1. Many sellers 2. Product differentiation 3. Free entry and exit Monopolistic Competition...

1. Many sellers

2. Product differentiation

3. Free entry and exit

Monopolistic Competition

Characteristics of Monopolistic Competition

Chinese Food

Funeral Services

1. Many sellers: Citysearch lists 1,832 Chinese restaurants in NYC

The Market for Chinese Food in NYC

2. Product differentiation: For people who want it…

spicy blandKosher fast

3. Free entry and exit: restaurants are constantly opening and closing.

 (21 reviews)  (9 reviews)  (1 reviews)  (7 reviews)  (2 reviews)

Source: CitySearchSource: CitySearch

Cost Rating→$ $ (under $20)

$$ ($21-$30)$$$ ($31-$40)

$$$$ (above $40)

Differentiated Products

Each Chinese restaurant produces meals that are slightly different from those of other Chinese restaurants.

Rather than being a price taker, each Chinese restaurant faces a downward-sloping demand curve.

The number of firms in the market adjusts until economic profits are zero.

Free Entry or Exit

Firms can enter or exit the market without restriction.

0 100 200 300 400 500 600 700 800 900 1000

Chinese Meals (number per week)

MC

D

Price ($ per meal)

0 100 200 300 400 500 600 700 800 900 1000

Chinese Meals (number per week)

MC

D

Qπ

P ATC

MR

=ATC

Over the last few years, a large number of Chinese from Fujian Province have been smuggled into New York City. Their “desperation” makes “them highly desirable as laborers” (NYTimes, 7/22/2001). Indeed, signs litter the windows of Chinese restaurants advertising jobs for “hard-working Fujianese,” including the front window of the Silk Road Palace.

0 100 200 300 400 500 600 700 800 900 1000

Chinese Meals (number per week)

MC2

D

Qπ2

P2

ATC2

MR

ATC(Qπ2)A

B

Total Revenue = A+B

Total Cost = B

Econ Profits = A

Short-run economic profits encourage new Chinese Restaurants to enter the market. This:• Increases the variety in Chinese meals.

• Reduces demand faced by restaurants already in the market.

• Incumbent restaurants’ demand curves shift to the left.

• Demand for the incumbent restaurants’ meals fall, and their profits decline.

The Long-Run Equilibrium

• Chinese restaurants will enter and exit until the firms are making exactly zero economic profits.

0 100 200 300 400 500 600 700 800 900 1000

Chinese Meals (number per week)

MC2

D3

Qπ3

P3= ATC2

MR3

ATC

The demand curve is tangent to the ATC curve.

And this tangency lies vertically above the intersection of MR and MC.

Monopolistic versus Perfect Competition

• There are two noteworthy differences between monopolistic and perfect competition:– Excess capacity– Markup over marginal cost

0 100 200 300 400 500 600 700 800 900 1000

Chinese Meals (number per week)

MC2

D3

Qπ3

P3= ATC2

MR3

ATC

The demand curve is tangent to the ATC curve.

And this tangency lies vertically above the intersection of MR and MC.

Monopolistic versus Perfect Competition

• Excess Capacity– Free entry results in competitive firms

producing at the point where average total cost is minimized, which is the efficient scale of the firm.

.– In monopolistic competition, output is less than

the efficient scale of perfect competition.

Quantity0

Price

Demand

(a) Monopolistically Competitive Firm

Quantity0

Price

P = MC P = MR(demand

curve)

(b) Perfectly Competitive Firm

MCATC

MCATC

MR

Efficientscale

P

Quantityproduced

Quantity produced =Efficient scale

Monopolistic versus Perfect Competition

Monopolistic versus Perfect Competition

• Markup over Marginal Cost– For a competitive firm, price equals marginal

cost.– For a monopolistically competitive firm, price

exceeds marginal cost.

Quantity0

Price

Demand

(a) Monopolistically Competitive Firm

Quantity0

Price

P = MC P = MR(demand

curve)

(b) Perfectly Competitive Firm

Markup

MCATC

MCATC

MR

Marginalcost

P

Quantityproduced

Quantity produced

Monopolistic versus Perfect Competition

Monopolistic Competition and the Welfare of Society

• There is the normal deadweight loss of monopoly pricing in monopolistic competition caused by the markup of price over marginal cost.

• However, it may be that people are willing to incur the cost to have the greater variety offered by monopolistically competitive markets.