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Module Micro: 31 Econ: 67 Introduction to Monopolistic Competition KRUGMAN'S MICROECONOMICS for AP* Margaret Ray and David Anderson What you will learn in this Module: • How prices and profits are determined in monopolistic competition, both in the short run and in the long run. • How monopolistic competition can lead to inefficiency and excess capacity. Monopolistic Competition • Characteristics in common with perfect comp.: • Many firms exist in the market, but not as many as perfect competition. • There are no barriers to entry or exit. • Characteristics in common with monopoly: • The product is differentiated. • Each firm has some ability to set the price of their product. Monopolistic Competition in the Short Run • In the short run, monopolistic competitors set price and quantity in the same way a monopoly does. • Monopolistic competitors can earn a profit in the short run. Monopolistic Competition in the Short Run ATC • Monopolistic competitors can also earn a loss in the short run. Monopolistic competition in the Long Run • Entry and exit occur in response to short-run profits or losses • In the long run, Monopolistic competitors earn a normal profit Comparing Monopolistic Competition with Perfect Competition • Economic profit = 0 (normal profit), so ATC=P in both due to entry and exit • MR = MC in both (profit maximization rule) • In perfect competition, ATC = P = MR = MC • In monopolistic competition ATC = P > MR = MC • Perfect competition achieves productive efficiency by producing at the minimum ATC • Monopolistic competition results in excess capacity Is Monopolistic Competition Inefficient? • Yes, P > MC so there is DWL (deadweight loss) • BUT, variety (differentiated products) provides a benefit to consumers. Figure 67.1 The Monopolistically Competitive Firm in the Short Run Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers Figure 67.2 Entry and Exit Shift Existing Firms’ Demand Curves and Marginal Revenue Curves Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers Figure 67.3 The Long-Run Zero-Profit Equilibrium Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers Figure 67.4 Comparing Long-Run Equilibrium in Perfect Competition and Monopolistic Competition Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers