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By:
Prof. Sharif Memon
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xMonopolistic Competitionx Many firms selling products that are similar
but not identical.
x Oligopoly
x Only a few sellers, each offering a similar or
identical product to the others.
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Markets that have some
features of competition and
some features of monopoly.
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x
Many sellersx Product differentiation
x Free entry and exit
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There are many firms competing for the
same group of customers.
xProduct examples include books, CDs,movies, computer games, restaurants,
piano lessons, furniture, etc.
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xEach firm produces a product that is
at least slightly different from those
of other firms.xRather than being a price taker, each
firm faces a downward-sloping
demand curve.
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x Firms can enter or exit the market
without restriction.
xThe number of firms in the marketadjusts until economic profits are zero.
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(a) Firm Makes a Profit
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Short-run economic profits encourage new
firms to enter the market. This:
x Increases the number of products offered.x Reduces demand faced by firms already in the
market.
x Incumbent firms demand curves shift to theleft.
x Demand for the incumbent firms products fall,
and their profits decline.
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Short-run economic losses encourage firms
to exit the market. This:
x Decreases the number of products offered.x Increases demand faced by the remaining
firms.
x Shifts the remaining firms demand curvesto the right.
x Increases the remaining firms profits.
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Firms will enter and exit untilthe firms are making exactly
zero economic profits.
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As in a monopoly, price exceeds marginal
cost.xProfit maximization requires marginal
revenue to equal marginal cost.
x
The downward-sloping demand curvemakes marginal revenue less than
price.
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As in a competitive market, price equals
average total cost.x Free entry and exit drive economic profit
to zero.
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x For a competitive firm, price equalsmarginal cost.
x For a monopolistically competitive firm,price exceeds marginal cost.
s Because price exceeds marginal cost, an
extra unit sold at the posted price meansmore profit for the monopolisticallycompetitive firm.
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Monopolistic competition does nothave all the desirable properties of
perfect competition.
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Monopolistic Competition and
the Welfare of Society
x There is the normal deadweight loss of
monopoly pricing in monopolistic
competition caused by the markup of
price over marginal cost.
x However, the administrative burden of
regulating the pricing of all firms that
produce differentiated products would be
overwhelming.
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Another way in which monopolistic
competition may be socially inefficient is
that the number of firms in the market may
not be the ideal one. There may be too
much or too little entry.
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Externalities of entry include:
x product-variety externalities.
x business-stealing externalities.
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The product-variety externality:Because consumers get some consumer
surplus from the introduction of a new
product, entry of a new firm conveys a
positive externality on consumers.
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The business-stealing externality:Because other firms lose customers and
profits from the entry of a new competitor,
entry of a new firm imposes a negative
externality on existing firms.
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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.
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x Firms that sell highly differentiatedconsumer goods typically spend between10 and 20 percent of revenue onadvertising.
x Critics of advertising argue that firmsadvertise in order to manipulate peoplestastes.
x They also argue that it impedescompetition by implying that productsare more different than they truly are.
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x Defenders argue that advertising providesinformation to consumers
x They also argue that advertising increases
competition by offering a greater varietyof products and prices.
x The willingness of a firm to spend
advertising dollars can be a signal toconsumers about the quality of the
product being offered.
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xCritics argue that brand names cause
consumers to perceive differences that do
not really exist.