Download Monopolistic Competition

Monopolistic Competition
Chapter 11
In This Chapter…
 11.1.
Distinguishing Features of
Monopolistically Competitive
Markets
 11.2.
Profit Maximizing Price and
Output Decisions
 11.3. Problems of Monopolistically
Competitive Markets
11.1.
Distinguishing Features of
Monopolistically Competitive
Markets
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.
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 and the “hordes”
that characterize perfect competition.
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).
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.
Market Power
 A monopolistically competitive firm
confronts a downward-sloping
demand curve for its output.
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.
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.
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 wouldbe producers to enter a particular
market, such as patents.
Behavior
 Monopolistic competition has
distinctive behavior.
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.
Brand Image
 Each firm has a distinct identity – a
brand image.
 Consumers perceive its output to be
somewhat different than others in the
industry.
Brand Loyalty
 By differentiating their products,
monopolistic competitors establish
brand loyalty.
 Brand loyalty gives producers greater
control over the price of their
products.
Brand Loyalty
 Each firm only has a monopoly on its
brand image.
• It still competes with other firms offering
close substitutes.
Brand Loyalty
 Brand loyalty makes the demand
curve facing the firm less priceelastic.
• Brand loyalty implies that consumers shun
substitute goods even when they are
cheaper.
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.
 11.2.
Profit Maximizing Price and
Output Decisions
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).
Short-Run Price and Output
 As always, the profit-maximizing rate
of output is achieved by producing
the quantity where MR = MC.
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.
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.
 Thus, in the long run, there are no
economic profits in monopolistic
competition.
Equilibrium in Monopolistic
Competition
Price or Cost (dollars per unit)
The short run
pa
MC
F
ATC
ca
Demand
K
MR
0
qa
Quantity (units per period)
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)
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)
Equilibrium in Monopolistic
Competition
pa
ca
F
MC
The long run
ATC
Demand
K
MR
0
qa
Quantity (units per period)
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)
 11.3. Problems of Monopolistically
Competitive Markets
Inefficiency
 Monopolistic competition tends to be
less efficient in the long run than a
perfectly competitive industry.
Excess Capacity
 Because of the industry-wide excess
capacity, each firm produces a rate of
output that is less than its minimum
ATC.
 I.e., the same level of industry output
could be produced at lower cost with
fewer firms.
 The Industry has excess capacity…
Flawed Price Signals
 The monopolistically competitive firm
will always price its output above the
level of marginal cost.
Flawed Price Signals
 Monopolistic competition results in
both production inefficiency (aboveminimum average cost) and allocative
inefficiency (wrong mix of output).
Advertising Wars: No Cease-Fire
 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 Wars: No Cease-Fire
 Advertising may be more responsible
for brand loyalty than the taste of the
product.
• Having a recognizable name is worth
billions in sales.