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The Kinked Demand Curve
Price, cost
marginal
revenue
W
If production increases beyond Q*, other firms
will retaliate and produce more too  firm will
gain very few sales.
If production decreases , firm does not
expect rivals to do the same 
firm will lose relatively
large # of sales.
Tacit collusion
outcome
MC
P*
1
MC
2
X
1. Any marginal
cost in this
region
Y
MR
D
Q*
Z
2. … corresponds to this level of
output
Quantity
Warm-up: November 4, 2016
Leo manages the Wonderful Wok stand in the food court of a
big shopping mall. He offers the only Chinese food there, but
there are more than a dozen alternatives, from burgers to
pizza to burritos.
1. How much market power does Leo have? (power to
set prices)
2. How would you describe Leo’s situation? Is this
perfect competition? Monopoly? Oligopoly?
Monopolistic Competition:
1. Large # of sellers
ex: vendors in food court, hotels in
Anaheim, clothing stores at the mall
2. Differentiated products
ex: Chinese vs. burgers vs. pizza vs.
Mexican
3. Free entry and exit in the long run
Product Differentiation
Differentiation by style/type
Example: (again) vendors in food court
Let’s say chinese food is $7/plate, but a burger
meal is $5. Would you ever choose the
more expensive meal? Why?
Other examples of differentiation by style/type:
vs
vs
vs
Differentiation by Location
Example: gas stations in a city (gas is not monop
comp though)
The gas is the same (more or less) but location
matters to consumers
1997
Differentiation by pay method:
June 2008
Differentiation by Quality
VS
Understanding Monopolistic Competition

Because each firm is offering a distinct product, it faces
a downward-sloping demand curve and has some
market power—the ability within limits to determine
the price of its product.

However, a monopolistically competitive firm does face
competition: the amount of its product it can sell
depends on the prices and products offered by other
firms in the industry.
The MC Firm in the Short Run
(b) An Unprofitable Firm
(a) A Profitable Firm
Price,
cost,
marginal
revenue
Price,
cost,
marginal
revenue
MC
MC
ATC
P
P
ATC
U
P Loss
U
Profit
ATC
ATC
P
MR
P
Q
P
Profit-maximizing quantity
D
P
D
U
MR
U
Q
U
Quantity
Loss-minimizing quantity
What does this diagram remind you of??
Quantity
Monopolistic Competition in the Long Run

If the typical firm earns positive profits, new firms will enter
the industry in the long run, shifting each existing firm’s
demand curve to the left. If the typical firm incurs losses,
some existing firms will exit the industry in the long run,
shifting the demand curve of each remaining firm to the
right.

In the long run, equilibrium of a monopolistically competitive
industry, the zero-profit-equilibrium, firms just break even.
The typical firm’s demand curve is just tangent to its average
total cost curve at its profit-maximizing output.
What does this remind you of??
So, here’s what happens:
1.Firm is profiting (yay!)
2.Outsiders see this, they enter the market to get
some of your profits (boo!)
3.The new competition takes some of your customers
– demand for your product falls ()
4.Firms enter until all firms break even in the long
run.
Entry and Exit Shift Existing Firm’s Demand Curve and
Marginal Revenue Curve
(a) Effects of Entry
(b) Effects of Exit
Price,
marginal
revenue
Price,
marginal
revenue
Entry shifts the
existing firm’s
demand curve and its
marginal revenue
curve leftward.
MR
2
MR
1
D
2
D
1
Quantity
Exit shifts the
existing firm’s
demand curve and
its marginal
revenue curve
rightward.
MR
1
MR D1
2
D
2
Quantity
The Long-Run Zero-Profit Equilibrium
Price, cost,
marginal revenue
MC
Point of tangency
ATC
Z
P
= ATC
MR
Q
D
Quantity
Partner practice:
1. Currently a monopolistically competitive industry, composed of firms
with U-shaped average total cost curves, is in long-run equilibrium.
Describe how the industry adjusts, in both the short and long run, in
each of the following situations.
A. A technological change that increases fixed cost for every firm
in the industry. Illustrate this with a graph.
B. A technological change that decreases marginal cost for every
firm in the industry (you can try the graph, good luck)
2. Why, in the long run, is it impossible for firms in a monopolistically
competitive industry to create a monopoly by joining together to
form a single firm?
3. The market for clothes is monopolistically competitive. What impact
will fewer firms in the industry have on you as a consumer?
Address the following issues:
a. Variety of clothes
b. Differences in quality of service
c. Price
Warm-up: December 9, 2013
Use the three conditions for M.C. to determine if the
following firms are likely to be operating as
monopolistic competitors. If not, are they more like
monopoly? Oligopoly? PC?
1. A local band that plays for weddings, parties, etc.
2. Minute Maid, a producer of individual-serving juice
boxes
3. Your local dry cleaner
4. A farmer who produces soybeans
Warm-up: December 10, 2012
Is Monopolistic Competition Inefficient?
 Firms in a monopolistically competitive industry
have excess capacity: they produce less than the
output at which average total cost is minimized.
 Price exceeds marginal cost, so some mutually
beneficial trades are unexploited.
 The higher price consumers pay because of excess
capacity is offset to some extent by the value they
receive from greater diversity.
 Hence, it is not clear that this is actually a source of
inefficiency.
Question: Why don’t milk companies advertise?
Controversies About Product Differentiation
No discussion of product differentiation is complete
without spending at least a bit of time on the two related
issues—and puzzles—of advertising and brand names.
Why do firms advertise?
What types of messages are conveyed through
advertisements?
What makes certain advertisements effective?
Which of the following advertisements are economically
useful?
What is the effect of brand names on consumers?
Which Burberry bag is the real deal?
Is there really any difference??
Brand names can also convey information:
Example: On a long road trip, you stop in a small town
to stay the night. You have the option of staying at a
Holiday Inn or the Happi Inn. Which are you most likely
to choose?
1. In which of the following cases is advertising likely to be
economically useful? Economically wasteful?
a. Ads on the benefits of aspirin
b. Ads on the benefits of Bayer aspirin
c. Ads on the benefit of drinking orange juice
d. Ads on the benefit of drinking Tropicana orange
juice
e. Ads that state how long a plumber or an
electrician has been in business
2. Some analysts have stated that a successful brand
name is like a barrier to entry. Explain the reasoning
behind this statement.