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Monopolistic Competition

Monopolistic Competition. The Theory of the Firm. Learning Targets . Describe, using examples, the assumed characteristics of MC. How does product differentiation leads to a small degree of monopoly power and therefore a negatively sloping demand curve for the product.

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Monopolistic Competition

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  1. Monopolistic Competition The Theory of the Firm

  2. Learning Targets • Describe, using examples, the assumed characteristics of MC. • How does product differentiation leads to a small degree of monopoly power and therefore a negatively sloping demand curve for the product. • Distinguish between price competition and non-price competition. • Explain, using a graph, a profit/loss making firm in MC. • Explain, using a diagram, why in the long-run a firm in a MC will make normal profits. • Explain, using a diagram, why neither allocative nor productive efficiency can be achieved in MC firms • Compare and contrast, using a diagram, MC with PC and MC with monopoly.***

  3. Monopolistic Competition • Cross between monopoly and perfect competition • It gets its name from sharing some characteristics with pure monopoly and some with perfect competition.

  4. Characteristics

  5. Examples • Restaurants in a major city: • There are hundreds of restaurants in a city of any reasonable size. • They all sell a similar product (food), • which is differentiated from one seller to the other (Chinese, Mexican, French, Barbecue, etc…) • Each restaurant can set its own prices, but only to an extent (have you ever seen a $100 hamburger?)

  6. Apparel: The market for clothing is highly competitive • there hundreds (or thousands) of clothing manufactures are competing for our business by differentiating their products from the competition. • Again, firms have some price-making power, but consumers can always switch brands if prices rise too much, so demand is relatively elastic.

  7. Automobiles: • Even the car market shows some characteristics of monopolistic competition • although due to the relatively substantial economies of scale, it could be considered oligopolistic in some markets. • Each car is a close substitute for all other cars, but is differentiated to try to make demand for it less elastic.

  8. Test your knowledge • In your groups • Describe, using examples, the assumed characteristics of MC.

  9. Revenue Curves

  10. Revenue Curves for the Monopolistic Competitor • Because each firm in in a monopolistically competitive market makes a product that is differentiated from its competitors, • it is able to control the price for its output, but only to a certain extent.

  11. Revenue Curves Monopolistically Competitive firm P • Observations of the Monopolistic Competitor’s Demand and MR curves: • With many other firms making similar products, each firm faces a relatively, but not perfectly, elastic demand curve. • A price increase will lead to a large loss of buyers, but a price decrease will lead to a large increase in buyers. • In order to sell additional units of its product, a firm must lower the price of all its output. • For this reason, the firm’s marginal revenue will fall faster than its price (same asMonopoly) P D=AR=P MR Q Q

  12. Profit Max. in The Short-Run

  13. Profit Maximization in the Short-run • As with firms in competing in the other market structures, • Amonopolistic competitor will maximize its total profits when it produces at the quantity of output at which: • MR=MC

  14. Graph Monopolistically Competitive firm P MC ATC Economic Profits Pf ATC D=AR=P MR Qf Q

  15. Graph Analysis • The firm is producing at its profit maximizing quantity (Qf) and charging the price consumers are willing to pay for that quantity (Pf) • At this point, price is greater than ATC, so the firm is earning an economic profit. • Given the existence of profits in this market (assuming this firm is a typical firm) new firms will be attracted to the industry. • Since entry barriers are low, these short-run economic profits are likely to be eliminated in the long-run as new firms enter the market.

  16. Test your knowledge • With your partner • Explain, using a graph, a profit/loss making firm in MC.

  17. Profit max. in The Long-Run

  18. Entry Eliminates Profits • One of the key characteristics of monopolistic competition is the low entry barriers. • Getting into such a market is relatively cheap and easy • and entrepreneurs will therefore be attracted to any economic profits that are earned .

  19. Graph P P MC MC ATC ATC Economic Profits Pf ATC P=ATC D=AR=P D=AR=P MR MR Qf Qf1 Q Q Economic profits attract new firms to the market, increasing the amount of competition and the number of substitutes for this firm’s product More competition reduces demand for this firm’s product, and makes it more elastic (flatter). Demand decreases until the firm is only breaking even

  20. Exit Eliminates Losses • Just as it is relatively easy to enter a monopolistically competitive market, • it is also easy to leave. • This means that if the firms in such a market are earning losses, some will exit the market, • increasing the demand for those that remain until they are breaking even.

  21. Graph MC MC P P ATC ATC Economic Losses ATC P=ATC Pf D=AR=P D=AR=P MR MR Qf Qf1 Q Q Due to weak demand, firms are earning losses, leading some firms to exit the market. As they do so, demand for the remaining firms increases… Less competition increases demand for this firm’s product, and makes it less elastic (steeper). Demand increases until the firm is breaking even again

  22. Test your knowledge • With your partner • Explain, using a diagram, why in the long-run a firm in a MC will make normal profits.

  23. Efficiency in MC Markets

  24. To determine whether monopolistically competitive firms are economically efficient, we must determine whether: • P = MC/MC=MB: This is an indicator of allocativeefficiency • since price represents the marginal benefits of consumers and MC the marginal cost to producers • P = minimum ATC: This tells us whether firms are productively efficient • since if the price equals the lowest ATC, then firms are forced to use their resources in the least-cost manner.

  25. Graph MC P ATC Efficiency is not achieved! -As we can see in the graph, a monopolistic competitor, in long-run: - Equilibrium will achieve neither productive nor allocative efficiency. -The lack of competition allows firms to produce at a cost higher than their minimum ATC and produce a quantity lower than what is socially optimal. P=ATC P>min. ATC P>MC MC D=AR=P MR Qf Qso(where P=MC) Q

  26. Test your knowledge • In your groups • Explain, using a diagram, why neither allocative nor productive efficiency can be achieved in MC firms

  27. MC vs. PC • It may appear that: • since they do not achieve economic efficiency, • monopolistically competitive markets are less desirable than perfectly competitive markets. • However, there are also several benefits of monopolistic competition over perfect competition.

  28. Video • http://www.econclassroom.com/?p=3128

  29. Test your knowledge • In your groups • Compare and contrast, using a diagram, MC with PC and MC with monopoly. (this is a 15 mark paper 1 question) • Post answers on edmodo

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