Download Monopolistic Competition Chapter 12

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
• A monopolist is independent- doesn’t have
to look over his shoulder for retaliatory
competitor move.
• Monopolistic competitor 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 price-elastic.
implies that consumers shun substitute
goods even when they are cheaper.
Example: the price differences between
computers which are essentially the same.
Example: Differentiation at the
Graveyard—High-Definition RIP
• For centuries, graveyard operators have explored the limits of product
differentiation.
• In most graveyards, tombstones come in all manners of shapes, sizes
and colors.
• In the latest twist on tombstone differentiation, one producer offers
tombstones that come equipped with solar-powered speaker systems
and flat-panel screens.
• What does a seller of grave markers gain from product differentiation?
Non-price competition
Advertising.
http://www.youtube.com/watch?v=
xffOCZYX6F8
http://www.youtube.com/watch?v=xffOCZY
X6F8
• What do you think?
– Would a perfect competitor have any incentive
to advertise?
– Why would a monopolistically competitive
firm advertise?
– Can advertising lead to efficiency?
• Sales promotion and advertising
– Can increase demand for a firm
– Can differentiate a firm’s product
– Can result in increased profits
Monopolistic Competition
• Question
– How much advertising should be undertaken?
• Answer
• It should be carried to the point at which the
additional revenue from one more dollar of
advertising just equals that one dollar of
additional cost.
Then there is the Super Bowl – hedging their bets
on the quality of their advertising and product
demand
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 pure economic profits in
monopolistic competition.
Which other market model has long run zero or normal
profit?
• 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)
Figure 26-2 Comparison of the Perfect Competitor with the
Monopolistic Competitor
• 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
Never underestimate power of an
ad!
• http://www.youtube.com/watch?v=341rybZ
42vA