CH 16: MONOPOLISTIC COMPETITION

CHARACTERISTICS OF MONOPOLISTIC COMPETITION

1. Many sellers

• There are many producers

• Consumers have choices of what to consume

2. Product differentiation

• Goods are NOT identical

3. Multiple dimensions of competition

• Since these products have substitutes, firms use non-price competition such as advertising, brand names and packaging, service, etc.

CHARACTERISTICS OF MONOPOLISTIC COMPETITION

4. Entry and exit of firms in the long run

• There are no significant barriers to entry

5. Firms experience zero economic profit in the long run

6. At its profit maximizing output (MC=MR), marginal cost will be less than price

CHARACTERISTICS OF MONOPOLISTIC COMPETITION

“MONOPOLY” + “COMPETITION”= MONOPOLISTIC COMPETITION

Monopolistic Qualities

• Control over price of own good due to differentiated product

• D is greater than MR

• Plenty of advertising

• Not efficient

Perfect Competition Qualities

• Large number of smaller firms

• Relatively easy entry and exit

• Zero economic profit in long-run

ADVERTISING AND MONOPOLISTIC COMPETITION

• Why do monopolistically competitive firms advertise?

• To increase demand and make demand more inelastic (to show their “differentness” in order to attract consumers)

• Advertising increases ATC

DRAWING THE GRAPH: MONOPOLISTIC COMPETITION EARNING A PROFIT IN THE SHORT RUN

• Draw a downward sloping demand curve

• The MR curve starts at the same point on the price axis as does P

• It bisects the demand curve

• Draw the MC curve

• Find the point where MC=MR

• Take this point down to the quantity axis to determine profit-maximizing quantity

• Take this point up the demand curve and over to the price axis to determine price

DRAWING THE GRAPH: MONOPOLISTIC COMPETITION EARNING A PROFIT IN THE SHORT RUN

• Now, add the ATC to show a profit

• ATC should be below price

• Take price off the demand curve down to ATC to find the profit

• Shade the area of profit

DRAWING THE GRAPH: MONOPOLISTIC COMPETITION EARNING A PROFIT IN THE SHORT RUN

Q

P

Q1

MC

D

MR

P1

ATC

Profit

DRAWING THE GRAPH: MONOPOLISTIC COMPETITION EARNING A PROFIT IN THE SHORT RUN

• In this graph, ATC will be above price

• Take the price off of the demand curve up to the ATC to determine the area of loss

• Shade the area of loss

DRAWING THE GRAPH: MONOPOLISTIC COMPETITION EARNING A LOSS IN THE SHORT RUN

Q

P

Q1

MC

D

MR

P1

ATC

Loss

DRAWING THE GRAPH: MONOPOLISTIC COMPETITION EARNING A LOSS IN THE SHORT RUN

• In this graph the ATC will be tangent to the demand curve at the output the firm produces but NOT at its minimum

• For a monopolistic competitor in long-run equilibrium, (P = ATC) ≥ (MC = MR)

DRAWING THE GRAPH: MONOPOLISTIC COMPETITION IN THE LONG RUN: ZERO ECONOMIC PROFIT

Q

P

ATC

Q1

MC

D

MR

P1

DRAW THE GRAPH: MONOPOLISTIC COMPETITION IN THE LONG RUN: ZERO ECONOMIC PROFIT

ARE MONOPOLISTICALLY COMPETITIVE FIRMS EFFICIENT?

• Socially optimal/allocatively efficient level (SO/AE): where D=MC (or supply=demand)• Not allocatively efficient because P MC

• Productively efficient level: minimum ATC; using the least combination of inputs to produce maximum output for minimum cost• Not productively efficient because not producing at minimum

ATC

• Firms have excess capacity: firm could be producing at the lowest cost but is producing less quantity (not allocatively efficient)

ARE MONOPOLISTICALLY COMPETITIVE FIRMS EFFICIENT?

Q

P

Q1

MC

D

MR

P1

ATC

PE

SO/AE

QPE Qso

PPE

Pso

•Socially optimal/allocatively efficient level: where D=MC

•Productively efficient level: minimum ATC

DRAW THE GRAPH: MONOPOLISTIC COMPETITION EARNING A PROFIT IN THE SHORT RUN WITH SO AND PE

MONOPOLISTIC COMPETITION COMPARED TO PERFECT COMPETITION

• In monopolistic competition in the long run, P > min ATC

• In perfect competition in the long run, P = min ATC

• Outcome: monopolistic competition output is lower, and price is higher, than perfect competition

Monopolistic Competition compared to Perfect Competition

Q

P

QMC

MC

D

MR

PMC

ATC

QPC

PPC

DWL

Because a monopolistically competitive firm produces at a higher price and a lower output than a perfectly competitive firm there is DWL

MONOPOLISTIC COMPETITION COMPARED TO PERFECT COMPETITION

COMPARING MONOPOLISTIC COMPETITION TO A MONOPOLY

• It is possible for the monopolist to make economic profit in the long run because of the existence of barriers to entry

• No long-run economic profit is possible in monopolistic competition because there are no significant barriers to entry (if profit is being made, more firms enter the industry)

• For a monopolistic competitor in long-run equilibrium, (P = ATC) ≥ (MC = MR)

CHAPTER SUMMARY

• Monopolistic competition is characterized by:

• Many sellers

• Differentiated products

• Multiple dimensions of competition

• Ease of entry of new firms

• Monopolistic competitors differ from perfect competitors in that the former face a downward sloping demand curve

• Monopolistic competitors differ from monopolists in that monopolistic competitors make zero long-run profit