Transcript LN25Miller950022_17_LN25

Chapter 25
Monopolistic
Competition
Introduction
John Locke is the author of crime-adventure e-books
selling for 99 cents at Amazon’s website. When he saw
that successful authors were charging $9.99 for their ebooks, he expressed a confidence that he would have
customers who feel that the other books are not
necessarily ten times better than his.
E-books are an example of a product that exhibits
product differentiation, a fundamental characteristic of
monopolistic competition. In this chapter, you will learn
why the growing importance of e-books has complicated
the process of selling both e-books and physical books.
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Learning Objectives
• Discuss the key characteristics of a
monopolistically competitive industry
• Contrast the output and pricing decisions of
monopolistically competitive firms with those of
perfectly competitive firms
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Learning Objectives (cont'd)
• Explain why brand names and advertising are
important features of monopolistically competitive
industries
• Describe the fundamental properties of information
products and evaluate how the prices of these
products are determined under monopolistic
competition
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Chapter Outline
• Monopolistic Competition
• Price and Output for the Monopolistic
Competitor
• Comparing Perfect Competition with
Monopolistic Competition
• Brand Names and Advertising
• Information Products and Monopolistic
Competition
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Did You Know That …
• A company called J & D Foods offers baconflavored and turkey-and-gravy-flavored soft
drinks?
• And you can buy bottled water in flavors of Buffalo
wings, cheeseburger, and fish and chips?
• Product heterogeneity, variations in product
characteristics, and advertising did not show up in
our analysis of perfect competition.
• These are features of monopolistic competition—
the subject of this chapter.
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Monopolistic Competition
• In the 1920s and 1930s, economists were
aware of industries that did not fit under
perfect competition or pure monopoly
• Theoretical and empirical research was
instituted to develop some sort of middle
ground
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Monopolistic Competition (cont'd)
• Two separately developed models of
monopolistic competition resulted
• At Harvard, Edward Chamberlin published
Theory of Monopolistic Competition in 1933
• That same year, Joan Robinson of
Cambridge published The Economics of
Imperfect Competition
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Monopolistic Competition (cont'd)
• Monopolistic Competition
– A market situation in which a large number of
firms produce similar but not identical products
– Entry into the industry is relatively easy
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Monopolistic Competition (cont'd)
• Characteristics of monopolistic competition
1. Significant numbers of sellers in a highly
competitive market
2. Differentiated products
3. Sales promotion and advertising
4. Easy entry of new firms in the long run
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Monopolistic Competition (cont'd)
• Implications of the large number of firms
1. Small market share
2. Lack of collusion
3. Independence
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Monopolistic Competition (cont'd)
• Product Differentiation
– The distinguishing of products by brand name,
color, and other minor attributes.
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Monopolistic Competition (cont'd)
• Product differentiation and price
– The firm has some control over the price it
charges
– Unlike a perfect competitor, it faces a downward
sloping demand curve
– Consider the abundance of brand names for
many products
• The more successful the firm is at differentiation, the
more control it has over price
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Example: Is Punxsutawny Phil Hogging Too Much
Attention?
• Since 1887, Punxsutawny Phil, the groundhog
residing in the Pennsylvania town of that name,
has been used to predict the weather on February
2—the official Groundhog Day.
• Today, there are at least 17 “groundhog lodges” in
Pennsylvania and nearby states, each of which
promotes its own groundhog’s weather-forecasting
talents in an effort to attract tourists to their
communities.
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Monopolistic Competition (cont'd)
• What do you think about advertising?
– Would a perfect competitor have any incentive
to advertise?
– Why would a monopolistically competitive firm
advertise?
– Can advertising lead to efficiency?
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Monopolistic Competition (cont'd)
• Sales promotion and advertising
– Can increase demand for a firm
– Can differentiate a firm’s product
– Can result in increased profits
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Monopolistic Competition (cont'd)
• Question
– How much advertising should be undertaken?
• Answer
– It should be carried to the point at which the
additional revenue from one more dollar of
advertising just equals that one dollar of
additional cost
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Example: A Biodegradable Chips Bag
is Crunchier Than the Chips
• As part of its product differentiation, the
snack-food company Frito-Lay designed a
biodegradable bag for its Sun Chips brand.
• The bag also produces a loud crunching
sound when squeezed.
• Frito-Lay has incorporated the crunchiness
of this bag into its marketing, as a way of
distinguishing Sun Chips from competing
products.
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Monopolistic Competition (cont'd)
• Ease of entry
– For any current monopolistic competitor,
potential competition is always lurking in the
background
– The easier—that is, the less costly—entry is, the
more a current competitor must worry about
losing business
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Price and Output for the
Monopolistic Competitor
• The individual firm’s demand and cost
curves
– Demand curve slopes downward
– Profit maximized where MC intersects MR from
below
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Price and Output for the
Monopolistic Competitor (cont'd)
• Short-run equilibrium
– In the short run, it is possible for a monopolistic
competitor to make economic profits—profits
over and above the normal rate of return, or
beyond what is necessary to keep that firm in
the industry
– Losses in the short run are clearly also possible
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Price and Output for the
Monopolistic Competitor (cont'd)
• The long run: zero economic profits
– The rate of return will tend toward normal
– Economic profits will tend toward zero
• So many firms produce substitutes, any economic
profits will disappear with competition
• Reduced to zero either through entry of new firms
seeking to earn a higher rate or return, or by changes
in product quality and advertising outlays by existing
firms
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Figure 25-1 Short-Run and Long-Run Equilibrium
with Monopolistic Competition,
Panel (a)
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Figure 25-1 Short-Run and Long-Run Equilibrium
with Monopolistic Competition,
Panel (b)
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Figure 25-1 Short-Run and Long-Run Equilibrium
with Monopolistic Competition,
Panel (c)
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Comparing Perfect Competition with
Monopolistic Competition
• Question
– If both a monopolistic and perfect competitor
make zero economic profit in the long run, how
are they different?
• Answer
– Demand curve for individual perfect competitor
is perfectly elastic
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Figure 25-2 Comparison of the Perfect Competitor
with the Monopolistic Competitor
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Comparing Perfect Competition with
Monopolistic Competition (cont'd)
• In perfect competition, the long-run equilibrium
occurs where average total cost is minimized (this
does not occur in monopolistic competition)
• Some have argued that this is not necessarily a
waste of resources—as the added cost arises from
product differentiation
• Chamberlin argued it is rational for consumers to
have a taste for differentiation; consumers willingly
accept the resultant increased production costs in
return for more choice and variety of output
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Brand Names and Advertising
• Because “differentness” has value for
consumers, monopolistically competitive
firms regard their brand names as valuable
private (intellectual) property
– Firms use trademarks, words, symbols, and
logos to distinguish their product brands from
goods or services sold by other firms
• A successful brand image contributes to a firm’s
profitability
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Brand Names and Advertising
(cont'd)
• Brand names and trademarks
– A company’s value in the marketplace depends
largely on current perceptions of future
profitability
– We can see it in the market value of the world’s
most valuable product brands
– Valuation depends on the market prices of
shares of stock of a company times the number
of shares traded
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Table 25-1 Values of the Top Ten
Brands
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Methods of Advertising
• Direct Marketing
– Advertising targeted at specific consumers: email, regular mail
• Mass Marketing
– Advertising intended to reach as many
customers as possible: radio, TV, newspaper
• Interactive Marketing
– Permits consumer to follow up directly by
searching for more information
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International Example: A Push to Make
Electronic Billboards Interactive in Japan
• In Japan, when a person glances at an
electronic advertising display, the ad often
looks back with a mechanism that can
determine the age and gender of the
person.
• Based on the individual’s characteristics, the
display will recommend a specific product
tailored to individual needs.
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Figure 25-3 Distribution of U.S.
Advertising Expenses
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Informational Versus Persuasive
Advertising
• Search Good
– A product with characteristics that enable an
individual to evaluate the product’s quality in
advance of a purchase
• Experience Good
– A product that an individual must consume
before the product’s quality can be established
• Credence Good
– A product with qualities that consumers lack the
expertise to assess without assistance
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Brand Names and Advertising
• Examples of search goods
– Clothing and music evaluated prior to purchase
• Examples of experience goods
– Soft-drinks, restaurants, movies
• Examples of credence goods
– Health care, legal advice
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Brand Names and Advertising
(cont'd)
• Informational Advertising
– Advertising that emphasizes transmitting
knowledge about the features of a product
• Persuasive Advertising
– Advertising that is intended to induce a
consumer to purchase a particular product and
discover a previously unknown taste for an item
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Brand Names and Advertising
(cont'd)
• Advertising as a signaling behavior
– Individual companies can explicitly engage in
signaling behavior
– They do so by establishing brand names or
trademarks and promoting them
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What If … the government were to limit or even
ban “excessive” advertising?
• Informational advertising is informative to buyers
of search goods.
• Even a firm’s expenditures on persuasive
advertising communicate an intention to continue
its operations for the foreseeable future.
• Any attempt to restrict the amount of advertising
would reduce the informational benefits to society.
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Information Products and
Monopolistic Competition
• Information products, such as computer
operating systems, software, and digital
music and videos, have a unique cost
structure
• Product development entails high fixed
costs, but the marginal cost of producing a
copy for one more customer is low
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Information Products and Monopolistic
Competition (cont'd)
• Information Product
– An item that is produced using informationintensive inputs at a relatively high fixed cost
but distributed for sale at a relatively low
marginal cost
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Figure 25-4 Cost Curves for a Producer of an
Information Product
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Information Products and Monopolistic
Competition (cont'd)
• Short-Run Economies of Operation
– A distinguishing characteristic of an information
product arising from declining short-run average
total cost as more units of the product are sold
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Information Products and Monopolistic
Competition (cont'd)
• Consider how computer game
manufacturers operate in a monopolistically
competitive market.
• In monopolistic competition, marginal cost
pricing results in losses for the firm, even
though it creates efficiencies for the
economy as a whole.
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Information Products and Monopolistic
Competition (cont'd)
• Providing an information product entails incurring
relatively high fixed costs, but a relatively low perunit cost for additional units of output
• The ATC for a firm that sells an information
product slopes downward, meaning the firm
experiences short-run economies of operation
• In a long-run monopolistically competitive
equilibrium, price adjusts to equal ATC; the firm
earns sufficient revenues to cover total costs,
including the opportunity cost of capital
• Consumers thereby pay the lowest price necessary
to induce sellers to provide the item
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Figure 25-5 The Infeasibility of Marginal Cost Pricing
of an Information Product
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You Are There: Have You Smelled a Ford Lately?
• Linda Schmalz, a body interior materials engineer
at Ford Motor Company, is responsible for
determining the appropriate odors for accessories
within the passenger compartment of Ford
vehicles.
• Schmalz has discovered that there are regional
differences in people’s perception of odors.
• This has prompted her to think about offering
customized scents as a way of creating product
differentiation for Ford vehicles.
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Issues & Applications: Why E-Books Are
Upending the Publishing Business
• Book publishing exhibits many features of
monopolistic competition.
• Given the relatively high fixed cost of authoring a
book, publishers also face downward-sloping
average total cost curves.
• Variable costs are much lower for e-books, and this
alternative has caused a decrease in demand for
physical books.
• The likely consequence is that some publishers of
physical books will experience economic losses and
may therefore exit the industry.
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Summary Discussion of Learning
Objectives
• Key characteristics of a monopolistically
competitive industry
– Large number of small firms
– Differentiated products
– Easy entry and exit
– Advertising and sales promotion
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Summary Discussion of Learning
Objectives (cont'd)
• Contrasting the output and pricing decisions
of monopolistically competitive firms with
those of perfectly competitive firms
– Monopolistically competitive firm in short run
• Produces output to point MR = MC in short run
• Price set on demand curve, can be less than MC and
ATC in short run, firm earns economic profits
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Summary Discussion of Learning
Objectives (cont'd)
• Contrasting the output and pricing decisions
of monopolistically competitive firms with
those of perfectly competitive firms
– Monopolistically competitive firm in the long run
• Price = ATC in the long run as firms enter industry
• Like perfectly competitive firms, earns zero economic
profits in long run
• Price exceeds MC in long run
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Summary Discussion of Learning
Objectives (cont'd)
• Monopolistically competitive firms attempt to boost
demand for their products through product
differentiation
– They engage heavily in advertising and
marketing
• Providing an information product entails incurring
relatively high fixed costs but low marginal costs
– In the long run equilibrium, price adjusts to
equality with average total cost
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