Download Monopolistic Competition

Monopolistic Competition
Chapter 11
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Structure
• A distinguishing structural characteristic of
monopolistic competition is that there are
“many” firms in the industry.
• “Many” is somewhere between the “few” of
oligopolies or the “hordes” that
characterize perfect competition.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Structure
• Monopolistic competition is a market in
which many firms produce similar goods or
services but each maintains some
independent control of its own price.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Low Concentration
• Low concentration ratios are common in
monopolistic competition.
– Concentration ratio – The proportion of total
industry output produced by the largest firms
(usually the four largest).
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Market Power
• Each producer in monopolistic competition
is large enough to have some market
power.
– Market Power – The ability to alter the market
price of a good or service.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Market Power
• A monopolistically competitive firm
confronts a downward-sloping demand
curve for its output.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Independent Production
Decisions
• Modest changes in the output or price of
any single firm will have no perceptible
influence on the sales of any other firm.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Independent Production
Decisions
• The relative independence of monopolist
competitors means that they don’t have to
worry about retaliatory responses to every
price or output change.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Low Entry Barriers
• Another characteristic of monopolistic
competition is the presence of low barriers
to entry.
– Barriers to entry – Obstacles that make it
difficult or impossible for would-be producers
to enter a particular market, such as patents.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Behavior
• Monopolistic competition has distinctive
behavior.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Product Differentiation
• One of the most notable features of
monopolistically competitive behavior is
product differentiation.
– Product differentiation - Features that make
one product appear different from competing
products in the same market.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Brand Image
• Each firm has a distinct identity – a brand
image.
• Consumers perceive its output to be
somewhat different than others in the
industry.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Brand Loyalty
• By differentiating their products,
monopolistic competitors establish brand
loyalty.
• Brand loyalty gives producers greater
control over the price of their products.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Brand Loyalty
• Each firm only has a monopoly on its brand
image.
• It still competes with other firms offering
close substitutes.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Brand Loyalty
• Brand loyalty makes the demand curve
facing the firm less price-elastic.
• Brand loyalty implies that consumers shun
substitute goods even when they are
cheaper.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Brand Loyalty
• Each monopolistically competitive firm will
establish some consumer loyalty.
• A symptom of brand loyalty is the price
differences between computers which are
essentially the same.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Short-Run Price and Output
• The monopolistically competitive firm’s
production decision is similar to that of a
monopolist.
– Production decision - The selection of the
short-run rate of output (with existing plant and
equipment).
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Short-Run Price and Output
• As always, the profit-maximizing rate of
output is achieved by producing the
quantity where MR = MC.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Entry and Exit
• With low barriers to entry, new firms will
enter the market if there is economic profit.
– Economic profit – The difference between
total revenues and total economic costs.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Entry and Exit
• When firms enter a monopolistically
competitive industry:
– The market supply curve shifts to the right.
– The demand curves facing individual firms
shift to the left.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
No Long-Run Profits
• In the long run, there are no economic
profits in monopolistic competition.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Equilibrium in Monopolistic
Competition
F
pa
ca
MC
The long run
ATC
Demand
K
MR
0
qa
Quantity (units per period)
McGraw-Hill/Irwin
Price or Cost (dollars per unit)
Price or Cost (dollars per unit)
The short run
MC
ATC
pg
G
Initial
demand
Later
demand
0
qg Later MR
Quantity(units per period)
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Effects of Entry on Industry and
Firm
Effect of entry on the
monopolistically competitive firm
p1
p2
Initial market
supply
Later market
supply
New entry
MR
Market
demand
Quantity (units per time period)
McGraw-Hill/Irwin
Price (per unit)
Price (per unit)
Effect of entry on the industry
Reduced
market
share
Initial demand
facing firm
Later demand
facing film
Quantity (units per time period)
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Inefficiency
• Monopolistic competition tends to be less
efficient in the long run than a perfectly
competitive industry.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Excess Capacity
• Because of the industry-wide excess
capacity, each firm produces a rate of
output that is less than its minimum ATC.
• Thus, the same level of industry output
could be produced at lower cost with fewer
firms.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Flawed Price Signals
• The monopolistically competitive firm will
always price its output above the level of
marginal cost.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Flawed Price Signals
• Monopolistic competition results in both
production inefficiency (above-minimum
average cost) and allocative inefficiency
(wrong mix of output).
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
No Cease-Fire in Advertising
Wars
• In truly (perfectly) competitive industries,
firms compete on the basis of price.
• Imperfectly competitive firms engage in
nonprice competition – the most prominent
form being advertising.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
No Cease-Fire in Advertising
Wars
• Advertising may be more responsible for
brand loyalty than the taste of the product.
• Having a recognizable name is worth
billions in sales.
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Monopolistic Competition
End of Chapter 11
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.