Monopolistic Competition Chapter 26

1. Monopolistic CompetitionChapter 26

2. Key Questions for this chapter include: • What are the unique features of monopolistic competition? • How are the market outcomes affected by this market structure? • What are the long-run consequences of different market structures?

3. Structure • “many” firms in the industry. • many firms produce similar goods or services but each maintains some independent control of its own price. • “Many” is somewhere between the “few” of oligopolies or the “hordes” that characterize perfect competition. • Low barriers to entry

4. Low Concentration • Low concentration ratios are common in monopolistic competition. • Concentration Ratio – The proportion of total industry output produced by the largest firms (usually the four largest). • Examples of monopolistic competition include banks, radio stations, health spas, apparel stores, and convenience stores, fast foods, and shoe stores, • What about cellular industry?

5. Market Power • Each producer in monopolistic competition is large enough to have some market power. • Market Power – The ability to alter the market price of a good or service. • A monopolistically competitive firm confronts a downward-sloping demand curve.

6. Independent Production Decisions • The relative independence of monopolist competitors means that they don’t have to worry about retaliatory responses to every price or output change. • Monopolistic competition has distinctive behavior which involves product differentiation.

7. Product or Brand Loyalty • By differentiating their products, monopolistic competitors establish brand loyalty which gives them greater control over pricing. • Translated as a “Monopoly” on their own brand… (Give me some examples)

8. Brand Loyalty • Will compete with other firms but offer substitutes • makes the demand curve facing the firm less price-elastic. • implies that consumers shun substitute goods even when they are cheaper. • Example: the price differences between computers which are essentially the same.

9. Short Run Price and Output • Production Decision - The production decision is the selection of the short-run rate of output. As always, the profit-maximizing rate of output is achieved by producing the quantity where MR = MC. New firms enter when there is an economic profit and leave when there is not. In the long run, there are no economic profits in monopolistic competition.

10. When firms enter a monopolistically competitive industry: • The market supply curve shifts to the right. • The demand curves facing individual firms shift to the left.

11. Effect of entry on the mono-polistically competitive firm Effect of entry on the industry Initial market supply Reduced market share Later market supply Initial demand facing firm PRICE (per unit) PRICE (per unit) Later demand facing film Market demand New entry QUANTITY (units per time period) QUANTITY (units per time period)

12. The short run The long run MC MC F ATC pa ATC PRICE OR COST (dollars per unit) PRICE OR COST (dollars per unit) G pg Initial demand Demand K Later demand MR 0 qa 0 qg Later MR QUANTITY (units per period) QUANTITY(units per period) Equilibrium in Monopolistic Competition

13. The long run MC ATC PRICE OR COST (dollars per unit) G pg Initial demand Later demand 0 qg Later MR QUANTITY(units per period) • Because of the industry-wide excess capacity in monopolistic competition, each firm is producing at a rate of output that is less than its minimum-ATC output rate. Note: the less Efficient production Of Mono Comp from Perfect Comp

14. Thus, the same level of industry output could be produced at lower cost with fewer firms. • Monopolistic competition results in both production inefficiency (above-minimum average cost) and allocative inefficiency (wrong mix of output). Remember! Difference between two terms!

15. PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Expect New Competitors ATC P1 A1 Price and Costs Short-Run Economic Profits D MR Q1 Quantity

16. PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Expect New Competitors ATC New competition drives down the price level – leading to economic losses in the short run. P1 A1 Price and Costs Short-Run Economic Profits D MR Q1 Quantity

17. PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC ATC A2 P2 Short-Run Economic Losses Price and Costs D MR Q2 Quantity

18. PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Long-Run Equilibrium Normal Profit Only ATC P3 = A3 Price and Costs D MR Q3 Quantity

19. Advertising Wars • In truly (perfectly) competitive industries, firms compete on the basis of price. • Imperfectly competitive firms engage in nonprice competition with the most prominent form of nonprice competition being advertising. • Advertising may be more responsible for brand loyalty than the taste of the product.

20. Characteristics • Differentiated Products • Product Attributes • Service • Location • Brand Names and Packaging • Some Control Over Price • Easy Entry and Exit • Advertising

21. Characteristics continued • Relatively Large Number of Sellers • Small Market Shares • No Collusion • Independent Action

22. PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Expect New Competitors ATC P1 A1 Price and Costs Short-Run Economic Profits D MR Q1 Quantity

23. PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Expect New Competitors ATC New competition drives down the price level – leading to economic losses in the short run. P1 A1 Price and Costs Short-Run Economic Profits D MR Q1 Quantity

24. PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC ATC A2 P2 Short-Run Economic Losses Price and Costs D MR Q2 Quantity

25. PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Long-Run Equilibrium Normal Profit Only ATC P3 = A3 Price and Costs D MR Q3 Quantity

26. Graph A showsshort-run profits when there are few firms in the market • Graph B shows short-run losses as other companies see the success and join the market causing profits to drop • Graph C shows long-run equilibrium as the weaker firms leave the industry