Transcript Chapter 11: Entry and Monopolistic Competition

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11
Entry and
Monopolistic Competition
Prepared by:
Fernando Quijano and Yvonn Quijano
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
O’Sullivan/Sheffrin
Entry and Monopolistic Competition
• An entrepreneur is a person who has an idea
for a business and coordinates the production
and sale of goods and services.
• Entrepreneurs take risks, committing time and
money to a business without any assurance
that it will be profitable.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Natural Monopoly
• A natural monopoly is a market in which the
entry of a second firm would make price less
than average cost, so a single firm serves the
entire market.
• This is due to a large amount of indivisible inputs.
• When a 2nd firm enters, market output has
increased (supply)
• Therefore market price must decrease (law of
supply)
• BUT with many indivisible inputs, average cost
remains high, and price is now < average cost
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Output and Entry Decisions
Marginal PRINCIPLE
Increase the level of an activity if its marginal
benefit exceeds its marginal cost; reduce the
level of an activity if its marginal cost exceeds
its marginal benefit. If possible, pick the level
at which the activity’s marginal benefit equals
its marginal cost.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Short-Run Equilibrium in Monopolistic
Competition: A Single Toothbrush Producer
• The single toothbrush
producer (a monopolist)
picks point n (where
marginal revenue equals
marginal cost).
• 300 toothbrushes are
supplied per minute at a
price of $2.00 (point m) and
an average cost of $0.90
(point c).
• The profit per brush is
$1.10.
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Economics: Principles and Tools, 3/e
Entry Decreases Price
and Increases Average Cost
• The entry of a second
toothbrush producer
shifts the demand
curve for the original
firm to the left: A
smaller quantity is sold
at each price.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Entry Decreases Price
and Increases Average Cost
• The marginal principle is
satisfied at point x.
• The firm produces a
smaller quantity (200
instead of 300
toothbrushes) at a
higher average cost
($1.00 instead of $0.90)
and sells at a lower
price ($1.85 instead of
$2.00).
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
The Effects of Market Entry
• There are three
reasons why profit
decreases for the
individual firm after
entry of a second
firm:
• Lower price
• Lower quantity sold
• Higher average cost
of production
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Economics: Principles and Tools, 3/e
Monopolistic Competition
• Monopolistic competition is a market served
by dozens of firms selling slightly different
products.
1. Large number of firms: small firms can produce at
the same costs as large firms
2. Each firms sells slightly different products
• Product differentiation is a strategy of distinguishing one
product from other similar products.
3. No artificial barriers to market entry
• e.g. patents
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Monopolistic Competition
Firms may differentiate their product in
several ways:
• Physical characteristics
• Location
• Services
• Aura or image
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Long-Run Equilibrium with Monopolistic
Competition: Toothbrushes
• In a monopolistically
competitive market, new
firms will continue to enter
until economic profit is zero.
• The typical firm picks the
quantity at which its
marginal revenue equals its
marginal cost (point g).
• Economic profit is zero
because the price equals
the average cost (shown by
point h).
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Economics: Principles and Tools, 3/e
Trade-Offs with
Monopolistic Competition
Monopoly
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Monopolistic Competition
Economics: Principles and Tools, 3/e
Practice
• Answer questions 1-5 in your textbook.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e