Transcript Monopolistic Competition Chapter 12

Monopolistic Competition
Chapter 26
Key Questions for this chapter include:
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What are the unique features of monopolistic
competition?
How are the market outcomes affected by this market
structure?
What are the long-run consequences of different market
structures?
Structure
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“many” firms in the industry.
many firms produce similar goods or services but each
maintains some independent control of its own price.
“Many” is somewhere between the “few” of
oligopolies or the “hordes” that characterize perfect
competition.
Low barriers to entry
Low Concentration
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Low concentration ratios are common in
monopolistic competition.
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Concentration Ratio – The proportion of total industry
output produced by the largest firms (usually the four
largest).
Examples of monopolistic competition include banks,
radio stations, health spas, apparel stores, and
convenience stores, fast foods, and shoe stores,
What about cellular industry?
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Market Power
Each producer in monopolistic competition is large
enough to have some market power.
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Market Power – The ability to alter the market price of a
good or service.
A monopolistically competitive firm confronts a
downward-sloping demand curve.
Independent Production Decisions
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The relative independence of monopolist competitors
means that they don’t have to worry about retaliatory
responses to every price or output change.
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Monopolistic competition has distinctive behavior
which involves product differentiation.
Product or Brand Loyalty
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By differentiating their products, monopolistic
competitors establish brand loyalty which gives them
greater control over pricing.
Translated as a “Monopoly” on their own brand…
(Give me some examples)
Brand Loyalty
 Will
compete with other firms but offer substitutes
 makes the demand curve facing the firm less priceelastic.
 implies that consumers shun substitute goods even
when they are cheaper.
 Example: the price differences between computers
which are essentially the same.
Short Run Price and Output
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Production Decision - The production decision is the
selection of the short-run rate of output.
As always, the profit-maximizing rate of output is achieved by
producing the quantity where MR = MC.
New firms enter when there is an economic profit
and leave when there is not.
In the long run, there are no economic profits in
monopolistic competition.
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When firms enter a monopolistically competitive
industry:
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The market supply curve shifts to the right.
The demand curves facing individual firms shift to
the left.
Effect of entry on the monopolistically competitive firm
PRICE (per unit)
Initial market
supply
New entry
Later market
supply
Market
demand
QUANTITY (units per time period)
PRICE (per unit)
Effect of entry on the industry
Reduced
market
share
Initial demand
facing firm
Later demand
facing film
QUANTITY (units per time period)
Equilibrium in Monopolistic Competition
The long run
pa
F
MC
ATC
Demand
K
MR
0
qa
QUANTITY (units per period)
PRICE OR COST
(dollars per unit)
PRICE OR COST
(dollars per unit)
The short run
MC
ATC
pg
G
Initial
demand
Later
demand
0
qg Later MR
QUANTITY(units per period)
• Because of the industry-wide excess capacity in
monopolistic competition, each firm is producing at a rate
of output that is less than its minimum-ATC output rate.
The long run
PRICE OR COST
(dollars per unit)
Note: the less
Efficient production
Of Mono Comp from
Perfect Comp
MC
ATC
pg
G
Initial
demand
Later
demand
0
qg Later MR
QUANTITY(units per period)

Thus, the same level of industry output could be
produced at lower cost with fewer firms.

Monopolistic competition results in both production
inefficiency (above-minimum average cost) and
allocative inefficiency (wrong mix of output).
Remember! Difference between two terms!
PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
Expect New Competitors MC
Price and Costs
ATC
P1
A1
Short-Run
Economic
Profits
D
MR
Q1
Quantity
PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
Expect New Competitors MC
Price and Costs
ATC
New competition drives down the
P
price
level – leading to economic
A
losses in the short run.
1
1
Short-Run
Economic
Profits
D
MR
Q1
Quantity
PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
MC
Price and Costs
ATC
A2
P2
Short-Run
Economic
Losses
D
MR
Q2
Quantity
Price and Costs
PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
Long-Run Equilibrium MC
Normal
Profit
Only
ATC
P3
= A3
D
MR
Q3
Quantity
Advertising Wars
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In truly (perfectly) competitive industries, firms
compete on the basis of price.
Imperfectly competitive firms engage in
nonprice competition with the most prominent
form of nonprice competition being
advertising.
Advertising may be more responsible for brand
loyalty than the taste of the product.
Characteristics
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Differentiated Products
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Product Attributes
Service
Location
Brand Names and Packaging
Some Control Over Price
Easy Entry and Exit
Advertising
Characteristics continued
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Relatively Large Number of Sellers
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Small Market Shares
No Collusion
Independent Action
PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
Expect New Competitors MC
Price and Costs
ATC
P1
A1
Short-Run
Economic
Profits
D
MR
Q1
Quantity
PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
Expect New Competitors MC
Price and Costs
ATC
New competition drives down the
P
price
level – leading to economic
A
losses in the short run.
1
1
Short-Run
Economic
Profits
D
MR
Q1
Quantity
PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
MC
Price and Costs
ATC
A2
P2
Short-Run
Economic
Losses
D
MR
Q2
Quantity
Price and Costs
PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
Long-Run Equilibrium MC
Normal
Profit
Only
ATC
P3
= A3
D
MR
Q3
Quantity
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Graph A shows short-run
profits when there are few
firms in the market
Graph B shows short-run
losses as other companies
see the success and join the
market causing profits to
drop
Graph C shows long-run
equilibrium as the weaker
firms leave the industry