Transcript Monopolistic Competition

Monopolistic Competition
Hall and Lieberman, 3rd edition,
Thomson South-Western, Chapter 10
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Overview

What you will learn in this lecture
Three fundamental characteristics
 Short run equilibrium
 Long run equilibrium
 Excess capacity
 Non price competition

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Motivation of Imperfect Competition
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Advertising is everywhere in the economy
In perfect competition and monopoly firms
do little, if any, advertising
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Why?
Where, then, is all the advertising coming
from?

We must consider firms that are neither
perfect competitors nor monopolists
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The Concept of Imperfect Competition

Refers to market structures between
perfect competition and monopoly
there is more than one seller, but too
few to create a perfectly competitive
market
 products may not be standardized
 no free entry and exit

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Types of imperfectly competitive
markets
Monopolistic competition
 Oligopoly
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Monopolistic Competition

Hybrid of perfect competition and
monopoly

Three fundamental characteristics
 Many
buyers and sellers
 Sellers offer a differentiated product
 Sellers can easily enter or exit the
market
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Examples
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I. Many Buyers and Sellers
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Under monopolistic competition, an
individual buyer is a price taker

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But an individual seller, in spite of having
many competitors, decides what price to
charge
Assume that no interaction among firms in
market

Each firm only supplies a small part of the
market, that none of them needs to worry
that its actions will be noticed—and reacted
to—by others
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II. Sellers Offer a Differentiated Product
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Each seller produces a somewhat
different product from the others
Faces a downward-sloping
demand curve
In this sense is more like a
monopolist than a perfect
competitor
 When it raises its price a modest
amount, quantity demanded will
decline (but not all the way to zero)

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II. Sellers Offer a Differentiated Product

What makes a product differentiated?
 Quality of product
 Tastes – a subjective matter

Whether their perception is accurate or not
Difference in location
Thus, whenever a firm faces a downwardsloping demand curve, we know buyers
perceive its product as differentiated
 Firm chooses its price

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III. Easy Entry and Exit

This feature is shared by monopolistic
competition and perfect competition
Plays the same role in both
 Ensures firms earn zero economic
profit in long-run
 However, no barrier stops any firm
from copying the successful business
of other firms

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Monopolistic Competition in the Short-Run
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Individual monopolistic competitor
behaves very much like a monopoly
Key difference is the availability of
substitutes

When a monopolistic competitor
raises its price, its customers have
one additional option
 Can
buy similar good from some
other firm
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$
Monopolistically competitive firm making
positive economic profit
MC
P0
ATC
Demand
Q0
MR
Quantity
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Monopolistic Competition in the Long-Run
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Free entry condition

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Continue to occur, and demand curve will
continue to shift leftward
Till the time when each firm earns zero
economic profit
In real world, monopolistic competitors often
earn economic profit or loss in the short-run

But—given enough time—profits attract new
entrants, and losses result in an industry
shakeout, until firms are earning zero
economic profit
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$
Monopolistically competitive firm making
positive economic profit: invites entry, firm
demand shifts inward
MC
P0
ATC
Demand
Q0
MR
Quantity
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$
Monopolistically competitive firm making
positive economic profit: entry continues until
profits are zero
MC
P0
ATC
P1
Demand
Q1
Q0
Quantity
MR
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At equilibrium, P = ATC (zero profit) and
$
MR = MC
MC
ATC
P0
Q0
MR
Quantity
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Features of monopolistically
competitive industries
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Economy is not efficient - excess capacity
 too little output produced to achieve minimum
cost per unit
 costly to consumers
 equilibrium price is above minimum ATC
More firms (varieties) than necessary for least cost
production
Benefits
 Consumers usually benefit from product
differentiation
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Non-price Competition
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Definition: Any action a firm takes to increase
demand for its output—other than cutting its
price
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Example: better service, product guarantees,
free home delivery, more attractive packaging
another reason why monopolistic competitors
earn zero economic profit in long-run
Costly
 Must pay for advertising, for product
guarantees, for better staff training
 Shift each firm’s ATC curve upward
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