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Monopolistic Competition • Monopoly – one firm – faces downward sloping demand curve • Competition – many firms – face flat demand curve – free entry and exit over time Key Rationale: Product Differentiation The Best Thing About Monopolistic Competition: NO NEW DIAGRAMS! Yahoo! Hooray! Watch how a graph of a typical monopolistically competitive firm is sketched: It looks just like a monopoly The trick behind the treat of the monopolistic competition diagram • shift the demand curve and thus the marginal revenue curve of the typical firm as other firms enter and exit the industry • if there are economic profits: – demand shifts in as other firms enter • if there are economic losses (negative profits) – demand shifts out as other firms exit Here there are either profits or losses 11_03A Dollars Dollars If there are profits, firms enter, shifting in the MR and D Curves until profits equal zero. If there are losses, firms leave, shifting out the MR and D curves until profits equal zero. MC MC ATC ATC P P Profit Loss MR MR D Quantity Quantity (a) Short-Run Profit D (b) Short-Run Loss Here economic profits are zero: no incentive to exit or enter 11_03B Dollars MC ATC P MR (c) Long Run: Breakeven D Quantity Now let’s watch what happens as we move the D and MR curves In Long Run Equilibrium: Excess Average Total Costs 11_04 DOLLARS MC ATC Monopolistically competitive price (P) Excess costs per unit Minimum point on ATC or minimum efficient scale (MES) D MR QUANTITY Quantity produced Excess capacity by this amount Long run equilibrium of a monopolistically competitive industry • economic profits are driven to zero, • but – (1) average total cost (ATC) not at a minimum – (2) price is greater than marginal cost (P>MC) – (3) there is deadweight loss • can view the above three disadvantages as the “cost of variety” 11T Summary and Review: Predictions from Three Models Type of Model Competition Monopolistic competition Monopoly Price Deadweight Loss? Average Total Cost Minimized? Profit in Long Run? P = MC P > MC P > MC No Yes Yes Yes No No No No Yes Oligopoly • Few firms (duopoly = two) • Strategic considerations come into play – game theory • to concentrate on strategic considerations we focus on a case where one good is produced – but in reality oligopoly can have product differentiation too (Coke and Pepsi) Four Types of Models/Industries 11_01 Competition • Many firms, free entry • One product Product differentiation decreases (or increases). Number of firms increases (or decreases). Monopolistic Competition Oligopoly • Many firms, free entry • Differentiated product • Few firms, limited entry • One product Product differentiation decreases (or increases until a unique product appears). Number of firms increases (or decreases until only one is left). Monopoly • One firm, no entry • One product The Prisoners’ Dilemma Game: What set of strategies is an equilibrium for Pete and Ann? 11_05 Ann Remain Silent Confess Pete Confess Remain Silent 5 5 1 A Duopoly as a Prisoners’ Dilemma Game 11_06 Bageldee Bageldum Competitive Price Competitive Price Monopoly Price $0 $1 $0 $4 Monopoly Price $4 $2 $1 $2 The prisoners’ dilemma analogy suggests a tendency toward competition • Non cooperative outcome – prisoners confess – firms charge low price • Cooperative outcome – prisoners remain silent – firms charge high price End of Lecture
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