Transcript Chapter Seventeen

Chapter 17
Monopolistic Competition
Objectives
1. Recognize imperfect competition among
firms that sell differentiated products.
2. Understand the equalibrium characteristics
of monopolistic competition.
3. Be able to evaluate the outcomes of
monopolistically competitive market.
4. Understand the issues surrounding the
effects of advertising.
5. Understand the debate over the role
of brand names
The Spectrum of Market Structure
Pure
Competition
Pure
Monopoly
Chapter 14
Chapter 15
Imperfect
Competition
Chapters 16 & 17
Imperfect Competition
Two types of imperfectly competitive
markets:
Monopolistic Competition
Many firms selling products that are similar but
not identical (e.g. movies.)
Oligopoly
Only a few sellers, each offering a similar or
identical product to the others (e.g. tennis
balls.)
Monopolistic Competition
Markets
that have some features of
competition and some features of
monopoly.
Attributes of Monopolistic Competition
 Many Sellers
 Product Differentiation
 Free Entry/Exit
Monopolistic Competition

1.
2.
3.
4.
Monopolistic Competition is a market
structure characterized by
Many sellers
Highly differentiated product
Some control over price (pricemaker)
Easy entrance and exit from the
market
Attribute: Many Sellers
Many
firms competing
for the same group of
customers.
Examples:
– books, CDs, movies,
computer games,
restaurants, piano
lessons, cookies,
furniture, etc.
Attribute: Product Differentiation
Alternative
forms of differentiation:
– quality differences; additional service;
location; and packaging.
– Toys or prizes with kid’s meals at fast-food restaurants.
Results
in firm facing a downwardsloping demand curve.
– Demand curve is highly, but not perfectly,
elastic.
Attribute: 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.
Monopolistic Competition...
A
market structure between perfectly
competitive and monopolistic.
Departs from the perfectly competitive
because each seller offers a somewhat
different product.
Departs from a monopoly because
there are many sellers, each of which
is small compared to the market.
Short-Run Operation in
Monopolistic Competition
In
the short-run, the monopolistically
competitive firm:
– Follows a monopolist’s rule for profitmaximization.
MR = MC
Price > ATC
Price < ATC
– Figure 17-1
Monopolistically Competitors in the
Short-Run
Price
MC
ATC
P
ATC
Demand
MR
Q Profit Max.
Quantity
Monopolistically Competitors in the
Short-Run
Price
MC
ATC
P
P>ATC
ATC
Firm Makes
Profit
Demand
MR
Q Profit Max.
Quantity
Monopolistically Competitors in the
Short-Run
Price
MC
ATC
ATC
P
Demand
MR
Q Loss Min.
Quantity
Monopolistically Competitors in the
Short-Run
Price
MC
ATC
ATC
P
P<ATC
Firm Makes
Losses
Demand
MR
Q Loss Min.
Quantity
Long-Run Operation in
Monopolistic Competition
If
firms are making economic profits in
the short-run, new firms are
encouraged to enter the market.
 Results in the following:
– Increases the number of products offered
– Reduces demand faced by each firm
– Demand curves shift to the left, leading to
– More elastic demand.
Long-Run Operation in
Monopolistic Competition
Firms
will enter and exit until the firms
are making exactly zero economic
profits.
Two characteristics of monopolistic
competition in the long-run:
–Price exceeds marginal cost
–Price equals average total cost
– Figure 17-2
Price
A Monopolistic Competitor
in the Long-Run
MC
ATC
P=ATC
D
MR
Q Profit Max.
Quantity
Monopolistic Competition vs.
Perfect Competition
Two
differences arise in the long-run
between monopolistic competition
and perfect competition:
–Excess Capacity
–Markup
Monopolistic Competition:
Excess Capacity
In
perfect competition, firms produce
at the efficient scale, i.e. the point
where average total cost is minimized.
Free entry in competitive markets drive
firms to produce at the minimum of
average total cost.
Figure 17-3
The Competitive Firm’s Output in the
Long-Run
Price
MC
ATC
P=MR=AR
P=MC
QEfficient Scale
Quantity
Monopolistic Competition:
Excess Capacity
In
monopolistic competition, the
quantity of output is less than the
“efficient scale” of perfect competition.
A monopolistically competitive firm
could increase the quantity it produces
and lower the average total cost of
production.
Monopolistically Competitive Output in
the Long-Run
Price
MC
ATC
P
MC
Demand
MR
QProduced
Quantity
Monopolistically Efficient Output in the
Long-Run
Price
MC
ATC
P
MC
Demand
MR
Q
Q Efficient Scale
Quantity
Monopolistically Efficient Output in the
Long-Run
Price
MC
ATC
P
Excess
Capacity
MC
Demand
MR
Q
Q Efficient Scale
Quantity
Monopolistic Competition:
Mark Up Over Marginal Cost
For
a competitive firm, price equals
marginal cost.
For a monopolistically competitive
firm, price exceeds marginal cost.
Because price exceeds marginal cost,
an extra unit sold at the posted price
means more profit for the
monopolistic competitive firm.
Monopolistically Competitive Output in
the Long-Run
Price
MC
ATC
P
Mark-Up
MC
Demand
MR
Q
Q Efficient Scale
Quantity
Monopolistic Competition and the
Welfare of Society
Inefficiencies may arise and include:
The markup price over marginal cost
– Some consumers who value the good at more
than the marginal cost of production will be
deterred from buying it.
– Results in “deadweight loss” to society.
Monopolistic Competition
and the Welfare of Society
 There
is the normal deadweight loss
of monopoly pricing in monopolistic
competition 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.
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.
Monopolistic Competition and the
Welfare of Society
The number of firms in the market
may not be the “ideal” one.
– There may be too much or too little entry.
May lead to “externalities” of entry.
– Externalities of Entry:
Product-Variety
externality
Business-Stealing externality
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 on
consumers.
Monopolistic Competition
and the Welfare of Society
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 on existing
firms.
Quick Quiz!
List
the three key
attributes of
monopolistic
competition.
Draw and explain a
diagram to show the
long-run equilibrium in a
monopolistically
competitive market.
Monopolistic Competition: Advertising
and Brand Names
Product
differentiation leads to
advertising and brand names.
Some
critics of monopolistic
competition contend that advertising
and brand name exploit consumers
and reduce competition.
Defenders
argue that advertising
increases competition by offering a
greater variety of products and prices.
Monopolistic Competition: Advertising
Firms
that sell highly differentiated
consumer goods typically spend
between 10 and 20 percent of revenue
for advertising.
As a whole (total economy) about 2
percent of total firm revenue, or over
$100 billion a year is spent on
advertising.
Advertising
 Critics
of advertising argue that firms
advertise in order to manipulate
people’s tastes.
 They also argue that it impedes
competition by implying that products
are more different than they truly are.
Advertising
 Defenders
argue that advertising
provides information to consumers
 They also argue that advertising
increases competition by offering a
greater variety of products and prices.
 The willingness of a firm to spend
advertising dollars can be a signal to
consumers about the quality of the
product being offered.
Monopolistic Competition: Advertising
and Brand Names
Brand
Names may provide two
benefits to consumers:
– Provide consumers information about quality
when quality cannot be easily judged in
advance of purchase.
– Give firms an incentive to maintain high quality.
Brand Names
Critics
argue that brand names
cause consumers to perceive
differences that do not really exist.
Summary
Monopolistically
competitive markets
are characterized by many firms each
producing a differentiated product
with freedom of market entry.
In
equilibrium, monopolistically
competitive markets produce with
some excess capacity and each firm
charges a price above marginal cost.
Summary
The
selling price of a monopolistic
competitive market results in some
deadweight losses and resource
misallocation.
Product
differentiation leads to
advertising and brand names.
Summary
A
monopolistically competitive
market is characterized by three
attributes: many firms, differentiated
products, and free entry.
 The equilibrium in a monopolistically
competitive market differs from
perfect competition in that each firm
has excess capacity and each firm
charges a price above marginal cost.
Summary
 Monopolistic
competition does not
have all of the desirable properties
of perfect competition.
 There is a standard deadweight
loss of monopoly caused by the
markup of price over marginal cost.
 The number of firms can be too
large or too small.
Summary
 The
product differentiation
inherent in monopolistic
competition leads to the use of
advertising and brand names.
 Critics
of advertising and brand
names argue that firms use them to
take advantage of consumer
irrationality and to reduce
competition.
Summary
 Defenders
argue that firms use
advertising and brand names to
inform consumers and to
compete more vigorously on
price and product quality.