Monopolistic Competition Understanding Monopolistic Competition Monopolistic competition combines

Monopolistic Competition

Understanding Monopolistic Competition Monopolistic competition combines features of both monopoly and perfect competition. Like monopolists, firms offer a distinct product (like a unique fried chicken recipe or gasoline at a convenient location). Unlike monopolists, firms face competition. Firms thus face downward-sloping demand curves and have some power to set price for their product. The quantity they can sell depends on other firms’ prices and products.

Understanding Monopolistic Competition Fast food firms in a food court exemplify a monopolistically competitive market structure. Distinctive products and more convenient locations give firms some monopoly power, but they are also competing with one another for the same consumers.

Monopolistic Competition in the Short Run The firm infirm panel (b), however, is unprofitable The firm in panel (a) can be profitable at all quantities The profit-maximizing quantity Q is the If it produces at all, the best firm (b) The charges P and earns a profit P P This generates a loss equal to the area of theoutput orange because its ATC curve is the above its. ATC demand curve where itsmarginal average total cost curve is below its. DU where revenue MR equals marginal can do is to produce Q and charge equal to the area of green shaded P U rectangle. forcost every quantity. demand curve DP. MC. P rectangle. U.

Monopolistic Competition in the Long Run Just like a perfect competition In the long run, firms unable to operate at a profit (like the one in panel (b) in the previous figure) will exit the industry. Similarly, in the long run firms operating at a profit will lure new firms into the industry, so long as there is free entry.

Monopolistic Competition in the Long Run Entry and exit cease when every existing firm earns zero profit at its profitmaximizing quantity. So, in long-run equilibrium shown here, the demand curve of each firm is tangent to its average total cost curve at its profit-maximizing quantity.

Is Monopolistic Competition Efficient? Monopolistically competitive firms are allocatively inefficient both in the short run and in the long run because they charge a price that exceeds the marginal cost. Monopolistically competitive firms have excess capacity: they produce less than the output at which average total cost is minimized. Some economists also argue that monopolistic competition causes wasteful duplication (too many varieties of too similar goods), but the consensus is that this is not a large problem in practice.

How Firms Differentiate Their Products are differentiated in the following ways: 1) By style or type 2) By location 3) By quality Some customers pay more for high quality chocolate while others prefer to pay less for lower quality; a diverse market satisfies many needs and desires.

The Role of Advertising Not all firms use advertising: Firms in perfectly competitive markets don’t advertise because they can sell as much as they want at market price. Oligopolistic and monopolistically competitive firms do advertise to differentiate their products and boost demand. Monopolies also sometimes advertise to boost demand for their products.

Brand Names Nonprice competition includes advertising and brand name development, which firms use to modify consumers’ perceptions about their products and gain more sales without lowering prices. A brand name is a name owned by a particular firm that distinguishes its products from those of other firms.

Brand Names Brand names can create unjustified market power in which buyers pay more for a brand even if product quality is not higher. On the other hand, brand names convey to consumer that expectations will be met and that the firm has a reputation to protect. Many customers prefer Mc. Donald’s to burger chains they don’t know because they know what to expect.

Summary and Review 1) What does product differentiation allow monopolistic competitors and oligopolists to do? Lower competition, raise market power, and ultimately increase sales. 2) What are three ways that firms differentiate products? 1) By style or type 2) By location 3) By quality

Summary and Review 3) Which types of firms do not use advertisements and why? Firms in perfectly competitive markets don’t advertise because they can sell as much as they want at market price. 4) Which types of firms do advertise and why? Oligopolies and monopolistic competitors advertise to differentiate their products and boost demand. Monopoles advertise to boost demand.

Summary and Review 5) What is the term for a name owned by a firm that distinguishes its products from those of other firms? A brand name. 6) What type of competition uses advertising and brand names to modify consumers’ perceptions about products and gain more sales without lowering prices? Nonprice competition.

Walkthrough: Free-Response Question 1 1. Refer to the table below showing the effects of running television commercials on a firm’s total revenue. Assume that each commercial costs $1, 000 to run. a. What is the marginal revenue from running the second commercial? b. Should the firm run a third commercial? Explain. c. If the firm has no variable costs aside from the cost of commercials, how many commercials should the firm run to maximize profits? Explain. (5 points) 1 point: $8, 000 1 point: Yes, it should run a third commercial. 1 point: Because the marginal revenue of $6, 000 exceeds the marginal cost of $1, 000 1 point: The firm should run five commercials. 1 point: Marginal revenue exceeds marginal cost for the first five commercials. Marginal revenue is less than marginal cost for the sixth commercial.

Summary and Review 1) How are firms under monopolistic competition like similar to firms under monopoly? Monopolistic competitors offer a distinct product and thus face downward-sloping demand curves and have some pricing power. 2) How are firms under monopolistic competition like similar to firms under perfect competition? They face competition, so the quantity they can sell depends on other firms’ prices and products.

Summary and Review 3) Are monopolistically competitive firms efficient or inefficient in the short run and long run? Why or why not? They are allocatively inefficient in the short run and long run because they charge a price above marginal cost. 4) Monopolistically competitive firms produce _____ because they produce less than the output at which average total cost is minimized. excess capacity

Walkthrough: Free-Response Question 1 1. a. Draw a correctly labeled graph for a monopolistically competitive firm that is taking a loss in the short run. Shade the area that represents the firm’s loss. (7 points) 1 point: Correctly labeled axes 1 point: Downward-sloping demand curve 1 point: Marginal revenue curve below the demand curve 1 point: Loss-minimizing quantity below where MC = MR 1 point: Loss-minimizing price on demand curve above where MC = MR 1 point: U-shaped average total cost curve above the demand curve at every quantity 1 point: Correct loss area shaded