Monopolistic
Competition
Chapter 17
Copyright ? 2001 by Harcourt,Inc.
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Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
The Four Types of Market Structure
Monopoly Oligopoly Monopolistic
Competition
Perfect
Competition
? Tap water
? Cable TV
? Tennis balls
? Crude oil
? Novels
? Movies
? Wheat
? Milk
Number of Firms?
Type of Products?
Many
firms
One
firm Few
firms Differentiated
products
Identical
products
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Types of Imperfectly
Competitive Markets
?Monopolistic Competition
?Many firms selling products that are similar
but not identical.
?Oligopoly
?Only a few sellers,each offering a similar or
identical product to the others.
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Monopolistic Competition
Markets that have some
features of competition and
some features of monopoly.
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Attributes of Monopolistic
Competition
?Many sellers
?Product differentiation
?Free entry and exit
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Many Sellers
There are many firms competing for the
same group of customers.
?Product examples include books,CDs,
movies,computer games,restaurants,
piano lessons,cookies,furniture,etc.
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Product Differentiation
?Each firm produces a product that is
at least slightly different from those
of other firms.
?Rather than being a price taker,
each firm faces a downward-sloping
demand curve.
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Free Entry or Exit
?Firms can enter or exit the market
without restriction.
?The number of firms in the market
adjusts until economic profits are
zero.
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Monopolistic Competitors in
the Short Run...
(a) Firm Makes a Profit
Quantity0
Price
Demand
MR
ATC
Profit
MC
Profit-
maximizing quantity
Price
Average
total cost
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Monopolistic Competitors in
the Short Run...
Quantity0
Price
Demand
MR
Losses
(b) Firm Makes Losses
MC ATC
Average
total cost
Loss-
minimizing
quantity
Price
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Monopolistic Competition in
the Short Run
Short-run economic profits encourage new
firms to enter the market,This:
? Increases the number of products offered.
? Reduces demand faced by firms already in the
market.
?Incumbent firms’ demand curves shift to the
left.
?Demand for the incumbent firms’ products fall,
and their profits decline.
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Monopolistic Competition in
the Short Run
Short-run economic losses encourage firms
to exit the market,This:
? Decreases the number of products offered.
? Increases demand faced by the remaining
firms.
?Shifts the remaining firms’ demand curves
to the right.
?Increases the remaining firms’ profits.
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The Long-Run Equilibrium
Firms will enter and exit until
the firms are making exactly
zero economic profits.
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A Monopolistic Competitor
in the Long Run...
Quantity
Price
0
DemandMR
ATC
MC
Profit-maximizing
quantity
P=ATC
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Two Characteristics of Long-
Run Equilibrium
?As in a monopoly,price exceeds marginal
cost.
?Profit maximization requires marginal
revenue to equal marginal cost.
?The downward-sloping demand curve makes
marginal revenue less than price.
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Two Characteristics of Long-
Run Equilibrium
?As in a competitive market,price equals
average total cost.
?Free entry and exit drive economic profit
to zero.
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Monopolistic versus Perfect
Competition
There are two noteworthy
differences between monopolistic
and perfect competition—excess
capacity and markup.
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Excess Capacity
?There is no excess capacity in perfect
competition in the long run.
?Free entry results in competitive firms
producing at the point where average
total cost is minimized,which is the
efficient scale of the firm.
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Excess Capacity
?There is excess capacity in
monopolistic competition in the long
run.
?In monopolistic competition,output is
less than the efficient scale of perfect
competition.
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Excess Capacity...
Quantity
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Quantity
Price
P = MR
(demand
curve)
MC ATC
Price
Demand
MC ATC
Excess capacity
Quantity
produced
Efficient
scale
P = MC
Quantity
produced
= Efficient
scale
P
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Markup Over Marginal Cost
?For a competitive firm,price
equals marginal cost.
?For a monopolistically
competitive firm,price exceeds
marginal cost.
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Markup Over Marginal Cost
Because price exceeds marginal
cost,an extra unit sold at the
posted price means more profit
for the monopolistically
competitive firm.
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Markup Over Marginal Cost...
Quantity
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Quantity
Price
P = MC P = MR
(demand
curve)
MC ATC
Quantity
produced
Price
Demand
Marginal
cost
MC ATC
MR
Markup
Quantity
produced
Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
Monopolistic versus Perfect
Competition...
Quantity
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Quantity
Price
P = MR
(demand
curve)
MC
ATC
Quantity
produced
Efficient
scale
Price
Demand
MC
ATC
P = MC
Excess capacity
Marginal
cost
Markup
MR
Quantity produced =
Efficient scale
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Monopolistic Competition and
the Welfare of Society
Monopolistic competition does not
have all the desirable properties of
perfect competition.
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Monopolistic Competition and
the Welfare of Society
?There is the normal deadweight loss of
monopoly pricing in monopolistic
competition caused by the markup of
price over marginal cost.
?However,the administrative burden of
regulating the pricing of all firms that
produce differentiated products would be
overwhelming,
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Monopolistic Competition and
the Welfare of Society
Another way in which monopolistic
competition may be socially inefficient is
that the number of firms in the market may
not be the,ideal” one,There may be too
much or too little entry.
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Monopolistic Competition and
the Welfare of Society
Externalities of entry include:
? product-variety externalities.
? business-stealing externalities.
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Monopolistic Competition and
the Welfare of Society
The product-variety externality:
Because consumers get some consumer
surplus from the introduction of a new
product,entry of a new firm conveys a
positive externality on consumers.
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Monopolistic Competition and
the Welfare of Society
The business-stealing externality:
Because other firms lose customers and
profits from the entry of a new competitor,
entry of a new firm imposes a negative
externality on existing firms.
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Advertising
When firms sell differentiated products
and charge prices above marginal cost,
each firm has an incentive to advertise in
order to attract more buyers to its
particular product.
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Advertising
?Firms that sell highly differentiated
consumer goods typically spend between
10 and 20 percent of revenue on
advertising.
?Overall,about 2 percent of total revenue,
or over $100 billion a year,is spent on
advertising.
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Advertising
?Critics of advertising argue that firms
advertise in order to manipulate people’s
tastes,
?They also argue that it impedes
competition by implying that products
are more different than they truly are.
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Advertising
?Defenders argue that advertising provides
information to consumers
?They also argue that advertising increases
competition by offering a greater variety
of products and prices.
?The willingness of a firm to spend
advertising dollars can be a signal to
consumers about the quality of the
product being offered.
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Brand Names
?Critics argue that brand names cause
consumers to perceive differences that do
not really exist.
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Brand Names
?Economists have argued that brand
names may be a useful way for
consumers to ensure that the goods they
are buying are of high quality.
?providing information about quality.
?giving firms incentive to maintain high
quality.
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Summary
?A monopolistically competitive market is
characterized by three attributes,many
firms,differentiated products,and free
entry.
?The equilibrium in a monopolistically
competitive market differs from perfect
competition in that each firm has excess
capacity and each firm charges a price
above marginal cost.
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Summary
?Monopolistic competition does not have
all of the desirable properties of perfect
competition.
?There is a standard deadweight loss of
monopoly caused by the markup of
price over marginal cost.
?The number of firms can be too large
or too small.
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Summary
?The product differentiation inherent
in monopolistic competition leads to
the use of advertising and brand
names.
?Critics of advertising and brand names
argue that firms use them to take
advantage of consumer irrationality and to
reduce competition.
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Summary
?Defenders argue that firms use
advertising and brand names to inform
consumers and to compete more
vigorously on price and product quality.
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Graphical
Review
Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
The Four Types of Market Structure
Monopoly Oligopoly Monopolistic
Competition
Perfect
Competition
? Tap water
? Cable TV
? Tennis balls
? Crude oil
? Novels
? Movies
? Wheat
? Milk
Number of Firms?
Type of Products?
Many
firms
One
firm Few
firms Differentiated
products
Identical
products
Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
Monopolistic Competitors in
the Short Run...
(a) Firm Makes a Profit
Quantity0
Price
Demand
MR
ATC
Profit
MC
Profit-
maximizing quantity
Price
Average
total cost
Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
Monopolistic Competitors in
the Short Run...
Quantity0
Price
Demand
MR
Losses
(b) Firm Makes Losses
MC ATC
Average
total cost
Loss-
minimizing
quantity
Price
Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
A Monopolistic Competitor
in the Long Run...
Quantity
Price
0
DemandMR
ATC
MC
Profit-maximizing
quantity
P=ATC
Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
Excess Capacity...
Quantity
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Quantity
Price
P = MR
(demand
curve)
MC ATC
Price
Demand
MC ATC
Excess capacity
Quantity
produced
Efficient
scale
P = MC
Quantity
produced
= Efficient
scale
P
Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
Markup Over Marginal Cost...
Quantity
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Quantity
Price
P = MC P = MR
(demand
curve)
MC ATC
Quantity
produced
Price
Demand
Marginal
cost
MC ATC
MR
Markup
Quantity
produced
Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
Monopolistic versus Perfect
Competition...
Quantity
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Quantity
Price
P = MR
(demand
curve)
MC
ATC
Quantity
produced
Efficient
scale
Price
Demand
MC
ATC
P = MC
Excess capacity
Marginal
cost
Markup
MR
Quantity produced =
Efficient scale