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Monopolistic Competition

Monopolistic Competition. Topics to be Discussed. Monopolistic Competition Oligopoly Price Competition Competition Versus Collusion: The Prisoners’ Dilemma. Topics to be Discussed. Implications of the Prisoners’ Dilemma for Oligopolistic Pricing Cartels. Monopolistic Competition.

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Monopolistic Competition

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  1. Monopolistic Competition

  2. Topics to be Discussed • Monopolistic Competition • Oligopoly • Price Competition • Competition Versus Collusion: The Prisoners’ Dilemma Chapter 12

  3. Topics to be Discussed • Implications of the Prisoners’ Dilemma for Oligopolistic Pricing • Cartels Chapter 12

  4. Monopolistic Competition • Characteristics 1) Many firms 2) Free entry and exit 3) Differentiated product Chapter 12

  5. Monopolistic Competition • The amount of monopoly power depends on the degree of differentiation. • Examples of this very common market structure include: • Toothpaste • Soap • Cold remedies Chapter 12

  6. Monopolistic Competition • Toothpaste • Crest and monopoly power • Procter & Gamble is the sole producer of Crest • Consumers can have a preference for Crest---taste, reputation, decay preventing efficacy • The greater the preference (differentiation) the higher the price. Chapter 12

  7. Monopolistic Competition • Question • Does Procter & Gamble have much monopoly power in the market for Crest? Chapter 12

  8. Monopolistic Competition • The Makings of Monopolistic Competition • Two important characteristics • Differentiated but highly substitutable products • Free entry and exit Chapter 12

  9. MC MC AC AC PSR PLR DSR DLR MRSR MRLR QSR QLR A Monopolistically CompetitiveFirm in the Short and Long Run $/Q $/Q Short Run Long Run Quantity Quantity

  10. A Monopolistically CompetitiveFirm in the Short and Long Run • Observations (short-run) • Downward sloping demand--differentiated product • Demand is relatively elastic--good substitutes • MR < P • Profits are maximized when MR = MC • This firm is making economic profits Chapter 12

  11. A Monopolistically CompetitiveFirm in the Short and Long Run • Observations (long-run) • Profits will attract new firms to the industry (no barriers to entry) • The old firm’s demand will decrease to DLR • Firm’s output and price will fall • Industry output will rise • No economic profit (P = AC) • P > MC -- some monopoly power Chapter 12

  12. Deadweight loss MC AC MC AC P PC D = MR DLR MRLR QC QMC Comparison of Monopolistically CompetitiveEquilibrium and Perfectly Competitive Equilibrium Monopolistic Competition Perfect Competition $/Q $/Q Quantity Quantity

  13. Monopolistic Competition • Monopolistic Competition and Economic Efficiency • The monopoly power (differentiation) yields a higher price than perfect competition. If price was lowered to the point where MC = D, consumer surplus would increase by the yellow triangle. Chapter 12

  14. Monopolistic Competition • Monopolistic Competition and Economic Efficiency • With no economic profits in the long run, the firm is still not producing at minimum AC and excess capacity exists. Chapter 12

  15. Monopolistic Competition • Questions 1) If the market became competitive, what would happen to output and price? 2) Should monopolistic competition be regulated? Chapter 12

  16. Monopolistic Competition • Questions 3) What is the degree of monopoly power? 4) What is the benefit of product diversity? Chapter 12

  17. Monopolistic Competitionin the Market for Colas and Coffee • The markets for soft drinks and coffee illustrate the characteristics of monopolistic competition. Chapter 12

  18. Elasticities of Demand forBrands of Colas and Coffee Colas: Royal Crown -2.4 Coke -5.2 to -5.7 Ground Coffee: Hills Brothers -7.1 Maxwell House -8.9 Chase and Sanborn -5.6 Brand Elasticity of Demand Chapter 12

  19. Elasticities of Demand forBrands of Colas and Coffee • Questions 1) Why is the demand for Royal Crown more price inelastic than for Coke? 2) Is there much monopoly power in these two markets? 3) Define the relationship between elasticity and monopoly power. Chapter 12

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