Transcript 12A/25-2 - WordPress.com

Monopolistic
Competition
Prof. Charles Fusi
12A/25-1
Why do so many rock bands today adopt names that
involve odd combinations of everyday words?
After all, what you care about is the quality of a band’s
songs, its style, and the musical talents of the band
members.
To find out the answer to this question, you must learn
about the market structure in which today’s rock bands
interact, known as monopolistic competition.
Lecture by Prof. Charles Fusi
12A/25-2
 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
Lecture by Prof. Charles Fusi
12A/25-3
 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
Lecture by Prof. Charles Fusi
12A/25-4
 Monopolistic Competition
 Price and Output for the Monopolistic Competitor
 Comparing Perfect Competition with Monopolistic
Competition
 Brand Names and Advertising
 Information Products and Monopolistic Competition
Lecture by Prof. Charles Fusi
12A/25-5
 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
Lecture by Prof. Charles Fusi
12A/25-6
 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
Lecture by Prof. Charles Fusi
12A/25-7
 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
Lecture by Prof. Charles Fusi
12A/25-8
 Implications of the large number of firms
1. Small market share
2. Lack of collusion
3. Independence
Lecture by Prof. Charles Fusi
12A/25-9
 Product Differentiation
 The distinguishing of products by brand name,
color, and other minor attributes.
Lecture by Prof. Charles Fusi
12A/25-10
 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
Lecture by Prof. Charles Fusi
12A/25-11
 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.
Lecture by Prof. Charles Fusi
12A/25-12
 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?
Lecture by Prof. Charles Fusi
12A/25-13
 Sales promotion and advertising
 Can increase demand for a firm
 Can differentiate a firm’s product
 Can result in increased profits
12A/25-14
 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
Lecture by Prof. Charles Fusi
12A/25-15
 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
Lecture by Prof. Charles Fusi
12A/25-16
 The individual firm’s demand and cost curves
 Demand curve slopes downward
 Profit maximized where MC intersects MR from
below
Lecture by Prof. Charles Fusi
12A/25-17
 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
Lecture by Prof. Charles Fusi
12A/25-18
 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
Lecture by Prof. Charles Fusi
12A/25-19
• Price (P1) > ATC
• Economic profit
Lecture by Prof. Charles Fusi
12A/25-20
• Price (P1) < ATC
• Economic loss
Lecture by Prof. Charles Fusi
12A/25-21
• Price (P1) = ATC
• Normal rate of return
Lecture by Prof. Charles Fusi
12A/25-22
 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
Lecture by Prof. Charles Fusi
12A/25-23
Lecture by Prof. Charles Fusi
12A/25-24
 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
Lecture by Prof. Charles Fusi
12A/25-25
 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
Lecture by Prof. Charles Fusi
12A/25-26
 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
Lecture by Prof. Charles Fusi
12A/25-27
Lecture by Prof. Charles Fusi
12A/25-28
 Direct Marketing
 Advertising targeted at specific consumers: e-
mail, 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
Lecture by Prof. Charles Fusi
12A/25-29
Lecture by Prof. Charles Fusi
12A/25-30
 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
Lecture by Prof. Charles Fusi
12A/25-31
 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
Lecture by Prof. Charles Fusi
12A/25-32
 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
Lecture by Prof. Charles Fusi
12A/25-33
 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
Lecture by Prof. Charles Fusi
12A/25-34
 Because the purpose of persuasive advertising is more to
attract consumers’ attention and less to provide product
information, many people think that persuasive advertising
offers no clear benefits to society at large.
 A company’s persuasive ads may demonstrate that it
intends to expand its customer base and thereby
perpetuates its operations for years to come.
 In this way, even persuasive advertising offers some
information to consumers.
Lecture by Prof. Charles Fusi
12A/25-35
 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
Lecture by Prof. Charles Fusi
12A/25-36
 Information Product
 An item that is produced using information-
intensive inputs at a relatively high fixed cost but
distributed for sale at a relatively low marginal
cost
Lecture by Prof. Charles Fusi
12A/25-37
• TFC is $250,000
• Producer sells 5,000 copies
AFC falls to $50 per copy
• What is AFC if producer sells
50,000 copies?
Lecture by Prof. Charles Fusi
12A/25-38
 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
Lecture by Prof. Charles Fusi
12A/25-39
 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.
Lecture by Prof. Charles Fusi
12A/25-40
 Providing an information product entails incurring
relatively high fixed costs, but a relatively low per-unit 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
Lecture by Prof. Charles Fusi
12A/25-41
Firm cannot behave
as if it were a perfect
competitor setting
price at $2.50
Lecture by Prof. Charles Fusi
12A/25-42
 Vroom Foods differentiates its “energy candy” products—
Buzz Bites and Foosh Energy Mints—as “the most
caffeinated products out there.”
 Vroom’s competitors in the energy candy market include
Crackheads, Extreme Sport Beans, Ice Breakers Energy
Mints, and Snicker Charged candy bars.
 In addition to including caffeine, Vroom is increasingly
seeking to differentiate its energy candy products from the
products of its competitors.
Lecture by Prof. Charles Fusi
12A/25-43
 The industry or rock music is monopolistically competitive
as most bands seek to differentiate themselves by writing
their own novel songs, and developing their own styles.
 Another key product characteristic is a band’s name, as
evidenced by names such as the Beatles, Grateful Dead, Led
Zeppelin, Metallica, and Pink Floyd.
 Thus, one of the first agenda items for a band after its
formation is to find a unique name and obtain a legal
trademark for it.
Lecture by Prof. Charles Fusi
12A/25-44
 Key characteristics of a monopolistically competitive
industry
 Large number of small firms
 Differentiated products
 Easy entry and exit
 Advertising and sales promotion
Lecture by Prof. Charles Fusi
12A/25-45
 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
Lecture by Prof. Charles Fusi
12A/25-46
 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
Lecture by Prof. Charles Fusi
12A/25-47
 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
Lecture by Prof. Charles Fusi
12A/25-48