Monopolistic Competition

(1)

Monopolistic

Competition

Chapter 17

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The Four Types of Market Structure

Monopoly

Oligopoly

Monopolistic

Competition

Perfect

• Tap water

• Cable TV

• Tennis balls

• Crude oil

• Novels

• Movies

• Wheat

• Milk

Number of Firms?

Type of Products?

Many

firms

One

firm

Few

firms

_{Differentiated}

products

Identical

products

Types of Imperfectly

Competitive Markets

u

Monopolistic Competition

u

Many firms selling products that are similar

but not identical.

u

Oligopoly

u

Only a few sellers, each offering a similar or

identical product to the others.

(2)

Monopolistic Competition

Markets that have some

features of competition and

some features of monopoly.

Attributes of Monopolistic

Competition

u

Many sellers

u

Product differentiation

u

Free entry and exit

Monopolistic Competitors in

the Short Run...

(a) Firm Makes a Profit

Quantity

0 Price

Demand

MR

ATC

Profit

MC

Profit-maximizing quantity

Price

Average

total cost

(3)

A Monopolistic Competitor

in the Long Run...

Quantity

Price

0 Demand

MR

ATC

MC

Profit-maximizing

quantity

P=ATC

Monopolistic versus Perfect

Competition

There are two noteworthy

differences between monopolistic

and perfect competition—

excess

capacity

and

markup.

Excess Capacity

u

There is no excess capacity in perfect

competition in the long run.

u

Free entry results in competitive firms

producing at the point where average

total cost is minimized, which is the

efficient scale

of the firm.

(4)

Excess Capacity

u

There is excess capacity in

monopolistic competition in the long

run.

u

In monopolistic competition, output is

less than the efficient scale of perfect

competition.

Excess Capacity...

Quantity

(a) Monopolistically Competitive Firm

(b) Perfectly Competitive Firm

Quantity

Price

P = MR

(demand

curve)

MC ATC

Price

Demand

MC ATC

Excess capacity

Quantity

produced

Efficient

scale

P = MC

Quantity

produced

= Efficient

scale

P

Markup Over Marginal Cost

u

For a competitive firm, price

equals marginal cost.

u

For a monopolistically

competitive firm, price exceeds

marginal cost.

(5)

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...

Quantity

(a) Monopolistically Competitive Firm

(b) Perfectly Competitive Firm

Quantity

Price

P

=

MC

_P

₌

_MR

(demand

curve)

MC ATC

Quantity

produced

Price

P

Demand

Marginal

cost

MC ATC

MR

Markup

Quantity

produced

Monopolistic versus Perfect

Competition...

Quantity

(a) Monopolistically Competitive Firm

(b) Perfectly Competitive Firm

Quantity

Price

P

=

MR

(demand

curve)

MC

ATC

Quantity

produced

Efficient

scale

Price

P

Demand

MC

ATC

P

=

MC

Excess capacity

Marginal

cost

Markup

MR

Quantity produced =

Efficient scale

(6)

Advertising

When firms sell differentiated products

and charge prices above marginal cost,

each firm has an incentive to advertise in

order to attract more buyers to its

particular product.

Advertising

u

Firms that sell highly differentiated

consumer goods typically spend between

10 and 20 percent of revenue on

advertising.

u

Overall, about 2 percent of total revenue,

or over $100 billion a year, is spent on

advertising.

Advertising

u

Critics of advertising argue that firms

advertise in order to manipulate people’s

tastes.

u

They also argue that it impedes

competition by implying that products

are more different than they truly are.

(7)

Advertising

u

Defenders argue that advertising provides

information to consumers

u

They also argue that advertising increases

competition by offering a greater variety

of products and prices.

u

The willingness of a firm to spend

advertising dollars can be a signal to

consumers about the quality of the

product being offered.

Brand Names

u

Critics argue that brand names cause

consumers to perceive differences that do

not really exist.

Brand Names

u

Economists have argued that brand

names may be a useful way for

consumers to ensure that the goods they

are buying are of high quality.

u

providing

information

about quality.

u

giving firms

incentive

to maintain high