Download Chapter 17 - Effingham County Schools

Chapter 17
Monopolistic Competition
Characteristics of Monopolistic
Competition
1. Many sellers
2. Product differentiation
3. Free entry
Examples: books, CD’s, restaurants,
movies, etc.
In the Short Run…
• Because the product is differentiated, it
faces a downward D curve and MR curve
• Profit-Maximization is same as monopoly:
go to MR=MC for Q of output, then to D
curve to find P
• Firms will make profits or losses just like a
monopoly in short run
Figure 1 Monopolistic Competition in the
Short Run
(a) Firm Makes Profit
Price
MC
ATC
Price
Average
total cost
Demand
Profit
MR
0
Profitmaximizing
quantity
Quantity
Figure 1 Monopolistic Competitors in the
Short Run
(b) Firm Makes Losses
Price
MC
ATC
Losses
Average
total cost
Price
MR
0
Lossminimizing
quantity
Demand
Quantity
In the Long Run…
• Profits = entry; shifts D curve to left
• Losses = exit; shifts D curve to right
• This process continues until firms are making
exactly 0 economic profit
• D curve and ATC curve become TANGENT
• P > MC
• P > MR
• P = ATC
Figure 2 A Monopolistic Competitor in the
Long Run
Price
MC
ATC
The demand curve is
tangent to the ATC
curve.
P = ATC
And this tangency lies
vertically above the
intersection of MR and
MC.
Demand
MR
0
Profit-maximizing
quantity
Quantity
Monopolistic vs. Perfect
Competition
1. Excess Capacity – firms produce on the
downward-sloping portion of ATC, not at
efficient scale. Therefore, they could
produce more and decrease costs.
2. Markup – P > MC because firm always
has some market power, so an extra unit
sold = higher profit
Monopolistic Competition and the
Welfare of Society
• Inefficiency comes from P > MC, so a
mon. comp. market has same DWL as
monopoly pricing
• There is no way to regulate firms
• # of firms in market is not “ideal” because
of too much or too little entry
Externalities with entry/exit
• Product-variety externality – consumers
get some consumer surplus from the intro
of a new product, entry of a new firm is a
positive externality to consumers
• Business-stealing externality – other
firms lose customers and profits from
entry, it is a negative externality on
existing firms
Advertising
• Varies with products
• Firms selling highly differentiated goods
spend about 10%-20% of revenue on
advertising (soft drinks, razor blades,
cereal, dog food…)
• Firms selling industrial goods spend very
little on advertising (satellites, etc.)
• Firms selling homogeneous products
spend nothing (wheat, peanuts, oil)
Critique of Advertising
• manipulative of people’s tastes
• Psychological vs. informational
• Impedes competition – convinces people
products are more different than they
really are
Defense of Advertising
• Information allows customers to make
better decisions
• Fosters competition by allowing customers
to take advantages of price differences
• Decreases market power
• Can signal to the consumer that the quality
of product is high
Make sure to…
• Read case study about eyeglasses
• Read section on brand names and the
pros and cons of them