Monopolistic Competition : Outline

1. Monopolistic Competition: Outline • What is monopolistic competition? • Characteristics of monopolistic competition • Equilibrium in SR and the LR • Implications of Monopolistic Competition for social welfare • Advertisement and brand names- do they have any social value?

2. Monopolistic Competition • Monopolistic Competition is a market structure in which many firms sell products that are similar but not identical • Characteristics of Monopolistic Competition • Many sellers • Product differentiation (down-ward sloping demand curve) • Free entry

3. Monopolistic Competitionin the SR and LR • Monopolistically Competitive firm in the short run follows the monopolist’s rule for profit maximization and produces the quantity that maximizes its profits • In the LR, when existing firms are making a profit: • New firms have an incentive to enter • Existing firms experience a downward shift in their demand curve

4. Monopolistic Competitionin the LR • In the LR, when existing firms are making a loss: • Existing firms have an incentive to exit • The remaining firms experience an upward shift in their demand curve • Process of entry and exit continue up to the point until all the firms in the market are making zero economic profit. This is the market equilibrium

5. Monopolistic Competitionin the LR • Graphically, the market equilibrium occurs at the point where the firm’s demand curve is tangent to its ATC curve (Recall: Profit= Price-ATC) • Characteristics of LR equilibrium: • Similar to monopoly, monopolistic competitive market has price exceeding MC • Similar to a competitive market, monopolistic competitive market has P=ATC and therefore has zero economic profit

6. Monopolistic CompetitionVS Perfect Competition in the LR • Equilibrium in the Monopolistic competition in the LR differs from equilibrium in perfect competition in the LR on two accounts: • Excess capacity • Markup over MC

7. Monopolistic Competition and Welfare • Sources of inefficiency: • Markup of price over MC resulting in a deadweight loss • Public policy cannot lower prices since monopolistic competitors are already making zero economic profit (or a subsidy would be required)

8. Monopolistic Competition and Welfare • Sources of inefficiency: • Entry and exit may not ensurethat the idealnumber of firms exist in the market • The presence of ideal number is difficult to ensure because of the externalities associated with the entry of a new firm • Product variety externality- positive for consumers • Business stealing externality- negative for existing firms

9. Monopolistic Competition and Advertising • Advertisement: • Critique • Defense: information, promotes competition • Advertisement is a sign of quality • Brand names • Critique • Defense