’t really exist.
Copyright © 2004 South-Western
ADVERTISING
• The Defense of Advertising:
• Advertising provides information to consumers
• Advertising increases competition by offering a
greater variety of products and prices.
• Advertising dollars can be a signal to consumers
about the quality of the product being offered.
• Brand names may be a useful way for consumers to
ensure that the goods they are buying are of high
quality by
• providing information about quality.
• giving firms incentive to maintain high quality.
Copyright © 2004 South-Western