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Monopolistic Competition Chapter 26 Key Questions for this chapter include: What are the unique features of monopolistic competition? How are the market outcomes affected by this market structure? What are the long-run consequences of different market structures? Structure “many” firms in the industry. many firms produce similar goods or services but each maintains some independent control of its own price. “Many” is somewhere between the “few” of oligopolies or the “hordes” that characterize perfect competition. Low barriers to entry 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). Examples of monopolistic competition include banks, radio stations, health spas, apparel stores, and convenience stores, fast foods, and shoe stores, What about cellular industry? 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. A monopolistically competitive firm confronts a downward-sloping demand curve. 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. Monopolistic competition has distinctive behavior which involves product differentiation. Product or Brand Loyalty By differentiating their products, monopolistic competitors establish brand loyalty which gives them greater control over pricing. Translated as a “Monopoly” on their own brand… (Give me some examples) Brand Loyalty Will compete with other firms but offer substitutes makes the demand curve facing the firm less priceelastic. implies that consumers shun substitute goods even when they are cheaper. Example: the price differences between computers which are essentially the same. Short Run Price and Output Production Decision - The production decision is the selection of the short-run rate of output. As always, the profit-maximizing rate of output is achieved by producing the quantity where MR = MC. New firms enter when there is an economic profit and leave when there is not. In the long run, there are no economic profits in monopolistic competition. 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. Effect of entry on the monopolistically competitive firm PRICE (per unit) Initial market supply New entry Later market supply Market demand QUANTITY (units per time period) 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 The long run pa F MC 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) • Because of the industry-wide excess capacity in monopolistic competition, each firm is producing at a rate of output that is less than its minimum-ATC output rate. The long run PRICE OR COST (dollars per unit) Note: the less Efficient production Of Mono Comp from Perfect Comp MC ATC pg G Initial demand Later demand 0 qg Later MR QUANTITY(units per period) Thus, the same level of industry output could be produced at lower cost with fewer firms. Monopolistic competition results in both production inefficiency (above-minimum average cost) and allocative inefficiency (wrong mix of output). Remember! Difference between two terms! PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Expect New Competitors MC Price and Costs ATC P1 A1 Short-Run Economic Profits D MR Q1 Quantity PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Expect New Competitors MC Price and Costs ATC New competition drives down the P price level – leading to economic A losses in the short run. 1 1 Short-Run Economic Profits D MR Q1 Quantity PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Price and Costs ATC A2 P2 Short-Run Economic Losses D MR Q2 Quantity Price and Costs PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Long-Run Equilibrium MC Normal Profit Only ATC P3 = A3 D MR Q3 Quantity Advertising Wars In truly (perfectly) competitive industries, firms compete on the basis of price. Imperfectly competitive firms engage in nonprice competition with the most prominent form of nonprice competition being advertising. Advertising may be more responsible for brand loyalty than the taste of the product. Characteristics Differentiated Products Product Attributes Service Location Brand Names and Packaging Some Control Over Price Easy Entry and Exit Advertising Characteristics continued Relatively Large Number of Sellers Small Market Shares No Collusion Independent Action PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Expect New Competitors MC Price and Costs ATC P1 A1 Short-Run Economic Profits D MR Q1 Quantity PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Expect New Competitors MC Price and Costs ATC New competition drives down the P price level – leading to economic A losses in the short run. 1 1 Short-Run Economic Profits D MR Q1 Quantity PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Price and Costs ATC A2 P2 Short-Run Economic Losses D MR Q2 Quantity Price and Costs PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Long-Run Equilibrium MC Normal Profit Only ATC P3 = A3 D MR Q3 Quantity Graph A shows short-run profits when there are few firms in the market Graph B shows short-run losses as other companies see the success and join the market causing profits to drop Graph C shows long-run equilibrium as the weaker firms leave the industry
