Download Chapter 13: Monopolistic Competition: The Competitive Model in a

1
Economics
6th edition
Chapter 13
1
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Monopolistic Competition:
The Competitive Model in a
More Realistic Setting
2
Chapter Outline
13.1 Demand and Marginal Revenue for a Firm in a
Monopolistically Competitive Market
13.2 How a Monopolistically Competitive Firm Maximizes Profit in
the Short Run
13.3 What Happens to Profits in the Long Run?
13.4 Comparing Monopolistic Competition and Perfect
Competition
13.5 How Marketing Differentiates Products
13.6 What Makes a Firm Successful?
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Perfect Competition vs. Monopolistic
Competition
The perfectly competitive markets in the previous chapter had the
following three features:
1. Many firms
2. Firms sell identical products
3. No barriers to entry to new firms entering the industry
The first two features implied a horizontal demand curve for
individual firms, while the third implied zero long-run profit.
Monopolistically competitive firms share features #1 and #3, but
their products are not identical to their competitors’.
So we expect monopolistically competitive firms to have zero longrun profit but not to face a horizontal demand curve.
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Key Definitions
Explicit vs. Implicit Cost
Explicit Cost: A cost that involves spending money.
Implicit Cost: A nonmonetary opportunity cost.
Examples?
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Key Definitions
Profit = Total revenue (TR) – total cost (TC)
= (Price – ATC) * Q
Accounting Profit vs. Economic Profit
Accounting Profit: A firm’s net income, measured as revenue
minus operating expenses and taxes paid (i.e., explicit costs)
Economic Profit: A firm’s revenues minus all of its implicit and
explicit costs.
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Key Definitions
Accounting Profit: A firm’s net income, measured as revenue
minus operating expenses and taxes paid (i.e., explicit costs)
Economic Profit: A firm’s revenues minus all of its implicit and
explicit costs.
A company has $150,000 in revenues and $100,000 in explicit
costs and $25,000 in implicit costs. What are its:
Accounting profits?
Economic profits?
$50,000
$25,000
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13.1 Demand and Marginal Revenue for a
Firm in a Monopolistically Competitive Market
Explain why a monopolistically competitive firm has downward-sloping demand and
marginal revenue curves.
Monopolistic competition is a market structure in which barriers
to entry are low and many firms compete by selling similar, but not
identical, products.
The key feature here is that the products that monopolistically
competitive firms sell are differentiated from one another in some
way.
Example: Chipotle sells burritos and competes in the burrito
market against other firms selling burritos; but its burritos are not
identical to its competitors’.
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Figure 13.1 The Downward-Sloping Demand Curve for
Burritos at Chipotle
Chipotle sells burritos;
while other firms also sell
burritos, some customers
have a preference for
Chipotle’s burritos.
So if Chipotle raises its
price, some but not all of
its customers will switch
to buying their burritos
elsewhere.
This means Chipotle
faces a downwardsloping demand curve.
If Chipotle were in a perfectly competitive mkt,
what would happen if raised prices?
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Table 13.1 Demand and Marginal Revenue at a Chipotle
Burritos
Sold
per Week
(Q)
0
1
2
3
4
5
6
7
8
9
10
11
Price (P)
$10.00
9.50
9.00
8.50
8.00
7.50
7.00
6.50
6.00
5.50
5.00
4.50
Total Revenue
𝑇𝑅 = 𝑃 × 𝑄
$0.00
9.50
18.00
25.50
32.00
37.50
42.00
45.50
48.00
49.50
50.00
49.50
Average
Revenue
𝑇𝑅
𝐴𝑅 =
𝑄
Marginal
Revenue
𝛥𝑇𝑅
𝑀𝑅 =
𝛥𝑄
—
$9.50
9.00
8.50
8.00
7.50
7.00
6.50
6.00
5.50
5.00
4.50
—
$9.50
8.50
7.50
6.50
5.50
4.50
3.50
2.50
1.50
0.50
−0.50
Total revenue increases initially, then decreases; Chipotle has to
lower the price in order to sell additional burritos.
So marginal revenue is initially positive, then negative.
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Figure 13.2 How a Price Cut Affects a Firm’s Revenue (1 of 2)
When Chipotle reduces the price
of a burrito, it sells (let’s say) 1
more burrito.
Its revenue increases because of
the extra sale;
this is the output effect
of the price reduction.
But its revenue decreases also;
to sell another burrito, it reduces
the price on all burritos. It loses
$0.50 in revenue on each of the
burritos it would have already
sold at $7.50. This is the price
effect of the price reduction.
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Figure 13.2 How a Price Cut Affects a Firm’s Revenue (2 of 2)
Chipotle’s marginal revenue
for selling the extra burrito is
equal to the green area minus
the pink area: the output effect
minus the price effect.
MR = $7 - $2.50 = $4.50
The output effect is equal to
the price ($7); so marginal
revenue is lower than the
price.
For any firm with a downwardsloping demand curve, its
marginal revenue curve must
be below its demand curve.
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Figure 13.3 The Demand and Marginal Revenue Curves
for a Monopolistically Competitive Firm
After the tenth burrito,
reducing the price in order to
increase sales results in
revenue decreasing
(negative marginal revenue).
 The price effect becomes
larger than the output
effect.
 Rev. from selling 1 more
burrito < loss from
receiving lower price on all
burritos sold
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General point for Monopolistically Competitive Firms: Every
firm that has the ability to affect the price of the good it sells
will have a marginal revenue curve below its demand curve
Demand = MR
(Perfectly
Competitive)
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14
One reason why the "fast-casual" restaurant market is
competitive is that
A) demand for "fast -casual" food is very high.
B) it is trendy and therefore is likely to have a customer
following.
C) barriers to entry are low.
D) consumption takes place in public.
C
The reason that the "fast-casual" restaurant market is
monopolistically competitive rather than perfectly
competitive is because
A) barriers to entry are very low.
B) there are many firms in the market.
C) products are differentiated.
D) entry into the market is blocked.
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C
Quantity
1
2
3
4
5
6
Price
(dollars)
$7.50
7.00
6.50
6.00
5.50
5.00
What is the marginal revenue of the
3rd unit?
A) $6.50
B) $5.50
C) $1.83
D) $0.50
B
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Total Revenue
(dollars)
$7.50
14.00
19.50
24.00
27.50
30.00
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Quantity
1
2
3
4
5
6
Price
(dollars)
$7.50
7.00
6.50
6.00
5.50
5.00
The Table shows
A) an elastic segment of the demand schedule.
B) an inelastic segment of the demand schedule.
C) a demand schedule with an elastic segment from $7.50 to $6.50 followed
by an inelastic segment.
D) a demand schedule with an inelastic segment from $7.50 to $6.50
followed by an elastic segment.
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Total Revenue
(dollars)
$7.50
14.00
19.50
24.00
27.50
30.00
A
Quantity
1
2
3
4
5
6
Price
(dollars)
$7.50
7.00
6.50
6.00
5.50
5.00
Total Revenue
(dollars)
$7.50
14.00
19.50
24.00
27.50
30.00
What portion of the marginal revenue of the 4th unit is due to the
output effect and what portion is due to the price effect?
A) output effect = $24.00; price effect = $19.50
B) output effect = $6.50; price effect = $2.00
C) output effect = -$0.50; price effect = $5.00
D) output effect = $6.00; price effect = -$1.50
D
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13.2 How a Monopolistically Competitive
Firm Maximizes Profit in the Short Run
Explain how a monopolistically competitive firm maximizes profit in the short run.
Just like a perfectly competitive firm, a monopolistically
competitive firm should not simply try to maximize revenue.
• Each additional unit of output incurs some marginal cost.
• Profit maximization requires producing until the marginal
revenue from the last unit is just equal to the marginal cost:
MC = MR.
• This same rule holds for all firms that can marginally adjust
their output.
 Short run – means that not enough time for new firms to enter
the market
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Figure 13.4 Maximizing Profit in a Monopolistically
Competitive Market (Next 3 Slides)
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Burritos
Sold per
Week
(Q)
Price
(P)
0
$10.00
$0.00
—
$6.00
—
—
–$6.00
1
9.50
9.50
$9.50
11.00
$5.00
$11.00
–1.50
2
9.00
18.00
8.50
15.50
4.50
7.75
2.50
3
8.50
25.50
7.50
19.50
4.00
6.50
6.00
4
8.00
32.00
6.50
24.50
5.00
6.13
7.50
5
7.50
37.50
5.50
30.00
5.50
6.00
7.50
6
7.00
42.00
4.50
36.00
6.00
6.00
6.00
7
6.50
45.50
3.50
42.50
6.50
6.07
3.00
8
6.00
48.00
2.50
49.50
7.00
6.19
–1.50
9
5.50
49.50
1.50
57.00
7.50
6.33
–7.50
10
5.00
50.00
0.50
65.00
8.00
6.50
–15.00
11
4.50
49.50
–0.50
73.50
8.50
6.68
–24.00
Total
Marginal
Revenue Revenue
(TR)
(MR)
Total
Cost
(TC)
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Marginal Average
Cost
Total Cost
(MC)
(ATC)
Profit
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Chipotle sells burritos up until MC = MR.
This selects the profit-maximizing quantity. Then the demand curve shows
the price, and the ATC curve shows the average cost.
Since Profit = (P – ATC) x Q, we can show profit on the graph with the
green rectangle.
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To identify profit:
1. Use MC=MR to identify the profitmaximizing quantity.
2. Draw a vertical line at that quantity.
3. The vertical line will hit the demand
curve: this is the price.
4. The vertical line will also hit the ATC
curve: this is the average cost.
5. The difference between price and
average cost is the profit (or loss) per
unit.
6. Show the profit or loss with the
rectangle with height (P – ATC) and
length (Q* – 0), where Q* is the optimal
quantity.
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What is the profit-maximizing rule for a monopolistically
competitive firm?
A) to produce a quantity that maximizes market share
B) to produce a quantity that maximizes total revenue
C) to produce a quantity such that marginal revenue equals
marginal cost
D) to produce a quantity such that price equals marginal cost
C
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13.3 What Happens to Profits in the
Long Run?
Analyze the situation of a monopolistically competitive firm in the long run.
When a firm has total revenue greater than total cost, it makes an
economic profit.
• This economic profit gives entrepreneurs an incentive to enter
the market.
In our previous example, Chipotle makes an economic profit.
• We expect new firms to enter the burrito market over long run.
• These new firms will reduce the demand for Chipotle’s burritos.
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Figure 13.5 How Entry of New Firms Eliminates Profits
At first (left panel), Chipotle has few competitors, so demand for its
burritos is high. It makes an economic profit.
This economic profit attracts new firms, decreasing the demand for
Chipotle’s burritos (right panel).
This continues until Chipotle no longer makes an economic profit.
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Table 13.2 The Short Run and the Long Run for a Monopolistically
Competitive Firm (1 of 3)
In the short run, a monopolistically competitive firm might make a profit or
a loss. The situation where the firm is making a profit is above.
Notice that there are quantities for which demand (price) is above ATC;
this is what allows the firm to make a profit.
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Table 13.2 The Short Run and the Long Run for a Monopolistically
Competitive Firm (2 of 3)
Now the firm is making a loss.
Notice that there is now no quantity for which demand (price) is
above ATC; this firm must make a (short-run) economic loss, no
matter what quantity it chooses.
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Table 13.2 The Short Run and the Long Run for a Monopolistically
Competitive Firm (3 of 3)
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In the long run, the firm must break even. Notice that the ATC curve is just
tangent to the demand curve. The best the firm can do is to produce Q.
There is no quantity at which the firm can make a profit; the ATC curve is never
below the demand curve.
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Zero Profit in the Long Run?
Our model of monopolistic competition predicts that firms will earn
zero profit in the long run.
However firms need not passively accept this long-run outcome.
They could:
• Innovate so that their costs are lower than other firms, or
• Convince their customers that their product/experience is better
than that of other firms, either by actually making it better in
some unique way or making customers perceive that it is better,
perhaps through advertising.
Think of the long-run as “the direction of trend”; demand will
continue to fall to the zero (economic) profit level, unless the firm
is able to do something about it.
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Making the Connection: How Can
Chipotle Maintain Its Economic Profit?
One of Chipotle’s early marketing
strategies was to convince people
it was healthier than alternative
fast foods.
• But some reports have
suggested this is not the case.
To maintain its edge, Chipotle has
tried to appear more socially
responsible.
• It announced it would stop
using genetically modified
ingredients and publicized
buying many local ingredients.
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In the long run, if price is less than average cost
A) there is an incentive for firms to exit the market.
B) there is profit incentive for firms to enter the market.
C) the market must be in long-run equilibrium.
D) there is no incentive for the number of firms in the market
to change.
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A
31
A monopolistically competitive firm that is earning profits will,
in the long run, experience all of the following except
A) new rivals entering the market.
B) a decrease in demand for its product.
C) demand for the firm's product becomes more elastic.
D) a decrease in the number of rival products.
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D
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What is the
monopolistic
competitor's profit
maximizing output?
A) Q1 units
B) Q2 units
C) Q3 units
D) Q4 units
B
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What is the
monopolistic
competitor's profit
maximizing price?
A) P1
B) P2
C) P3
D) P4
D
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34
The firm represented
in the diagram
A) should exit the
industry.
B) makes zero
accounting profit.
C) makes zero
economic profit.
D) should expand its
output to take
advantage of
economies of scale.
C
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13.4 Comparing Monopolistic
Competition and Perfect Competition
Compare the efficiency of monopolistic competition and perfect competition.
Last chapter we learned that perfectly competitive firms achieved
two types of economic efficiency.
• Productive efficiency refers to producing items at the lowest
possible cost. (minimum pt of ATC curve)
• Allocative efficiency refers to producing all goods up to the
point where the marginal benefit to consumers is just equal to
the marginal cost to firms. [MC = MB (demand curve)]
 Monopolistic competition results in neither productive nor
allocative efficiency.
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Figure 13.6 Comparing Long-Run Equilibrium under Perfect
Competition and Monopolistic Competition (1 of 2)
In panel (a), a perfectly competitive firm in long-run equilibrium produces
at QPC, where price equals marginal cost and average total cost is at a
minimum. The perfectly competitive firm is both allocatively efficient and
productively efficient.
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Figure 13.6 Comparing Long-Run Equilibrium under Perfect
Competition and Monopolistic Competition (2 of 2)
Monopolistically competitive firms in panel (b) produce the quantity
where MC=MR. The marginal benefit to consumers is given by the
demand curve, so MC≠MB: not allocatively efficient.
And average cost is above its minimum point: not productively efficient.
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38
Is Monopolistic Competition Bad for
Consumers?
The lack of efficiency suggests that monopolistic competition is a
bad situation for consumers.
• But consumers might benefit from the product differentiation.
Example: If you were buying a car, would you prefer one
a. Produced and sold at the lowest possible cost but not wellsuited to your tastes and preferences; or
b. Produced and sold at a higher cost but designed to attract you
to purchasing it?
Many consumers are willing to accept a higher price for a
differentiated product. So monopolistic competition is not
necessarily bad for consumers.
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39
Making the Connection: Are All
Cupcakes the Same?
In 2002, Mia Bauer opened a
gourmet cupcake store,
Crumbs Bake Shop.
• She sold gourmet
cupcakes and was initially
very profitable, expanding
to 63 stores in 10 states.
But her brand was
insufficient to keep
competitors out of the
market, and in July 2014
Crumbs declared bankruptcy.
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40
What is the
productively efficient
output for the firm
represented in the
diagram?
A) Q1 units
B) Q2 units
C) Q3 units
D) Q4 units
D
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41
What is the
allocatively efficient
output for the firm
represented in the
diagram?
A) Q1 units
B) Q2 units
C) Q3 units
D) Q4 units
C
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What is the amount42
of excess capacity?
A) Q4 - Q3 units
B) Q4 - Q2 units
C) Q3 - Q2 units
D) Q3 - Q1 units
B
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43
13.5 How Marketing Differentiates
Products
Define marketing and explain how firms use marketing to differentiate their products.
Making customers believe that your product is worthwhile and
different from those of other firms is not a trivial exercise. It
typically involves some degree of marketing.
Marketing: All the activities necessary for a firm to sell a product
to a consumer.
Once a firm manages to differentiate its product, it must continue
to do so or risk heading toward the long-run outcome of zero
economic profit. The process of doing this is known as brand
management.
Brand management: The actions of a firm intended to maintain
the differentiation of a product over time.
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44
Advertising
Advertising is a critical element of marketing for monopolistically
competitive firms.
• By advertising effectively, firms can increase demand for their
products.
But they can also use advertising to differentiate their products:
effectively making the demand curve more inelastic.
• This allows firms to charge a higher price and earn more shortrun profit.
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45
Defending a Brand Name
Marketing experts and psychologists agree: a critical aspect of
marketing is creating a brand name for your product.
• A successful brand name can help to maintain product
differentiation and delay the ability of other firms to compete
away your profits.
But firms must always try to maintain the perception of their product
as better than others, making sure that, for example:
• A highly-successful name like Coke, Xerox, or Band-Aid is
uniquely associated to that product and not to generic products,
• Other firms don’t illegally use their brand name, and
• Franchisees and others legally allowed to use their brand name
maintain the level of quality and service you expect.
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46
13.6 What Makes a Firm Successful?
Identify the key factors that determine a firm’s success.
A firm’s ability to differentiate its product and to produce it at a
lower average cost than competing firms creates value for its
customers.
• Some factors that affect a firm’s profitability are not directly
under the firm’s control. Certain factors will affect all the firms in
a market.
• The factors under a firm’s control—the ability to differentiate its
product and the ability to produce it at lower cost—combine
with the factors beyond its control to determine the firm’s
profitability.
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47
Figure 13.7 What Makes a Firm Successful?
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48
Making the Connection: Is Being the
First Firm in a Market a Key to Success?
By being the first to sell a particular good, a firm may
gain a first-mover advantage, finding its name closely
associated with the good in the public’s mind.
Surprisingly, recent research has shown that the first
firm to enter a market often does not have a long-lived
advantage over later entrants.
Among dominant, but not first brands:
• Bic pens
• Apple iPod digital music player
• Hewlett Packard laser printers
In the end, providing customers with good products at a
low price is probably the best way to ensure success.
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