Monopolistic Competition

1. Monopolistic Competition Economics (H) Fall Semester Mrs. Huff

2. Definition A market structure characterized by: a large number of small firms, similar but not identical products sold by all firms, relative freedom of entry into and exit out of the industry, and extensive knowledge of prices and technology

3. Monopolistic competition approximates most of the characteristics of perfect competition, but falls short of reaching the ideal benchmark that IS perfect competition. It is the best approximation of perfect competition that the real world offers.

4. Examples! Fast Food Restaurants Clothing Radio Stations Convenience Stores Books, CDs, movies, etc There is a fine line between oligopoly and monopolistic competition. Depends on how you define the market.

5. MonopolisticCompetition Oligopolistic Competition YUM! ~ KFC, Pizza Hut, Taco Bell, Long John Silver’s, and A&W All-American Food Restaurants. 2008

6. M.C. vs. Oligopoly There is no clear-cut, obvious dividing line between monopolistic competition and oligopoly.

7. KEYS: Large# of smallfirms ~Each firm is relatively small when compared to the overall size of the market This ensures that all firms are relatively competitive with very little market control over price or quantity. Similar Products ~ Each firm sells a similar, but not identical product. The goods are close substitutes, but not perfect substitutes. Relative Resource Mobility ~ Relatively free to enter and exit an industry. They are largely unrestricted by government rules & regulations, start-up cost or other barriers to entry Extensive Knowledge ~ Buyers do not know everything, but they have relatively complete control about alternative prices. They have information about product differences, brand names, etc.

8. Product Differentiation Means that goods are essentially the same, but have slight differences. Physical Differences ~ The product is physically different from the product of other firms. (Rest.: Italian vs. Mexican) Perceived Differences ~ The goods are only perceived to be different, though no physical differences exist. Such differences are often created by brand names – only difference is packaging. Support Services ~ Products that are identical in #1 and #2 are differentiated by support services – one retail store offers “service with a smile” while another provides express checkout.

9. Product Differentiation Is the primary reason that each firm operating in a monopolistically competitive market is able to create a little monopoly all to its self.

10. What about brand loyalty?

11. What about brand names? Pros Cons • Brand names ensure quality. • Give firms an incentive to maintain high quality. • Provide information to the consumer about the quality of a product. • Cause consumers to perceive differences that usually don’t exist. • Consumers paying more for brand name products is irrational. • Irrationality is fostered by advertising.

12. Elasticity? Demand is relatively elastic in monopolistic competition because each firm faces competition from a large number of very, very close substitutes. However demand is not perfectly elastic (as in perfect competition) because the output of each firm is slightly different from that of other firms. M.C. goods are close substitutes, but not perfect substitutes.

13. Role of Advertising Because in a M.C. market, goods are close substitutes, but not perfect substitutes. . . . Firms must rely on advertising to help create perceived differences, either physically, in quality or in support services.

14. Advertising 101 What really good ads can you think of? Really BAD?

15. Why is even this effective?

16. Is advertising a waste of valuable resources?

17. Advertising Budgets Consumer Goods Industrial Goods • OTC Drugs • Perfumes • Soft drinks • Razor blades • Breakfast cereals • Dog Food • Spend ~ 10-20% of revenue on advertising. • Drill presses • Communication satellites • Spend very little on adv. • Homogeneous Products • Wheat, peanuts, crude oil • Spend NOTHING at all on advertising.

18. Critiques of Advertising Could do other things with the money. Ads can be manipulative. More psychological than informative. Subconscious messages. Encourage brand loyalty.

19. Defense of Advertising Catches customer’s attention. Sets your product apart from others. Brand name attachment. Provides information about product. Conveys prices, information and locations of stores. Allows customers to make an informed decision.

20. Advertising is a signal of quality. How much information does advertising really provide? Tells customer about product quality. Firm’s willingness to spend $ on advertising speaks to quality. It is usually rational for consumers to try a new product because the firm is confident about the quality.

21. In many cases. . . What the ad says is basically irrelevant – as long as the customer knows it was expensive.

22. TEST _______________________ Forms of Business! What is a conglomerate? Monopoly Oligopoly Monopolistic Competition