Monopolistic Competition
Chapter 17
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
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.
Monopolistic Competition
Markets that have some features of
competition and some features of
monopoly.
Attributes of Monopolistic
Competition
Many sellers
Product differentiation
Free entry and exit
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.
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.
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.
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
Quantity0
Price
Demand
MR
Losses
(b) Firm Makes Losses
MC ATC
Average
total cost
Loss- minimizing
quantity
Price
Monopolistic Competitors
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.
Monopolistic Competitors
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.
Monopolistic Competitors
in the Short Run...
The Long-Run Equilibrium
Firms will enter and exit until the firms
are making exactly zero economic profits.
A Monopolistic Competitor
in the Long Run...
Quantity
Price
0
DemandMR
ATC
MC
Profit-maximizing
quantity
P=ATC
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.
As in a competitive market,price equals
average total cost.
– Free entry and exit drive economic profit to
zero.
Monopolistic versus
Perfect Competition
There are two noteworthy differences
between monopolistic and perfect
competition—excess capacity and markup.
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.
There is excess capacity in monopolistic
competition in the long run.
In monopolistic competition,output is less
than the efficient scale of perfect competition.
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
Markup Over Marginal Cost
For a competitive firm,price equals
marginal cost.
For a monopolistically competitive firm,
price exceeds marginal cost.
Because price exceeds marginal cost,an
extra unit sold at the posted price means
more profit for the monopolistically
competitive firm.
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
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
Monopolistic Competition
and the Welfare of Society
Monopolistic competition does not have all the
desirable properties of perfect competition.
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.
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.
Externalities of entry include:
– product-variety externalities.
– business-stealing externalities.
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.
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.
Monopolistic Competition
and the Welfare of Society
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.
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.
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.
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.
Brand Names
Critics argue that brand names cause
consumers to perceive differences that do
not really exist.
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.
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.
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.
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.
Defenders argue that firms use advertising and
brand names to inform consumers and to
compete more vigorously on price and product
quality.
Exercise #17
Problems and applications
– #4,#11
经济学可以更有趣
为什么餐厅不会每天都变换价格？
Chapter 17
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
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.
Monopolistic Competition
Markets that have some features of
competition and some features of
monopoly.
Attributes of Monopolistic
Competition
Many sellers
Product differentiation
Free entry and exit
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.
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.
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.
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
Quantity0
Price
Demand
MR
Losses
(b) Firm Makes Losses
MC ATC
Average
total cost
Loss- minimizing
quantity
Price
Monopolistic Competitors
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.
Monopolistic Competitors
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.
Monopolistic Competitors
in the Short Run...
The Long-Run Equilibrium
Firms will enter and exit until the firms
are making exactly zero economic profits.
A Monopolistic Competitor
in the Long Run...
Quantity
Price
0
DemandMR
ATC
MC
Profit-maximizing
quantity
P=ATC
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.
As in a competitive market,price equals
average total cost.
– Free entry and exit drive economic profit to
zero.
Monopolistic versus
Perfect Competition
There are two noteworthy differences
between monopolistic and perfect
competition—excess capacity and markup.
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.
There is excess capacity in monopolistic
competition in the long run.
In monopolistic competition,output is less
than the efficient scale of perfect competition.
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
Markup Over Marginal Cost
For a competitive firm,price equals
marginal cost.
For a monopolistically competitive firm,
price exceeds marginal cost.
Because price exceeds marginal cost,an
extra unit sold at the posted price means
more profit for the monopolistically
competitive firm.
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
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
Monopolistic Competition
and the Welfare of Society
Monopolistic competition does not have all the
desirable properties of perfect competition.
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.
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.
Externalities of entry include:
– product-variety externalities.
– business-stealing externalities.
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.
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.
Monopolistic Competition
and the Welfare of Society
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.
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.
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.
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.
Brand Names
Critics argue that brand names cause
consumers to perceive differences that do
not really exist.
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.
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.
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.
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.
Defenders argue that firms use advertising and
brand names to inform consumers and to
compete more vigorously on price and product
quality.
Exercise #17
Problems and applications
– #4,#11
经济学可以更有趣
为什么餐厅不会每天都变换价格？
