Download Monopolistic Competition

Monopolistic
Competiton
Assumptions
• Many sellers and many buyers
• Slightly different products
• Easy entry and exit (low barriers)
Effect of assumptions
• With many sellers, each firm has no
effect on the others. If one firm changes
its price the others will not notice or
react.
• If a firm raises its price but the others
do not, it will lose many its customers.
• Not all customers will switch to another
firm because they like this seller’s
product more than others.
Comparison to
monopoly
• When a monopolist raises its price most
consumers continue to buy the product
because there are no close substitutes.
Comparison to
perfect competition
• When a perfectly competitive firm raises
its price, all of its current customers
switch to other firms because the
products are identical. They can get
exactly the same thing from another
firm at the market price.
MC firm’s demand
• When a mc firm raises its price, the
other firms do not react by raising their
prices. While its customers like their
product better, other firms offer a very
similar product at a lower price. Many
will switch.
• Result: a small percentage increase in
price will cause a large percentage
decrease in quantity demanded =
elastic demand.
MC firm’s demand
• When a mc firm lowers its price, the
other firms do not react by lower their
prices. Some customers of the other
firms will switch to its product. While the
number of customers that switch is
small relative to the market, it is a big
change for one firm.
• Result: a small percentage decrease in
price will cause a large percentage
increase in quantity demanded = elastic
demand.
MC firm’s D and MR
Profit maximization
Deadweight loss
Long run
• For long run equilibrium, there is no
incentive for firms to enter or exit.
• This occurs when each firm’s economic
profit = 0, or accounting profit = normal
profit.
• This means that the each firm’s price
just covers their cost of production,
including a normal profit as one of the
costs.
Long run equilibrium
Reaching LR
equilibrium
• If a typical firm’s demand curve is
above LRAC then its profits will be
greater than zero, causing other firms to
enter. With more firms in the market the
demand for each firm’s product will
decrease. This will continue until profits
equal zero and entry stops.
• What if its demand is below LRAC?
LR: PC vs MC
• In the LR each firm in PC will be at the
bottom of its LRAC curve.
• Each firm in MC will be on the left side
of its LRAC curve.
PC (left) vs MC (right)
PC vs MC
• In PC, each firm can sell as much as it
wants at the market price.
• In MC, having a slightly different
product allows each firm to raise its
price, but it also limits the demand for
its product.
• The result is that each firm in MC is
slightly smaller than each firm in PC,
resulting in slightly higher cost per unit.
Effect on consumers
• In PC, consumers get the lowest
possible price, but no product variety.
Each firm produces exactly the same
thing.
• In MC, consumers pay slightly higher
prices (because cost of production is
slightly higher) but they can choose the
one that they like the best.