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7/29/2019 Monopolistic Competition Final
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Chapter 1
Monopolistic Competition
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Imperfect Competition
We have so far seen two kinds of markets:
Perfect competition Many buyers
Many sellers
All sellers sell the exact same product
Monopoly Many buyers
One seller, the monopolist
These are the two extreme cases Imperfect Competition refers to markets in which
the degree of competition among sellers fallssomewhere in between these extremes
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Imperfect Competition
There are two main types of ImperfectCompetition Monopolistic Competition
Many sellers They sell products that are similar but not identical
New firms can enter freely, in the long run
Oligopoly
Only a few sellers
The product sold may be identical or similar but notidentical
New firms find it difficult to enter
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The Four Types of Market Structures
Tap water
Railway
Monopoly
Novels
Movies
Monopolistic
Competition
Laptops
Automobiles
Oligopoly
Number of Firms?
Perfect
Wheat
Milk
Competition
Type of Products?
Identical
products
Differentiated
products
One
firm
Few
firms
Many
firms
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Monopolistic Competition
This chapter focuses on monopolistic
competition
Main features of monopolistic competition Many sellers
Product differentiation: similar but non-
identical products
Free entry and exit
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Monopolistic Competition: main
features
Many Sellers There are many firms competing for the same
group of customers.
Product examples include books, CDs, movies,
computer games, restaurants, piano lessons,
cookies, furniture, etc.
This feature of monopolistic competition is shared
withperfect competition, which we studied in anearlier chapter
So, the decisions made by one firm do not
affect other firms in any perceptible way6
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Monopolistic Competition: main
features
Product Differentiation Each firm produces a product that
is at least slightly differentfrom
those of other firms. As a result,
Rather than being a price taker,
each firm faces a downward-
sloping demand curve. Monopolistic Competition shares this
feature with monopoly, which we
studied in an earlier chapter
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Demand
Quantity
Price
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Monopolistic Competition: main
features
Free Entry or Exit Firms can enter or exit the market without any
difficulty. As a result,
The number of firms in the market adjusts
until economic profits are zero.
This is another feature of monopolistic competition
that it shares withperfect competition
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Recap: Monopoly
Quantity0
Price
Profit-
maximizing
quantity
Price
Demand
MR
ATC
Average
total costProfit
MC
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Monopolistic Competition in the Short Run
Quantity0
Price
Profit-
maximizing
quantity
Price
Demand
MR
ATC
(a) Firm Makes Profit
Average
total costProfit
MC
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These profits willnot last.
Short-run
economic profits
encourage new
firms to enter the
market.
This reduces thedemand faced by
firms already in the
market (incumbent
firms)
Incumbent firms
demand curves
shift to the left.
Their profits fall
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Monopolistic Competition: effect of the entryof new firms on an incumbent
Quantity0
Price
Profit-
maximizing
quantity
Price
Demand
MR
ATC
(a2) Firm Makes Less Profit
ATCProfit
MC
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These profits willnot last either.
Profits encourage
new firms to enter
the market.
This reduces the
demand faced by
incumbent firms
Incumbent firms
demand curves
shift to the left.
Their profits fall
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Monopolistic Competition in the Long Run
Quantity0
Price
Profit-
maximizing
quantity
Demand
MR
ATC
(a3) Firm Makes No Profit
Price = ATC
MC
12
Zero profit
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Monopolistic Competitors in the Short Run
Demand
Quantity0
Price
Price
Loss-
minimizing
quantity
Average
total cost
(b) Firm Makes Losses
MR
LossesATC
MC
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These losses willnot last.
Losses force some
incumbent firms to
exitthe market.
This will increase
the demand faced
by the remainingfirms
Their demand
curves will shift to
the right.
Their losses will
shrink
In the long run,profits will be zero!
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Monopolistic Competition in the Long Run, again
Quantity
Price
0
DemandMR
ATC
MC
Profit-maximizing
quantity
P=ATC
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We have seen that in
the long run profitscannot be positive or
negative.
Therefore, profits
must be zero!
Note that P= ATC>
MR= MCin long run
equilibrium.
MR= MC
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Monopolistic Competition: Between Perfect
Competition and Monopoly
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Excess Capacity :- Monopolistic Competition versusPerfect Competition
Quantity0
Price
Demand
(a) Monopolistically Competitive Firm
Quantity0
Price
P= MC P= MR
(demand
curve)
(b) Perfectly Competitive Firm
Markup
Excess capacity
MCATC
MCATC
MR
Marginal
cost
Efficient
scale
P
Quantity
produced
Quantity produced =
Efficient scale
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The long run equilibrium under monopolistic competition shows
excess capacity. Under perfect competition, theres neither.
The difference between ideal output and the output actually
attained in the long run.
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Summary A monopolistically competitive market is
characterized by three attributes: many
firms, differentiated products, and free
entry.
The equilibrium in a monopolistically
competitive market differs from perfect
competition in that each firm has excesscapacity and each firm charges a price
above marginal cost.
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Summary Monopolistic competition does not have all
of the desirable properties of perfect
competition.
There is a standard deadweight loss of
monopoly caused by the markup of price
over marginal cost.
The number of firms can be too large or
too small.
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