Download Ch. 16 PP Notes - Mr. Lamb

CHAPTER 16
Monopolistic Competition and
Product Differentiation
Monopolistic Competition = Competitive
Competition; Example: Fast Food!
there are many buyers and sellers
each producer sells a differentiated product
(products similar, but not identical)
there is free entry and exit in the long run.
few barriers to entry
sellers are price searchers, not price takers
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Product Differentiation is key!
Tacit collusion is virtually impossible when
there are many producers.
Product differentiation is the only way
monopolistically competitive firms can acquire
some market power.
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Three forms of Product Differentiation
Differentiation by style or type – Sedans vs.
SUV’s; VW Bugs; Square hamburgers
Differentiation by location – Dry cleaner near
home vs. Cheaper dry-cleaner farther away
Differentiation by quality – Ordinary ($) vs.
gourmet chocolate ($$$)
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Product Differentiation causes…
Competition
among sellers: Producers
compete for the same market, so entry by
more producers reduces the quantity each
existing producer sells at any given price.
Example
Value
– food court in a mall
in diversity: In addition, consumers
gain from the increased diversity of products.
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Understanding Monopolistic Competition
Some features typical of monopoly + some
features typical of perfect competition:
Because each firm is offering a distinct
product, it is in a way like a monopolist: it faces
a downward-sloping demand curve and has
some market power—the ability within limits to
determine the price of its product.
However, unlike a monopolist, a
monopolistically competitive firm does face
competition: the amount of its product it can
sell depends on the prices and products offered
by other firms in the industry.
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The Monopolistically Competitive Firm in the
Short Run
The firm looks like any monopolist: it faces a
downward-sloping demand curve, which implies
a downward-sloping marginal revenue curve.
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The firm in panel (a) can be
profitable for some output levels:
the levels at which its ATC, lies
below its demand curve, DP. The
profit-maximizing output level is
QP, the output at which marginal
revenue, MRP, is equal to
marginal cost.
The firm above can never be
profitable because the ATC lies
above its demand curve, DU.
The best that it can do if it
produces at all is to produce
output QU and charge PU. Any
other output level results in a
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greater loss.
Long Run Monopolistic Competition
If the typical firm earns positive profits, new firms
will enter the industry in the long run, shifting each
existing firm’s demand curve to the left.
If the typical firm incurs losses, some existing firms
will exit the industry in the long run, shifting the
demand curve of each remaining firm to the right.
In the long run, (zero-profit-equilibrium) firms just
break even. The typical firm’s demand curve is just
tangent to its average total cost curve at its profitmaximizing output.
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The Long-Run
Zero-Profit
Equilibrium
A monopolistically
competitive firm is like a
monopolist without
monopoly profits.
If existing firms are profitable, entry will occur and shift each
firm’s demand curve leftward. If existing firms are
unprofitable, each firm’s demand curve shifts rightward as
some firms exit the industry. In long-run zero profit
equilibrium, the demand curve of each firm is tangent to its
average total cost curve at its profit-maximizing output level.
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Entry and Exit into the Industry Shift the Demand Curve
of Each Firm
Think about a food court at the shopping mall. If a new food
seller opens, the demand for the existing restaurants drops.
(Demand shifts left)
Entry and exit will end when the remaining firms make zero
profit.
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Long Run Monopolistic Competition
In the long-run equilibrium of a
monopolistically competitive industry, there are
many firms, all earning zero profit.
Price exceeds marginal cost so some mutually
beneficial trades are exploited.
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Panel (a) shows the situation of the typical firm in long-run
equilibrium in a perfectly competitive industry. The firm operates
at the minimum-cost output QC , sells at the competitive market
price PC , and makes zero profit. It is indifferent to selling another
unit of output because PC is equal to its marginal cost, MCC .
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Panel (b) shows the situation of the typical firm in long-run
equilibrium in a monopolistically competitive industry. At QMC it
makes zero profit because its price, PMC, just equals average total
cost. At QMC the firm would like to sell another unit at price PMC,
since PMC exceeds marginal cost, MCMC. But it is unwilling to lower
price to make more sales. It therefore operates to the left of the
minimum-cost output and has excess capacity.
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Is Monopolistic Competition Inefficient?
Firms in a monopolistically competitive industry
have excess capacity: they produce less than
the output at which average total cost is
minimized.
Consumers pay higher prices because of
excess capacity, but receive value from greater
diversity.
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Typical methods of Product
Differentiation
advertising
and
brand names
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The Role of Advertising
Firms advertise in order to increase the
demand for their products.
Advertising is not a waste of resources when it
gives consumers useful information about
products.
(yellow pages) (signs on interstate highway
for food or gas stations)
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Advertising that simply flaunts a product
is harder to explain.
Either consumers are irrational, or
expensive advertising communicates that
the firm's products are of high quality,
and they can afford to advertise.
(AFLAC goose) (beer ads)
(GEICO –Hey you woodchucks, stop
chucking my wood! )
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Brand Names
A brand name is a name owned by a
particular firm that distinguishes its products
from those of other firms.
As with advertising, the social value of brand
names can be ambiguous.
The names convey real information when they
assure consumers of the quality of a product.
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The End of Chapter 16
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