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Monopolistic Competition Chapter 17 [with marginalia] g m The Four Types of Market Structure Number of Firms? Many firms One firm Few firms Monopoly Oligopoly • Tap water • Cable TV Type of Products? Differentiated products Identical products Monopolistic Competition Perfect Competition • Tennis balls • Novels • Wheat • Crude oil • Movies • Milk Monopolistic Competition o Markets that have some features of competition and some features of monopoly. o Attributes of Monopolistic Competition o Many sellers o There are many firms competing for the same group of customers. o Product examples include books, CDs, movies, computer games, restaurants, piano lessons, cookies, furniture, etc. o Product differentiation o Each firm produces a product that is at least slightly different from those of other firms. o Rather than being a price taker, each firm faces a downwardsloping demand curve. o Free entry and exit o Firms can enter or exit the market without restriction. o The number of firms in the market adjusts until economic profits are zero. Monopolistic Competitors in the Short Run... (a) Firm Makes a Profit Price Price Average total cost MC ATC Demand Profit MR 0 Profitmaximizing quantity Quantity Monopolistic Competitors in the Short Run... (b) Firm Makes Losses Price MC ATC Losses Average total cost Price Demand MR 0 Lossminimizing quantity Quantity Monopolistic Competition in the Short Run o Short-run economic profits encourage new firms to enter the market. This: o Increases the number of products offered. o Reduces demand faced by firms already in the market. o Incumbent firms’ demand curves shift to the left. o Demand for the incumbent firms’ products fall, and their profits decline. Monopolistic Competition in the Short Run II o Short-run economic losses encourage firms to exit the market. This: o Decreases the number of products offered. o Increases demand faced by the remaining firms. o Shifts the remaining firms’ demand curves to the right. o Increases the remaining firms’ profits. o The Long-Run Equilibrium o Firms will enter and exit until the firms are making exactly zero economic profits. A Monopolistic Competitor in the Long Run... Two Characteristics of LongRun Equilibrium As in a monopoly, price exceeds marginal cost. Price MC ATC Profit maximization requires marginal revenue to equal marginal cost. P=ATC MR 0 Profit-maximizing quantity The downward-sloping demand curve makes marginal revenue less than price. Demand Quantity As in a competitive market, price equals average total cost. Free entry and exit drive economic profit to zero. Excess Capacity o o o There is no excess capacity in perfect competition in the long run. o 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. o In monopolistic competition, output is less than the efficient scale of perfect competition. For a competitive firm, price equals marginal cost. Therefore, monopolistic competition is “inefficient.” Excess Capacity... (a) Monopolistically Competitive Firm Price (b) Perfectly Competitive Firm Price MC MC ATC P P = MC ATC P = MR (demand curve) Excess capacity Demand Quantity Efficient produced scale Quantity Quantity= Efficient produced scale Quantity Advertising Monopolistic Competition is Characterized by Advertising. Is this good or bad? Has the quality of Presidential Candidates improved now that advertising is used? Are resources allocated to advertising wasted?