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Monopolistic
Competition
Topics to be Discussed

Monopolistic Competition

Oligopoly

Price Competition

Competition Versus Collusion: The
Prisoners’ Dilemma
Chapter 12
Slide 2
Topics to be Discussed

Implications of the Prisoners’ Dilemma
for Oligopolistic Pricing

Cartels
Chapter 12
Slide 3
Monopolistic Competition

Characteristics
1) Many firms
2) Free entry and exit
3) Differentiated product
Chapter 12
Slide 4
Monopolistic Competition

The amount of monopoly power
depends on the degree of
differentiation.

Examples of this very common market
structure include:

Toothpaste

Soap

Cold remedies
Chapter 12
Slide 5
Monopolistic Competition

Toothpaste

Chapter 12
Crest and monopoly power

Procter & Gamble is the sole producer of
Crest

Consumers can have a preference for
Crest---taste, reputation, decay preventing
efficacy

The greater the preference
(differentiation) the higher the price.
Slide 6
Monopolistic Competition

Question

Chapter 12
Does Procter & Gamble have much monopoly
power in the market for Crest?
Slide 7
Monopolistic Competition

The Makings of Monopolistic Competition
 Two
Chapter 12
important characteristics

Differentiated but highly substitutable
products

Free entry and exit
Slide 8
A Monopolistically Competitive
Firm in the Short and Long Run
$/Q
Short Run
$/Q
MC
Long Run
MC
AC
AC
PSR
PLR
DSR
DLR
MRSR
QSR
Quantity
MRLR
QLR
Quantity
A Monopolistically Competitive
Firm in the Short and Long Run

Observations (short-run)

Downward sloping demand--differentiated
product

Demand is relatively elastic--good
substitutes

MR < P

Profits are maximized when MR = MC

This firm is making economic profits
Chapter 12
Slide 10
A Monopolistically Competitive
Firm in the Short and Long Run

Observations (long-run)

Profits will attract new firms to the industry
(no barriers to entry)

The old firm’s demand will decrease to DLR

Firm’s output and price will fall

Industry output will rise

No economic profit (P = AC)

P > MC -- some monopoly power
Chapter 12
Slide 11
Comparison of Monopolistically Competitive
Equilibrium and Perfectly Competitive Equilibrium
Monopolistic Competition
Perfect Competition
$/Q
$/Q
MC
Deadweight
loss
AC
MC
AC
P
PC
D = MR
DLR
MRLR
QC
Quantity
QMC
Quantity
Monopolistic Competition

Monopolistic Competition and Economic
Efficiency
 The
monopoly power (differentiation) yields
a higher price than perfect competition. If
price was lowered to the point where
MC = D, consumer surplus would increase
by the yellow triangle.
Chapter 12
Slide 13
Monopolistic Competition

Monopolistic Competition and Economic
Efficiency
 With
no economic profits in the long run,
the firm is still not producing at minimum
AC and excess capacity exists.
Chapter 12
Slide 14
Monopolistic Competition

Questions
1) If the market became competitive,
what would happen to output
and price?
2) Should monopolistic competition be
regulated?
Chapter 12
Slide 15
Monopolistic Competition

Questions
3) What is the degree of monopoly
power?
4) What is the benefit of product
diversity?
Chapter 12
Slide 16
Monopolistic Competition
in the Market for Colas and Coffee

The markets for soft drinks and coffee
illustrate the characteristics of
monopolistic competition.
Chapter 12
Slide 17
Elasticities of Demand for
Brands of Colas and Coffee
Brand
Colas:
Ground Coffee:
Chapter 12
Elasticity of Demand
Royal Crown
Coke
Hills Brothers
Maxwell House
Chase and Sanborn
-2.4
-5.2 to -5.7
-7.1
-8.9
-5.6
Slide 18
Elasticities of Demand for
Brands of Colas and Coffee

Questions
1) Why is the demand for Royal Crown
more price inelastic than for Coke?
2) Is there much monopoly power in
these two markets?
3) Define the relationship between
elasticity and monopoly power.
Chapter 12
Slide 19