Download Chapter 26 - The Citadel

Chapter 26
Monopolistic
Competition
Introduction
A number of firms, including Hewlett-Packard,
Wal-Mart, Microsoft, and Amazon all are trying
to earn profits from downloadable digital
music files.
The theory of monopolistic competition
explains the nature of the pricing decisions
they face.
Slide 26-2
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
Slide 26-3
Learning Objectives
 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
Slide 26-4
Chapter Outline
 Monopolistic Competition
 Short-Run and Long-Run Equilibrium in
Monopolistic Competition
 Comparing Perfect Competition
with Monopolistic Competition
 Brand Names and Advertising
 Information Products and Monopolistic
Competition
Slide 26-5
Did You Know That...
 Nearly all of the quarter-million fastfood restaurants in the U. S. offer some
type of salad item on the menu?
 The advertising that promotes these
salads helps each fast-food chain
differentiate its products from those of
its competitors?
Slide 26-6
Monopolistic Competition
 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
Slide 26-7
Monopolistic Competition
 Characteristics of monopolistic
competition
– Significant number of sellers in a highly
competitive market
– Differentiated products
– Sales promotion and advertising
– Easy entry of new firms in the long run
Slide 26-8
Monopolistic Competition
 Implications of the large number of
firms
– Small market share
– Lack of collusion
– Independence
Slide 26-9
Monopolistic Competition
 Product Differentiation
– The distinguishing of products by brand
name, color, and other minor attributes
Slide 26-10
Monopolistic Competition
 Product differentiation and price
– Differentiate perfectly
• Producer is a monopoly
– Significant influence on price
– Differentiation is not perfect
• Producer is a monopolistic competitor
– The more successful it is at differentiation,
the more control it has over price
Slide 26-11
Example:
Product Differentiation in Toothpaste
 How do toothpaste manufacturers
differentiate their particular product
from other brands?
 By flavor, whitening effects, and type of
packaging.
Slide 26-12
Monopolistic Competition
 Sales promotion and advertising
– Can increase demand for a firm
– Can differentiate a firm’s product
– Should be continued to the point at which
the additional revenue from one more
dollar of advertising just equals that one
dollar of marginal cost
Slide 26-13
Monopolistic Competition
 What do you think?
– Would a perfect competitor have any
incentive to advertise?
– Why would a monopolistically
competitive firm advertise?
– Can advertising lead to efficiency?
Slide 26-14
Short-Run and Long-Run
Equilibrium with Monopolistic Competition
Panel (a)
MC
Dollars per Unit
ATC
P1
d
ATC
Profits
• Price (P1) > ATC
• Economic profit
A
MR
q
Quantity
Figure 26-1, Panel (a)
Slide 26-15
Short-Run and Long-Run
Equilibrium with Monopolistic Competition
Panel (b)
Dollars per Unit
MC
ATC
ATC
P1
d
Losses
A
-Price (P1) < ATC
-Economic loss
MR
q
Quantity
Figure 26-1, Panel (b)
Slide 26-16
Short-Run and Long-Run
Equilibrium with Monopolistic Competition
Panel (c)
Dollars per Unit
MC
P1=
ATC
ATC
T
d
A
MR
-Price (P1) = ATC
-Normal rate of return
q
Quantity
Figure 26-1, Panel (c)
Slide 26-17
Comparing Perfect Competition
with Monopolistic Competition
 Perfect competitors and monopolistic
competitors earn zero economic profit.
 How are they different?
Slide 26-18
Comparison of the Perfect Competitor
with the Monopolistic Competitor
Panel (a)
Perfect Competition
MC
MR = P
Minimum ATC
Dollars per Unit
d
P1
ATC
MC
ATC
Minimum ATC
Dollars per Unit
Panel (b)
Monopolistic Competition
P2
d
MR
q1
Quantity per Time Period
Figure 26-2, Panels (a) and (b)
q2
Quantity per Time Period
Slide 26-19
Comparing Perfect Competition
with Monopolistic Competition
 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 that allows consumers to have
more choice.
Slide 26-20
Brand Names
 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
Slide 26-21
Advertising
 Forms of advertising
– Direct marketing
– Mass marketing
– Interactive marketing
Slide 26-22
Advertising
 Search goods have characteristics that can
be evaluated prior to purchase
 Experience goods, such as movies and
haircuts, don’t fully reveal their value until
they have been consumed
 Advertising for experience goods is more
likely to be persuasive rather than
informational
Slide 26-23
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
Slide 26-24
E-Commerce Example:
Pop-Up Ads
 There have been court cases involving
the use of pop-up ads to promote
competing products when internet
customers place online orders.
 The legal rulings have been moving in
the direction of allowing more
interactive advertising.
Slide 26-25
Cost Curves for
Information Products
Figure 26-4
Slide 26-26
Cost Curves
for Information Products
 Sellers of information products
experience short-run economies of
scale.
 The average total cost continually
declines as quantity increases.
Slide 26-27
Monopolistic Competition and
Information Products
 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.
Slide 26-28
Infeasibility of Marginal Cost
Pricing of an Information Product
Figure 26-5, Panels (a) and (b)
Slide 26-29
Pricing for Information Products
 In the long-run, price will equal average total cost.
 This yields the long-run equilibrium condition of zero
economic profit.
 Firms selling information products in a
monopolistically competitive industry will recover all
their production costs.
 Customers will pay more than marginal cost, but
they will pay the minimum price necessary to call
forth the product to market.
Slide 26-30
Issues and Applications:
Selling Music Online
 The online distribution of music is now
a monopolistically competitive market.
 To supply downloadable music to
internet customers, firms must pay to
acquire the music, to provide the
bandwidth and other customer
services, and to process credit cards.
Slide 26-31
Issues and Applications:
Selling Music Online
 More firms have been entering the industry
of late, supplementing their revenues with
pop-up ads.
 Currently, there is a legal battle involving the
use of Apple’s iPod technology.
 Apple is trying to maintain some product
differentiation within the online music
industry.
Slide 26-32
Summary Discussion
of Learning Objectives
 Key characteristics of monopolistic
competition
– Large number of small firms
– Differentiated products
– Easy entry and exit
– Advertising and sales promotion
Slide 26-33
Summary Discussion
of Learning Objectives
 Contrasting the output and pricing decisions
of monopolistically competitive firms with
those of perfectly competitive firms
– Monopolistically competitive firm
•
•
•
•
MR = MC determines output
Price set on demand curve
P > MC
P = ATC in the long run
Slide 26-34
Summary Discussion
of Learning Objectives
 Monopolistically competitive firms
attempt to boost demand for their
products through product differentiation
 Providing an information product
entails incurring relatively high fixed
costs but low marginal costs
Slide 26-35
End of
Chapter 26
Monopolistic
Competition