Types of Imperfectly Competitive Markets o Monopolistic Competition

Types of Imperfectly Competitive Markets o Monopolistic Competition ä Many firms selling products that are similar but not identical. o Oligopoly ä Only a few sellers, each offering a similar or identical product to the others.

Monopolistic Competition o Markets that have some features of competition and some features of monopoly.

Attributes of Monopolistic Competition o Many sellers o Product differentiation o Free entry and exit

Many Sellers o There are many firms competing for the same group of customers. ä Product examples include books, CDs, movies, computer games, restaurants, piano lessons, cookies, furniture, etc.

Product Differentiation o Each firm produces a product that is at least slightly different from those of other firms. o Rather than being a price taker, each firm faces a downward-sloping demand curve.

Free Entry or Exit o Firms can enter or exit the market without restriction. o The number of firms in the market adjusts until economic profits are zero.

Monopolistic Competition in the Short Run o In the short run, the monopolistically competitive firm follows a monopolist’s rule for profit maximization. ä Produce the quantity where MR = MC. ä Price should be greater than ATC.

Monopolistic Competition in the Short Run

Monopolistic Competition in the Short Run Price 0 Quantity

Monopolistic Competition in the Short Run Price Demand MR 0 Quantity

Monopolistic Competition in the Short Run Price MC ATC Demand MR 0 Quantity

Monopolistic Competition in the Short Run Price MC ATC Price Demand MR 0 Profitmaximizing quantity Quantity

Monopolistic Competition in the Short Run Firm Makes a Profit Price MC ATC Price Demand MR 0 Profitmaximizing quantity Quantity

Monopolistic Competition in the Short Run Firm Makes a Profit Price MC ATC Price Average total cost Demand MR 0 Profitmaximizing quantity Quantity

Monopolistic Competition in the Short Run Firm Makes a Profit Price MC ATC Price Average total cost Demand Profit MR 0 Profitmaximizing quantity Quantity

Monopolistic Competition in the Short Run Price MC ATC Demand MR 0 Quantity

Monopolistic Competition in the Short Run MC Price ATC Demand MR 0 Quantity

Monopolistic Competition in the Short Run MC Price ATC Price Demand MR 0 Lossminimizing quantity Quantity

Monopolistic Competition in the Short Run Firm Makes Losses Price MC ATC Price Demand MR 0 Lossminimizing quantity Quantity

Monopolistic Competition in the Short Run Firm Makes Losses Price MC ATC Average total cost Price Demand MR 0 Lossminimizing quantity Quantity

Monopolistic Competition in the Short Run Firm Makes Losses Price MC ATC Losses Average total cost Price Demand MR 0 Lossminimizing quantity Quantity

Monopolistic Competition in the Short Run o Short-run economic profits encourage new firms to enter the market. This: ä Increases the number of products offered. ä Reduces demand faced by incumbent firms. ä Incumbent firms’ demand curves shift to the left. äDemand for the incumbent firms’ products fall, and their profits decline.

Monopolistic Competition in the Short Run o Short-run economic losses encourage firms to exit the market. This: ä Decreases the number of products offered. ä Increases demand faced by the remaining firms. ä Shifts the remaining firms’ demand curves to the right. äIncreases the remaining firms’ profits.

The Long-Run Equilibrium o Firms will enter and exit until the firms are making exactly zero economic profits.

Two Characteristics of Long-Run Equilibrium o As in a monopoly, price exceeds marginal cost. ä Profit maximization requires marginal revenue to equal marginal cost. ä The downward-sloping demand curve makes marginal revenue less than price.

Two Characteristics of Long-Run Equilibrium o As in a competitive market, price equals average total cost. However, not at the min of ATC. ä Free entry and exit drive economic profit to zero.

A Monopolistic Competitor in the Long Run

A Monopolistic Competitor in the Long Run Price 0 Quantity

A Monopolistic Competitor in the Short Run Price MC ATC 0 Quantity

A Monopolistic Competitor in the Short Run Price MC ATC 0 MR Demand Quantity

A Monopolistic Competitor in the Short Run Price MC ATC 0 MR Loss-minimizing quantity Demand Quantity

A Monopolistic Competitor in the Short Run Price MC ATC 0 MR Demand Quantity

A Monopolistic Competitor in the Long Run Price MC ATC MR 0 Demand Quantity

A Monopolistic Competitor in the Short Run Price MC ATC 0 Quantity

A Monopolistic Competitor in the Short Run Price MC ATC MR 0 Demand Quantity

A Monopolistic Competitor in the Short Run Price MC ATC MR 0 Profit-maximizing quantity Demand Quantity

A Monopolistic Competitor in the Short Run Price MC ATC MR 0 Demand Quantity

A Monopolistic Competitor in the Long Run Price MC ATC MR 0 Demand Quantity

A Monopolistic Competitor in the Long Run Price MC ATC MR 0 Demand Quantity

A Monopolistic Competitor in the Long Run Price MC ATC MR 0 Long-run Profit-maximizing quantity Demand Quantity

Monopolistic versus Perfect Competition • There are two noteworthy differences between monopolistic and perfect competition—excess capacity and markup.

Excess Capacity • There is no excess capacity in perfect competition in the long run.

Excess Capacity • Free entry results in competitive firms producing at the point where average total cost is minimized, which is the efficient scale.

Excess Capacity • There is excess capacity in monopolistic competition in the long run.

Excess Capacity • In monopolistic competition, output is less than the efficient scale of perfect competition.

Excess Capacity Monopolistically Competitive Firm Price Perfectly Competitive Firm Price Quantity

Excess Capacity Monopolistically Competitive Firm Price Perfectly Competitive Firm Price MC MR ATC Demand Quantity

Excess Capacity Monopolistically Competitive Firm Perfectly Competitive Firm Price MC MC ATC P = MC MR ATC P = MR (demand curve) Demand Quantity

Excess Capacity Monopolistically Competitive Firm Perfectly Competitive Firm Price MC MC ATC P P = MC MR ATC P = MR (demand curve) Demand Quantity

Excess Capacity Monopolistically Competitive Firm Perfectly Competitive Firm Price MC MC ATC P P = MC MR P = MR (demand curve) Demand Quantity produced ATC Quantity produced

Excess Capacity Monopolistically Competitive Firm Perfectly Competitive Firm Price MC MC ATC P P = MC ATC P = MR (demand curve) Demand Quantity Efficient produced scale Quantity = Efficient produced scale

Excess Capacity Monopolistically Competitive Firm Perfectly Competitive Firm Price MC MC ATC P P = MC ATC P = MR (demand curve) Excess capacity Demand Quantity Efficient produced scale Quantity = Efficient produced scale

Excess Capacity • Unlike a competitive firm, a monopolistically competitive firm could increase the quantity it produces and lower the average total cost of production.

Markup Over Marginal Cost • For a competitive firm, price equals marginal cost. • For a monopolistically competitive firm, price exceeds marginal cost.

Markup Over Marginal Cost • Because price exceeds marginal cost, an extra unit sold at the posted price means more profit for the monopolistically competitive firm.

Markup Over Marginal Cost Monopolistically Competitive Firm Price Perfectly Competitive Firm Price ATC Quantity

Markup Over Marginal Cost Monopolistically Competitive Firm Price Perfectly Competitive Firm Price MC ATC P = MR (demand curve) MR Demand Quantity

Markup Over Marginal Cost Monopolistically Competitive Firm Perfectly Competitive Firm Price MC MC ATC P P = MC MR ATC P = MR (demand curve) Demand Quantity

Markup Over Marginal Cost Monopolistically Competitive Firm Perfectly Competitive Firm Price MC MC ATC P P = MC MR P = MR (demand curve) Demand Quantity produced ATC Quantity produced

Markup Over Marginal Cost Monopolistically Competitive Firm Perfectly Competitive Firm Price MC P Marginal cost MC ATC P = MC MR P = MR (demand curve) Demand Quantity produced ATC Quantity produced

Markup Over Marginal Cost Monopolistically Competitive Firm Perfectly Competitive Firm Price Markup MC P Marginal cost MC ATC P = MC MR P = MR (demand curve) Demand Quantity produced ATC Quantity produced

Monopolistic Competition and the Welfare of Society o Monopolistic competition does not have all the desirable properties of perfect competition.

Monopolistic Competition and the Welfare of Society o There is the standard deadweight loss of monopolistic competition caused by the markup of price over marginal cost. o However, regulating the pricing of all firms that produce differentiated products would be impractical.

Monopolistic Competition and the Welfare of Society o The variety of products in the market can be too large or too small to be socially efficient. That is, there may be too much or too little market entry.

Monopolistic Competition and the Welfare of Society • Externalities of entry include productvariety externalities and business-stealing externalities. • Because the inefficiencies are subtle, hard to measure, and hard to fix, there is no easy way public policy can improve the market outcome.

Quick Quiz! • List the three key attributes of monopolistic competition.

Quick Quiz! • Draw and explain a diagram to show the long-run equilibrium in a monopolistically competitive market.

Advertising and Brand Names o Product differentiation leads to advertising and brand names. o Some critics of advertising and brand naming contend that they exploit consumers and reduce competition. n n Creates desire that wouldn’t otherwise exist Less concerned with price, more about loyalty

Advertising and Brand Names o Defenders argue that advertising provides information and increases competition by offering a greater variety of products and prices. o Case study - eyeglasses

Advertising and Brand Names o Firms that sell highly differentiated consumer goods typically spend between 10 and 20 percent of revenue on advertising.

Advertising and Brand Names o o Overall, firms spends about 2% of total revenue on advertising. Top 10 n n n AT&T Chevy GEICO Ford Macy’s Verizon Mc. Donalds Toyota TMobile Wal-Mart

Advertising and Brand Names

Conclusion o Monopolistically competitive markets are characterized by many firms each producing a differentiated product with freedom of market entry and exit.

Conclusion o In long-run equilibrium, monopolistically competitive markets produce with some excess capacity and each firm charges a price above marginal cost.

Conclusion o The selling price of a monopolistically competitive market results in some deadweight losses and resource misallocations that regulations cannot practically remedy.

Conclusion o Product differentiation leads to advertising and brand names.