Principles of Microeconomics Chapter 16 Monopolistic Competition Monopolistic

  • Slides: 22
Download presentation
Principles of Microeconomics Chapter 16 Monopolistic Competition

Principles of Microeconomics Chapter 16 Monopolistic Competition

Monopolistic Competition • Monopolistically Competitive Markets: – Have many buyers and sellers – Sell

Monopolistic Competition • Monopolistically Competitive Markets: – Have many buyers and sellers – Sell similar but differentiated products – Free entry and exit in the market • Firms: – Have some price control – In short run: experience economic profits + act as monopoly – In long run: zero economic profits + act as perfect competition

Writing to Learn Exercise • Log onto Amazon. com • Search for an ordinary

Writing to Learn Exercise • Log onto Amazon. com • Search for an ordinary consumer good (ie: soap, socks, tea ect. ) – – How many sellers do you find? How many different varieties of the product can you find? Do the prices differ? How is this related to the concept of monopolistic competition?

Monopolistic Competition in Short Run • Firms have a “monopoly” on their differentiated good

Monopolistic Competition in Short Run • Firms have a “monopoly” on their differentiated good • Exert price control over their good • Can incur positive economic profits in short run!

In the short run… • Market outcome looks similar to monopoly • Profit Max

In the short run… • Market outcome looks similar to monopoly • Profit Max Point: MR = MC • Price > MR = MC If P > ATC POSITIVE ECONOMIC PROFITS Possible in Short Run Determines quantity based on MR = MC Determines price based on demand

In the long run… • Market outcome similar to perfectly competitive markets • Reason:

In the long run… • Market outcome similar to perfectly competitive markets • Reason: FREE ENTRY/EXIT Firms in the long run operate at: P > MC Due to firm facing a downward sloping demand curve P = ATC Due to free entry and exit into the market

In the long run… • Market outcome similar to perfectly competitive markets • Reason:

In the long run… • Market outcome similar to perfectly competitive markets • Reason: FREE ENTRY/EXIT Firms in the long run operate at: P > MC Due to firm facing a downward sloping demand curve P = ATC Due to free entry and exit into the market

In the long run… • Market outcome similar to perfectly competitive markets • Reason:

In the long run… • Market outcome similar to perfectly competitive markets • Reason: FREE ENTRY/EXIT Firms in the long run operate at: P > MC Due to firm facing a downward sloping demand curve P = ATC Due to free entry and exit into the market

Long Run when P > ATC • If P > ATC: Short run positive

Long Run when P > ATC • If P > ATC: Short run positive profits • Overtime: more firms enter to take advantage of profits – Increase variety of goods as more firms enter – Decrease in demand for each firm’s differentiated good – Decrease in price for firms until P = ATC Zero Economic Profits In long run • Adjust until P = ATC in Long run

Short Run when P > ATC Gina’s Soap Makers Price (Cost) Market for Soap

Short Run when P > ATC Gina’s Soap Makers Price (Cost) Market for Soap Price MC MC S ATC MR D Quantity 10

Short Run when P > ATC Gina’s Soap Makers Price (Cost) Market for Soap

Short Run when P > ATC Gina’s Soap Makers Price (Cost) Market for Soap Price MC MC S ATC P* P* MR = MC MR Q* D Quantity 11

Short Run when P > ATC Gina’s Soap Makers Price (Cost) Market for Soap

Short Run when P > ATC Gina’s Soap Makers Price (Cost) Market for Soap Price MC MC S ATC P* P* PROFIT ATC MR Q* D Quantity In the short run – Gina’s Soap Makers Inc. is making a profit! Other firms observe this 12

Short Run to Long Run when P > ATC Gina’s Soap Makers Price (Cost)

Short Run to Long Run when P > ATC Gina’s Soap Makers Price (Cost) Market for Soap Price MC MC S S. 2 ATC P* PROFIT ATC MR Q* D Quantity New firms enter overtime to take advantage of the positive economic profits. Supply curve shifts increase in number of buyers D Quantity 13

Long Run when P > ATC Gina’s Soap Makers Price (Cost) Market for Soap

Long Run when P > ATC Gina’s Soap Makers Price (Cost) Market for Soap Price MC MC S S. 2 ATC P* P* P** MR MR. 2 D. 2 Q** Q* D Quantity D Q* Q** Quantity As new firms enter supply of soap in the market goes up But for each individual firm demand goes down because buyers have more options! No change in costs adjustment until P= ATC 14

Long Run when P > ATC Gina’s Soap Makers Price (Cost) Market for Soap

Long Run when P > ATC Gina’s Soap Makers Price (Cost) Market for Soap Price MC MC S S. 2 ATC P* P* P** D MR MR. 2 D. 2 Q** Q* Quantity Gina’s price for soap decreases Quantity of soap she sells also decreases D Q* Q** Quantity Price for soap in the market decreases Quantity of soap available increases 15

Long Run when P < ATC • If P < ATC: Short run negative

Long Run when P < ATC • If P < ATC: Short run negative profits – Loss! • Overtime: firms exit market to avoid losses – Decrease variety of goods as more firms exit – Increase in demand for each firm’s differentiated good – Increase in price for firms that stay in market until P = ATC Zero Economic Profits In long run • Adjust until P = ATC in Long run

Application Consider John’s Muffin Shop which is currently competing with many other bakeries selling

Application Consider John’s Muffin Shop which is currently competing with many other bakeries selling similar pastries in a small town, but none as good as John’s (so he believes). Assume that because of the market dynamics, John finds himself selling his muffins at a price below the cost to produce each muffin. • Draw John’s Muffin Shop’s production decision graph as well as the market for pastries graph • Indicate what is happening in the short run for John’s Muffin Shop in terms of price, quantity, average total cost, and profit/loss. • What will happen in the long run for John’s Muffin Shop and the market for pastries? Illustrate to the best of your abilities.

Application Reflection Why does this matter? • • • In the short run, monopolistically

Application Reflection Why does this matter? • • • In the short run, monopolistically competitive firms can experience positive or negative economic profits depending on price and cost per unit (ATC). Due to free entry/exit in this type of market – all firms will return to long run equilibrium with zero economic profits. The number of firms in the market will continue to adjust until all firms are operating at this equilibrium and no single firm has the incentive to enter or leave the market. What’s the most important takeaway? • • Firms can tolerate negative economic profits temporarily, but eventually either they leave or, when other firms leave, the price adjusts so they operate with zero economic profits Remember, economic profits include implicit/opportunity costs! So zero economic profits does not mean zero accounting profits! MUDDIEST POINT?

Externalities in M. C. Market Positive for the consumer Negative for the business Product

Externalities in M. C. Market Positive for the consumer Negative for the business Product Variability Externality • Consumers are better off with more choices! • So when new firms enter a market – consumers benefit because there are more varieties of the product to choose from Business Stealing Externality • Existing firms suffer when new firms enter a market • More variety means less demand for the existing products • New firms steal business, demand consumers for the goods of existing firms

Externalities in M. C. Market Positive for the consumer Negative for the business Product

Externalities in M. C. Market Positive for the consumer Negative for the business Product Variability Externality • Consumers are better off with more choices! • So when new firms enter a market – consumers benefit because there are more varieties of the product to choose from Business Stealing Externality • Existing firms suffer when new firms enter a market • More variety means less demand for the existing products • New firms steal business, demand consumers for the goods of existing firms

Externalities in M. C. Market Positive for the consumer Negative for the business Product

Externalities in M. C. Market Positive for the consumer Negative for the business Product Variability Externality • Consumers are better off with more choices! • So when new firms enter a market – consumers benefit because there are more varieties of the product to choose from Business Stealing Externality • Existing firms suffer when new firms enter a market • More variety means less demand for the existing products • New firms steal business, demand consumers for the goods of existing firms

Key Takeaways • Monopolistically Competitive firms act as both monopolies (in SR) and perfectly

Key Takeaways • Monopolistically Competitive firms act as both monopolies (in SR) and perfectly competitive firms (in LR) • Have some excess capacity and mark up because have some price control • Advertising only works when there are similar but differentiated products – only in M. C. markets