Download Monopolistic Competition

Chapter
Monopolistic
Competition
CHAPTER OUTLINE
I. Describe and identify monopolistic competition.
A. Large Number of Firms
1. Small Market Share
2. No Market Dominance
3. Collusion Impossible
B. Product Differentiation
C. Competing on Quality, Price, and Marketing
1. Quality
2. Price
3. Marketing
D. Entry and Exit
E. Identifying Monopolistic Competition
1. The Four-Firm Concentration Ratio
2. The Herfindahl-Hirschman Index
3. Limitations of Concentration Ratios
2. Explain how a firm in monopolistic competition determines its output and
price in the short run and the long run.
A. The Firm’s Profit-Maximizing Decision
B. Profit Maximizing Might Be Loss Minimizing
C. Long Run: Zero Economic Profit
D. Monopolistic Competition and Perfect Competition
1. Excess Capacity
2. Markup
E. Is Monopolistic Competition Efficient
1. Deadweight Loss
2. Making the Relevant Comparison
3. The Bottom line
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3. Explain why advertising costs are high and why firms use brand names in
monopolistic competition.
A. Innovation and Product Development
1. Cost Versus Benefit of Product Innovation
2. Efficiency and Product Innovation
B. Advertising
1. Advertising Expenditures
2. Selling Costs and Total Costs
3. Selling Costs and Demand
C. Using Advertising to Signal Quality
D. Brand Names
E. Efficiency of Advertising and Brand Names
CHAPTER ROADMAP
What’s New in this Edition?
Chapter 15 has been up‐dated. The point that the maximum loss a firm will suffer is equal to its fixed cost is now made explicit. Where We Are
In this chapter, we examine another market structure, mo‐
nopolistic competition. The profit‐maximizing quantity and price is discussed. The chapter shows why firms in monopo‐
list competition decide to advertise, use brand names, and develop new products. Where We’ve Been
The previous chapters studied perfectly competitive firms and monopoly firms. The material dealing with monopoly is used in this chapter because monopolistic competition is similar in some regards to monopoly. Where We’re Going
The next chapter covers the last industry structure, oligop‐
oly. Then Chapter 17 studies how the government chooses to regulate monopolies and antitrust law. The material in Chapter 17 primarily uses results from Chapter 13, on per‐
fect competition, and Chapter 14, on monopoly. Chapter 15 . Monopolistic Competition
IN THE CLASSROOM
Class Time Needed
You can complete this chapter in one and half to two sessions. By this point the students are familiar with the diagrams illustrating how firms in monopolistic competition select their profit‐maximizing price and quantity, so be sure to point out this similarity. Use two sessions if you have students who will be majoring in business disciplines because the material on advertising and brand names will be helpful to them. An estimate of the time per checkpoint is: •
15.1 What is Monopolistic Competition?—10 to 15 minutes •
15.2 Output and Price Decisions—40 to 50 minutes •
15.3 Product Development and Marketing—10 to 25 minutes 383
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CHAPTER LECTURE
15.1
What is Monopolistic Competition?
Monopolistic competition is a market structure in which • A large number of firms compete. Each firm has a small market share and collusion is impossible. • Each firm produces a differentiated product. Product differentiation means that each firm makes a product that is slightly different from the products of competing firms. Some people will pay more for one variety of a product, so the demand curve for the firm’s product is downward sloping. • Firms compete on product quality, price, and marketing. • Firms are free to enter and exit the market. Identifying Monopolistic Competition
There are two measures of market concentration used to help identify whether a market is com‐
petitive or dominated by a small number of firms: •
The four-firm concentration ratio is the percentage of the total revenue accounted for by the four largest firms in the industry. The four‐firm concentration ratio ranges be‐
tween near 0 (extremely competitive) to 100 (not very competitive). •
The Herfindahl–Hirschman index (HHI) is the square of the percentage market share of each firm summed over the largest 50 firms (or summed over all the firms if there are fewer than 50) in a market. The HHI ranges between near 0 (extremely competitive) to 10,000 (a monopoly). • The U.S. Justice Department uses the HHI to classify markets: • Markets with an HHI of less than 1,000 are regarded as highly competitive • Markets with an HHI of between 1,000 and 1,800 are regarded as moderately competitive. • Markets with an HHI above 1,800 are regarded as concentrated. •
Concentration ratios have two major limitations: • Geographic Scope of the Market: Concentration ratios define the market as the entire United States, but the relevant market might be smaller than the entire nation (news‐
papers, for which the market is a city) or larger than the entire nation (automobiles, for which the market is the entire world). • Barriers to Entry and Firm Turnover: For some industries, a few firms might be cur‐
rently operating in the market but competition in these industries might be fierce, with firms regularly entering and exiting the industry. Ford Motor Company advertises that it is the largest seller of pickup trucks in the United States. Should we be concerned that Ford might have too much market power in that area of the market? Ask the students to consider identifying what would be an appropriate definition for the “market” such that a proper market concentration measure might be cal‐
culated. Should only pickup trucks be included? Or should all cars and trucks be consid‐
ered as possible substitutes? How about minivans and/or SUVs? Chapter 15 . Monopolistic Competition
15.2
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Output and Price Decisions
The Firm’s Profit-Maximizing Decisions
•
•
•
•
In the short run, a monopolistically competitive firm makes its output and price decisions just like a monopoly firm. The figure shows a monopolisti‐
cally competitive firm’s downward slop‐
ing demand curve and the downward sloping MR curve that lies below the demand curve. The firm maximizes its profit by produc‐
ing the quantity where MR = MC and using the demand curve to set the high‐
est price at which people will buy the quantity it produces. In the figure, the firm produces 20 pizzas per hour and sets a price of $16 per pizza. The firm in the figure earns an economic profit because P > ATC. The amount of the economic profit is equal to the area of the darkened rectangle. If P < ATC, the firm incurs an economic loss. The firm will shut down if P < AVC, so the maximum loss the firm will incur is equal to its fixed costs. Long Run: Zero Economic Profit
•
•
Unlike a monopoly, firms in monopo‐
listic competition cannot earn eco‐
nomic profit in the long run. If the firms are earning an economic profit, other firms enter the market. Entry continues as long as firms in the indus‐
try earn an economic profit. As firms enter, each existing firm loses some of its market share. The demand for each firm’s product decreases and the firm’s demand curve shifts leftward. Eventually the demand decreases enough so that the firms earn only a normal profit, where P = ATC. Entry then stops. This outcome is illustrated in the figure, in which the firm pro‐
duces 13 pizzas per hour (where MR = MC ) and sets a price of $12 per pizza. Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
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Monopolistic Competition and Perfect Competition
Unlike firms in perfect competition, firms in monopolistic competition have excess capacity and a markup: • Excess Capacity: A firm has excess capacity if it produces less than the quantity at which average total cost is a minimum. The quantity at which average total cost is a minimum is the efficient scale. A firm in perfect competition produces at the efficient scale but, as the figure above shows, a firm in monopolistic competition produces less than the effi‐
cient scale of output. • Markup: A firm’s markup is the amount by which its price exceeds its marginal cost. A firm in perfect competition has no markup but, as the figure above shows, a firm in mo‐
nopolistic competition has a markup. Is Monopolistic Competition Efficient?
Firms in monopolistic competition have higher costs than firms in perfect competition, but firms in monopolistic competition produce variety, which is valued by consumers. So compared to the alternative of complete uniformity, monopolistic competition is efficient. 15.2
Output and Price Decisions
Innovation and Product Development
Monopolistically competitive firms compete through product development and marketing. New product development allows a firm to gain a temporary competitive edge and economic profit before competitors imitate the innovation. A firm decides upon the extent of innovation and product development by comparing the marginal cost of innovation or product development to its marginal revenue. Advertising
•
•
•
Advertising and packaging allow a firm to differentiate its product. Firms in monopolis‐
tic competition incur heavy advertising expenditures which make up a large portion of the price it charges for the product. Selling costs, such as advertising, are fixed costs that increase the ATC at any given level of output but do not affect the MC. Advertising efforts are successful if they increase de‐
mand, which can lead to increased profit. But if all firms advertise, more firms might survive and so the demand for any one firm is less than otherwise. Heavy marketing and advertising expenditures are a signal to consumers of a high‐
quality product. A signal is an action taken by an informed person (or firm) to send a message to uninformed people. Brand Names
Monopolistically competitive spend a lot of money to promote brand names. A brand name gives consumers information about the product quality. • Advertising and creating brand names are expensive. To the extent that they provide the consumer with valuable information, they are a benefit of monopolistic competition. But in some instances it seems as if the cost exceeds the benefit. So, ultimately the total effi‐
ciency of monopolistic competition is ambiguous. Chapter 15 . Monopolistic Competition
Lecture Launchers
1. Students have no difficulty seeing monopolistic competition in the world all around them. Emphasize that the work they’ve just done understanding the models of perfect competition and monopoly are not wasted because the real‐world situation of monopolistic competition, as its name implies, is a mixture of both extremes. Some of what they learned in each of the two previous chapters survives and operates in the middle ground of monopo‐
listic competition. 2. Product differentiation is the heart of the difference between monopoly and competition. After listing the characteristics of monopolistic competition and securing suggested examples of firms in monopolistic competition, you can get your students to suggest how, if they ran a small coffee shop, they could attract more customers than their competition. Or, discuss more gen‐
erally in what ways can producers in a monopolistically competitive market increase the demand for their product? Consider grocery stores: they have little latitude on prices as their markup is so small, so to build sales they at‐
tract customers in what ways? Some methods include friendliness, advertis‐
ing loss‐leaders, attractiveness of displays, speed, signage, perhaps even clean restrooms! Land Mines
1. While students have gotten familiar with the demand, marginal revenue, and marginal cost curves over the past two chapters, still take the time to point out the curves as you draw them. Use actual numbers for quantity and price. 2. Unlike the case of perfect competition, the demand curve for a firm’s differ‐
entiated product in monopolistic competition is downward sloping. Re‐
mind the students about the ceteris paribus condition that defines a de‐
mand curve. Along the demand curve for Nike tennis shoes, the prices of Adidas, Fila, Head, K Swiss, Prince, Reebok, and Wilson tennis shoes are constant. Some people prefer Nike to the other brands and will pay a bit more for Nike. Other people prefer some other brand and will buy Nike only if its price is low enough. Buyers have brand preferences, but they will switch brands if price differences are large enough. So the higher the price of a Nike shoe, the prices of the other brands remaining the same, the smaller is the quantity of Nike shoes demanded. 3. Students seem to have a bit of trouble appreciating that entry and exit change the demand for a firm’s product. Explain this effect by sticking with the tennis shoes example. Explain that the demand for Nike tennis shoes changes and the demand curve for Nike tennis shoes shifts if other firms enter or exit. If Tommy Hilfiger and the Gap started to make tennis shoes, 387
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some of Nike’s former customers would switch to these two new brands, and the demand for Nike shoes would decrease. The demand curve for Nike shoes would shift leftward. If Adidas, Fila, and Reebok stopped mak‐
ing tennis shoes, some of their former customers would switch to Nike, and the demand for Nike shoes would increase. The demand curve for Nike shoes would shift rightward. Chapter 15 . Monopolistic Competition
ANSWERS TO CHECKPOINT EXERCISES
CHECKPOINT 15.1 What Is Monopolistic Competition?
1a. The firms and the percentage of their total revenue shares are Truffles (30 percent), Bond (20 percent), Mayfair (15 percent), All Nature (15 percent), Gold (15 percent), and Magic (5 percent). The four largest are Truffles, Bond, and then two of Mayfair, All Nature, and Gold. The four‐firm concentration ratio is 30 + 20 + 15 + 15, which is 80. 1b. The HHI equals 302 + 202 + 152 + 152 + 152 + 52 = 2,000. 1c. Based on the four‐firm concentration ratio and the HHI, the chocolate in‐
dustry is an oligopoly. 1d. If firms in the chocolate industry face competition from foreign suppliers, the industry is more competitive than the four‐firm concentration ratio and HHI suggest. In this case the industry might be monopolistic competition. 1e. To be sure that the industry is monopolistic competition, we need to know the extent to which firms engage in product differentiation, whether firms are free to enter and exit, and the extent to which firms compete on product quality, price, and marketing. 2. The new technology lowers the barriers to entry. Most likely there would be entry of new firms, so there would be greater product differentiation and fiercer competition on product quality, price, and marketing. CHECKPOINT 15.2 Output and Price Decisions
1a. Lorie maximizes profits by producing 10 racquets. (Marginal cost is $15 a racquet. Marginal revenue between zero and 10 racquets is $20 and be‐
tween 10 and 20 racquets is $10, so marginal revenue equals $15 at 10 rac‐
quets.) Lorie’s charges $20 a racquet, which is the price from the demand curve for the 10th racquet a month. Lorie’s average fixed cost is $100 ($1,000 ÷ 10) and average variable cost (marginal cost) is $15 a racquet. Average to‐
tal cost is $115 a racquet. Lorie incurs an economic loss of $20 − $115, which is $95 a racquet. 1b. Firms will not enter; Firms will exit the restringing business. 1c. In the long run, the demand for Lorie’s restringing business will increase if she stays in the market. 1d. In the long run, Lorie will earn zero economic profit. Lori will either leave the industry or if she remains open, the demand for her services increases as other firms leave and she earns normal profit. 389
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CHECKPOINT 15.3 Product Development and Marketing
1a. The increase in demand will increase the number of cookies sold and most likely increase the price she charges. (The effect on the price depends on the precise manner in which the demand curve shifts, but most likely her price will rise.) Her economic profit will increase. 1b. If additional advertising enables sales to increase so that total revenue in‐
creases more than total cost, she can increase economic profit. Chapter 15 . Monopolistic Competition
ANSWERS TO CHAPTER CHECKPOINT EXERCISES
1a. The cable television market is not an example of monopolistic competition. 1b. The wheat market is not an example of monopolistic competition. 1c. The athletic shoe market is an example of monopolistic competition. There are several producers of athletic shoes, with extensive product differentia‐
tion and competition on quality, price, and marketing. 1d. The soda market is not an example of monopolistic competition. 1e. The shaving cream market is an example of monopolistic competition. There are several producers of shaving cream, with product differentiation and competition on quality, price, and marketing. 1f. The toothbrush market is an example of monopolistic competition. There are many producers of toothbrushes, with extensive product differentia‐
tion and competition on quality, price, and marketing. 1g. The ready‐mix concrete market is not an example of monopolistic competi‐
tion. 2. The audio equipment market is an example of monopolistic competition. 3a. Lite and Kool produces 125 pairs of shoes a week because this is the quan‐
tity at which marginal revenue equals marginal cost. 3b. Lite and Kool charges a price of $75 a pair of shoes. 3c. Lite and Kool’s price is $75 a pair of shoes and its marginal cost is $50 a pair of shoes. So, Lite and Kool’s markup is $75 a pair of shoes − $50 a pair of shoes, which is $25 a pair of shoes. 3d. Lite and Kool’s price is $75 a pair of shoes and its average total cost is $35 a pair of shoes. So Lite and Kool makes an economic profit of $75 a pair of shoes − $35 a pair of shoes, which is $40 a pair of shoes. Lite and Kool pro‐
duces 125 pairs of shoe a week, so its weekly economic profit is $40 × 125, which is $5,000 a week. 3e. Firms in monopolistic competition do not always have excess capacity in the short run. 3f. Lite and Kool does not have excess capacity. Its efficient scale, where its average total cost is at its minimum, is less than 125, so Lite and Kool is producing beyond its efficient scale. 3g. Firms enter the market because the existing firms, of which Lite and Kool is one, are earning an economic profit. 391
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4a. Figure 15.1 illustrates Stiff Shirt’s demand curve, marginal revenue curve, average total cost curve, and marginal cost curve. Stiff Shirt produces 100 shirts a week because this is the quantity at which marginal revenue equals marginal cost. 4b. Stiff Shirt charges a price of $85 a shirt. 4c. Stiff Shirt’s price is $85 a shirt and its mar‐
ginal cost is $70 a shirt. So, Stiff Shirt’s markup is $85 a shirt − $70 a shirt, which is $15 a shirt. 4d. Stiff Shirt’s economic profit equals the area of the gray rectangle in Figure 15.1 Stiff Shirt’s price is $85 a shirt and its average total cost is $75 a shirt. So Stiff Shirt makes an economic profit of $85 a shirt − $75 a shirt, which is $10 a shirt. Stiff Shirt produces 100 shirts a week, so its weekly economic profit is $10 × 100, which is $1,000. 4e. Stiff Shirt has excess capacity. Its efficient scale is greater than 100, so Stiff Shirt is producing less than its efficient scale. 4f. If Stiff Shirt increased its production, its average total cost would fall. 4g. Stiff Shirt does not increase its production because to do so would decrease its economic profit. 4h. Stiff Shirt is earning an economic profit, so firms will enter the market. 4i. As more firms enter the market, the demand for shirts from Stiff Shirt decreases and the price of a shirt falls. 5a. Figure 15.2 illustrates La Bella’s demand curve, marginal revenue curve, average total cost curve, and marginal cost curve. La Bella produces 75 pizzas a day because this is the quantity at which marginal revenue equals marginal cost. 5b. La Bella charges a price of $15 a pizza. 5c. La Bella incurs an economic loss equal to the area of the gray rectangle in Figure 15.2 La Bella’s price is $15 a pizza and its average to‐
tal cost is $16 a pizza. So La Bella makes an economic profit of $15 a pizza − $16 a pizza, which is −$1 a pizza, that is, La Bella incurs an economic loss of $1 a pizza. La Bella produces Chapter 15 . Monopolistic Competition
5d. 5e. 5f. 5g. 75 pizzas a day, so its economic loss is $1 × 75, which is $75 a day. La Bella is producing less than its efficient scale, so La Bella has excess ca‐
pacity. La Bella has a price markup because its price exceeds its marginal cost. La Bella is incurring an economic loss, so firms will exit the market. As firms exit the market, the price of a pizza rises. 6a. Bob produces 75 burgers a day because this is the quantity at which mar‐
ginal revenue equals marginal cost. 6b. Bob charges a price of $3 a burger. 6c. Bob’s price is $3 a burger and his average total cost is $3 a burger. So Bob makes zero economic profit. 6d. Other firms will not enter the burger industry because the firms, of which Bob is one, are earning zero economic profit, that is, they are earning nor‐
mal profit. 6e. Bob is producing less than his efficient scale, so Bob has excess capacity. 6f. Bob has a price markup because price exceeds marginal cost. 7a. Jeb is the wheat farmer. The market for wheat is perfectly competitive and, in the long run, firms in a perfectly competitive market produce at mini‐
mum average total cost. Jeb said that if he changed his production, his av‐
erage total cost would increase, which means that Jeb is producing at minimum average total cost. George runs the diner. Restaurants are in a monopolistically competitive market. Firms in monopolistic competition have excess capacity, which means that if they increase output, average to‐
tal cost would fall, which is what George described. 7b. Jeb, the wheat farmer, is producing as efficiently as possible because he is minimizing his average total cost. Firms in perfect competition are effi‐
cient. George is not producing as efficiently as possible because he could lower his average total cost if he produced more. Firms in monopolistic competition have excess capacity. 7c. Though the conversation does not bear directly on economic profit, firms in a competitive market—be it perfect competition or monopolistic compe‐
tition—earn zero economic profit in the long run. 393
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8a. Figure 15.3 shows Mike’s situation with no advertising. Mike produces 500 pairs of shoes a day, determined by the intersection of the MR curve and MC curve and sets a price of $100 a pair of running shoes. 8b. Figure 15.4 shows Mike’s situation with advertising. Relative to the no‐
advertising situation in Figure 15.3, Mike’s average total cost is higher at every level of output. The demand for Mike’s shoes has increased and the demand curve and marginal revenue curve have shifted rightward. Mike now produces 1,000 pairs of shoes a day, the quantity at which the mar‐
ginal cost curve and new marginal revenue curve intersect. Mike sets a price of $50 a pair of running shoes. 8c. Mike’s markup is larger in the no‐advertising situation. 8d. Mike has more excess capacity in the no‐advertising situation. 9a. No, the behavior does not mean that these people are irrational. They value the benefits provided by the name brand enough to buy the higher‐
priced, branded product. 9b. Brand names signal the consumer that a good or service has a high and consistent quality. 9c. Brand names give the producer the incentive to keep the quality of the good or service high and consistent. 9d. Brand names are efficient if the benefits of brand names exceed the costs of creating and maintaining brand names. In this case, banning brand names leads to inefficiency. Chapter 15 . Monopolistic Competition
Critical Thinking
10. Advertising and brand names have costs and benefits. Both advertising and establishing a brand name are costly endeavors. But these costs must be weighed against the benefits. For instance, some advertising provides consumers with valuable information. And, brand names signal the con‐
sumer that a good or service has a high and consistent quality. Brand names also give the producer the incentive to keep the quality of the good or service high and consistent. If the benefits of advertising and brand names exceed the costs, then they are beneficial to society. 11a. Students’ favorite commercials will vary from one student to the next. 11b. Most advertisements have some signaling aspect to them, especially those that are most entertaining. So it will be a rare student whose favorite commercial has no signal. 11c. Advertisements increase the producer’s profit by influencing the demand for the product and the costs of producing the product. If the advertise‐
ment increases the demand sufficiently, the firm’s profit increases. Indeed, if demand increases enough, the average total cost of the good or service falls, which can further increase the producer’s profit. 11d. The benefit of each advertisement will vary from one student to the next. Keep in mind that if the advertisement helps create or maintain a brand name, the advertisement reminds the consumer of the high and consistent quality of the product, which benefits the consumer. And the advertise‐
ment gives the producer the incentive to keep the product’s quality high and consistent, which also benefits the consumer. 11e. The advertisement can create a deadweight loss to the extent to which it stifles competition. And the fewer the number of firms in the market, the closer the output is to the monopoly output and the greater the dead‐
weight loss. 12a. Xerox does not want its brand name to be applied to all copiers because Xerox has spent a great deal of money advertising the high quality of its copiers. Xerox is concerned that consumers will come to think that the quality of its copies is the same as that of its competitors. 12b. Consumers benefit to the extent that Xerox continues to spend resources ensuring that the quality of its copiers remains high and consistent. 395
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Web Exercises
13a. The items picked by your students will vary from one student to the next. 13b. The items picked by your students will vary from one student to the next. 13c. The crucial point of explanation is that for the items selected as examples of monopolistic competition (the answer to part (a)), the four‐firm concen‐
tration ratio should be less than 40 and the HHI be less than 1,800 though less than 1,000 is preferable. And, for items selected as examples that are not monopolistic competition, the four‐firm concentration ratio should ex‐
ceed 60 and the HHI should be greater than 1,800. 14a. The item and the price will vary from one student to the next. 14b. The item and the price will vary from one student to the next. 14c. The answer will vary from one student to the next. In general, the expecta‐
tion is that the high‐price source offers a higher quality buying experience. For instance, the high‐price source might be one that is more well known than the low‐price source, so the shopper can feel more secure that the item will be delivered if he or she buys from the high‐price source. 14d. The students’ answers will vary from one student to another. Those who buy from the high‐price source must be able to point to some attribute that more than compensates for the higher price they would pay. 15a. Brand names benefit both the buyer and the seller. But unscrupulous peo‐
ple have taken to counterfeiting brand name merchandise. Counterfeiting harms consumers because they are not getting what they believe they are getting, namely an assurance of quality. In addition, if a consumer pur‐
chases an inferior quality counterfeit brand name product, the consumer is unable to complain to anyone about the poor quality. So be prudent about buying potentially counterfeited products. 15b. The article generally does a good job in identifying the benefits of brand names. The article states: “The owner of a brand uses it to insure that cus‐
tomers recognize the source of the product and that it is an indication of a consistent level of productʹs quality. Consumers can rely on a given brand to indicate the nature and quality to which he/she has become accus‐
tomed.” The article misses the idea that producers who brand their prod‐
ucts will strive to insure that the quality of the products remains high and consistent. 15c. The article is generally correct in its identification of the benefits to con‐
sumers. The article points out that “Consumers can rely on a given brand to indicate the nature and quality to which he/she has become accus‐
tomed.” Chapter 15 . Monopolistic Competition
16. The brand‐naming service offers to create brand names “based on the prin‐
ciples of linguistic morphology.” The service asserts “The right brand name makes consumers and other businesses want to use your product or associate with your company. The right brand name is what consumers remember when they want to use your product again.” It’s unclear how a particular brand name can lead to a consumer wanting to use a particular product, so this claim seems overblown. It is, however, correct that con‐
sumers must remember the brand name to buy the same product once again, so the second claim has some validity. The service also asserts that “A successful trade name should be instantly recognizable,” which also has validity. Essentially, a brand name will not have the benefits ascribed to it in this chapter unless consumers can remember the brand name and the product to which it is affixed. 397
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ADDITIONAL EXERCISES FOR ASSIGNMENT
Questions
CHECKPOINT 15.1 What Is Monopolistic Competition?
1. How would a merger between Pizza Hut and Papa Johns affect the four‐
firm concentration ratio for the home delivery pizza market? How would it affect the Herfindahl‐Hirschman Index for the home delivery pizza market? CHECKPOINT 15.2 Output and Price Decisions
2. Draw an example of a firm in monopolistic competition that is incurring an economic loss. Be sure to label all the curves. Indicate the area that equals the firm’s economic loss. CHECKPOINT 15.3 Product Development and Marketing
3. Explain how selling costs in monopolistic competition affect the efficiency of monopolistic competition. Answers
1. 2. CHECKPOINT 15.1 What Is Monopolistic Competition?
Both Pizza Hut and Papa Johns are two of the three largest firms in the home delivery pizza market. So a merger between Pizza Hut and Papa Johns would raise the four‐firm concentration ratio and raise the Herfin‐
dahl‐Hirschman Index. CHECKPOINT 15.2 Output and Price Decisions
Figure 15.5 illustrates a firm in monopolistic competition that is incurring an economic loss. The economic loss equals the area of the gray rectangle. Chapter 15 . Monopolistic Competition
3. CHECKPOINT 15.3 Product Development and Marketing
The additional selling costs from product differentiation and marketing increase consumer choice by providing variety. This benefits society and weighs in favor of the efficiency of monopolistic competition. Selling costs increase the costs of a monopolistically competitive firm above those of a perfectly competitive firm or a monopoly. Also, at times the product differ‐
entiation is more apparent than real. These factors harm society and count against the efficiency of monopolistic competition. 399
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USING EYE ON THE U.S. ECONOMY
Examples of Monopolistic Competition
You can list several of the industries given in the figure on the board. Ask stu‐
dents to list them in order of competitiveness. You also can use these data to promote discussion on calculating the four‐firm concentration ratio and the Her‐
findahl‐Hirschman Index.