Transcript monopolistic competition

SLIDES
BY
SOLINA LINDAHL
CHAPTER
15
Monopolistic Competition
and Product Differentiation
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What you will
learn in this chapter
 The meaning of monopolistic competition
 Why oligopolists and monopolistically competitive
firms differentiate their products
 How prices and profits are determined in
monopolistic competition in the short run and the
long run
 Why monopolistic competition poses a trade-off
between lower prices and greater product diversity
 The economic significance of advertising and
brand names
To
Video
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Active Learning
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THE LANDSCAPE OF FIRMS
YOU ARE
HERE
Competition
Monopolistic
competition
Oligopoly
Monopoly
More competition
(less price control)
Less competition
(more price control)
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MONOPOLISTIC COMPETITION
Monopolistic competition is a market
structure that’s a little like monopoly and a
little like perfect competition. Specifically:
 many competitors
 products similar but not identical
 free entry into and exit from the
industry in the long run
Restaurants: monopolistic competitors
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PRODUCT DIFFERENTIATION
Product differentiation plays a crucial role
in monopolistic competition.
Tacit collusion is almost impossible when
there are many producers.
Product differentiation is the only way these
firms can acquire some market power.
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PRODUCT DIFFERENTIATION
There are three important forms of
product differentiation:
Differentiation by style or type
sedans vs. SUVs
Differentiation by location
dry cleaner near home vs. cheaper dry
cleaner far away
Differentiation by quality
ordinary ($) vs. gourmet chocolate ($$$)
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PRODUCT DIFFERENTIATION
There are two important features of
industries with differentiated products.
Competition among sellers: Entry by
more producers reduces the quantity
each existing producer sells.
Value in diversity: Consumers gain from
the increased diversity of products.
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ECONOMICS
IN ACTION
Any color, so long as it’s black
Ford’s strategy was to offer just one style of
car, which maximized his economies of
scale but made no concessions to
differences in taste.
Alfred P. Sloan of GM challenged this
strategy by offering a range of car types,
differentiated by quality and price.
By the 1930s the verdict was clear:
Customers preferred a range of styles!
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A (BLACK) STYLE FOR EVERY
OCCASION
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SHORT-RUN PROFIT MAXIMIZATION
Same profit maximizing rule as previously used:
1. Produce the Q at which MR = MC.
2. Like monopoly firms, set price according to demand.
Price, cost,
marginal
revenue
MC
This profit will
attract new
entrants.
ATC
Z
P
ATC
Profit
This profit cannot
last.
D
MR
Q
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Quantity
S
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LEARN BY DOING: PRACTICE QUESTION
To identify the profit-maximizing output for this firm in
the short run, this graph needs:
a) the market price identified.
b) the MR curve identified.
c) the AVC curve identified.
d) All of the answers are true.
e) Answers (b) and (c) are true.
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To Next
Active Learning
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ADJUSTMENTS TO LONG-RUN
EQUILIBRIUM
New entrants mean fewer customers for the
original firms: Demand and MR shift left.
(Economic) profits fall to zero: Firms break
even and new entry stops. MC
Price, cost,
marginal
revenue
ATC
P
P = ATC Profit
ATC
D
MR
Q
Q
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SHORT-RUN LOSSES
New exits mean more customers for the
remaining firms: Demand and MR shift right.
(Economic) profits fall to zero: Firms break
even and exits stop.
MC
Price, cost,
marginal
revenue
ATC
ATC
P = ATC
Loss
D
MR
Q Q
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THE LONG-RUN ZERO-PROFIT
EQUILIBRIUM
Price, cost,
marginal
revenue
MC
Point of tangency
ATC
Z
PMC = ATCMC
DMC
MRMC
QMC
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ZERO PROFIT IN THE LONG RUN
If firms are earning economic profits, new
firms will want to enter the industry.
This will reduce the demand curve facing
each individual producer.
In the long run, each supplier will earn
normal profits, and price will equal ATC.
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COMPARING LR EQUILIBRIUM IN PC
AND MC
(a) Long-run equilibrium
in perfect competition
Price,
cost,
marginal
revenue
MC
ATC
(b) Long-run equilibrium
in monopolistic
competition
Price,
cost,
marginal
revenue
MC ATC
PMC= ATCMC
PPC = MCPC =
ATCPC
D= MR = PPC
MCMC
QPC
DMC
MRMC
QMC
Quantity
Quantity
Minimum-cost output
Minimum-cost output
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IS MONOPOLISTIC COMPETITION
INEFFICIENT?
Firms in a monopolistically competitive
industry have excess capacity: They
produce less than the output at which
average total cost is minimized.
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IS MONOPOLISTIC COMPETITION
INEFFICIENT?
Price > MC, so some mutually beneficial
trades are unexploited.
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IS MONOPOLISTIC COMPETITION
INEFFICIENT?
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THE ECONOMICS OF ADVERTISING
Oligopolies and monopolistically
competitive firms advertise.
Is advertising good or bad? Yes.
(There are different types of
advertising.)
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ECONOMICS
IN ACTION
THE PERFUME INDUSTRY: LEADING
CONSUMERS BY THE NOSE
Only 3% of a perfume bottle’s cost
is ingredients… the rest is
marketing and packaging.
Studies show that people identify
their favorite scents based on ego
and branding… and often dislike
the same scents in blind tests.
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TYPES OF ADVERTISING
Advertising as part of the product:
Even if NO information is given, does “branding”
make the product more enjoyable?
Tasters enjoy the cola more if it’s labeled
“Coke”…
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TYPES OF ADVERTISING
“Informative” advertising:
price, quality and availability information
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ECONOMICS
IN ACTION
THE HOUSING BUST AND THE DEMISE OF THE 6%
COMMISSION
Real estate agents look a lot like Monopolistic
Competitors… except that they collected a high price that
never changed (6% commission)
Why?
• They controlled the MLS (Multiple Listing Service)
• They refused to work with discounters
What has changed?
• Justice department sued the national
agents’ group
• Housing crash forced commissions down
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TYPES OF ADVERTISING
Advertising as Signaling
“If they’re spending so
much $$$ on advertising
for this product, they
must expect it to be
profitable and around a
long time. Must be
good.”
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LEARN BY DOING: APPLICATION VIDEO
In this engaging TED talk, Rory Sutherland makes the daring
assertion that a change in perceived value can be just as
satisfying as what we consider “real” value—and his
conclusion has interesting consequences for how we look at
life. (16 minutes)
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LEARN BY DOING: PRACTICE QUESTION
In your opinion, is advertising
“worth it” for society?
a)Yes
b)No
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LEARN BY DOING: BUSINESS CASE
GILETTE VERSUS SCHICK: A CASE OF
RAZOR BURN?
Competitive razor launches and their
huge advertising budgets: are they
worth it?
Do you pay more for the innovation of
the Hydro5, Fusion Pro-Glide with
FlexBall TM ?
Or are you joining the Dollar Shave
Club?
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