Download MONOPOLISTIC COMPETITION INTRODUCTION Key questions

INTRODUCTION

Key questions answered in this chapter include:



What are the unique features of monopolistic
competition?
How are the market outcomes affected by this market
structure?
What are the long-run consequences of different
market structures?
MONOPOLISTIC COMPETITION
Chapter 11
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STRUCTURE
LOW CONCENTRATION
A distinguishing structural characteristic of
monopolistic competition is that there are “many”
firms in the industry.
 Monopolistic competition is a market in which
many firms produce similar goods or services but
each maintains some independent control of its
own price.
 “Many” is somewhere between the “few” of
oligopolies or the “hordes” that characterize
perfect competition.


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).
Examples of monopolistic competition include
banks, radio stations, health spas, apparel stores,
and convenience stores.
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MARKET POWER


INDEPENDENT PRODUCTION DECISIONS
Each producer in monopolistic competition is
large enough to have some market power.

4
Modest changes in the output or price of any
single firm will have no perceptible influence on
the sales of any other firm.
 The relative independence of monopolist
competitors means that they don’t have to worry
about retaliatory responses to every price or
output change.

Market Power – The ability to alter the market
price of a good or service.
A monopolistically competitive firm confronts a
downward-sloping demand curve for its output.
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LOW ENTRY BARRIERS

BEHAVIOR: PRODUCT DIFFERENTIATION
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.
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.
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BRAND IMAGE
BRAND LOYALTY
Each firm has a distinct identity – a brand
image.
 Consumers perceive its output to be somewhat
different than others in the industry.
 By
differentiating their products, monopolistic
competitors establish brand loyalty.
 Brand loyalty gives producers greater control
over the price of their products.
 Each firm only has a monopoly on its brand
image.


It still competes with other firms offering close
substitutes.
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BRAND LOYALTY
SHORT-RUN PRICE AND OUTPUT
 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.

 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.
The monopolistically competitive firm’s
production decision is similar to that of a
monopolist.

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Production decision - The selection of the shortrun rate of output (with existing plant and
equipment).
As always, the profit-maximizing rate of output is
achieved by producing the quantity where MR =
MC.
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EQUILIBRIUM IN MONOPOLISTIC
COMPETITION
ENTRY AND EXIT
With low barriers to entry, new firms will enter
the market if there is economic profit.
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.
 In
the long run, there are no economic
profits in monopolistic competition.
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EFFECTS OF ENTRY ON INDUSTRY AND
FIRM
New entry
Later market
supply
Market
demand
Quantity (units per time period)
Price (per unit)
Price (per unit)
Initial market
supply
Reduced
market
share
ca
0
F
MC
K
ATC
Demand
MR
qa
Quantity (units per period)
MC
ATC
pg
G
Initial
demand
Later
demand
0
qg Later MR
Quantity(units per period)14
INEFFICIENCY

Effect of entry on the
monopolistically competitive firm
Effect of entry on the industry
pa
The long run
Price or Cost (dollars per unit)

The short run
Economic profit – The difference between total
revenues and total economic costs.

Price or Cost (dollars per unit)

Monopolistic competition tends to be less efficient
in the long run than a perfectly competitive
industry.
Initial demand
facing firm
Later demand
facing film
Quantity (units per time period)
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EXCESS CAPACITY
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FLAWED PRICE SIGNALS
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.
The monopolistically competitive firm will always
price its output above the level of marginal cost.
 Monopolistic competition results in both
production inefficiency (above-minimum average
cost) and allocative inefficiency (wrong mix of
output).


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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.
 Advertising may be more responsible for brand
loyalty than the taste of the product.

MONOPOLISTIC COMPETITION
 Having
a recognizable name is worth
billions in sales.
End of Chapter 11
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