Chapter 23

1. Chapter 23 Monopolistic Competition and Oligopoly (NOTE I MAY HAVE AC =ATC same thing – average total cost)

2. Overview In this chapter we will study the market structure known as monopolistic competition and the strategic nature of oligopoly industries. In this section I will have notes on monopolistic competition. As the name implies, this market structure exhibits parts of competition and parts of monopoly. Recall in competition that firms are price takers and in the long run profit is driven to zero (P = AC) because other firms can enter the industry to try to get some of that profit. In monopoly the firm is a price maker and while there is no guarantee of profit, profit can exist in the long run because no one else makes a close substitute.

3. Monopolistic Competition Monopolistic competition is a structure where 1) there are many firms, like in competition, 2) each sells a slightly differentiated product, so this means the firm is like a monopoly, and 3)There is easy entry to and exit from the industry because firms are somewhat small relative to overall market. Examples of industries of this type include retail bakeries, jewelry stores and plastic bag makers. Since each firm sells a differentiated product we have some components of the monopoly structure to think about and since there are many firms we have the perfect competition component to think about. I find it useful to think about the monopoly feature in the short run and the competitive feature in the long run.

4. Monop. comp $ MC The differentiated nature of the product means each firm is a monopoly as the seller of its own product and thus the demand is downward sloping . The firm will operate where MR = MC and charge the price on the demand curve at this output level. ATC P* D Q* MR

5. Long term $ MC In the long run it is thought that if monop. comp. firms have profit other firms will enter the industry in the hopes of also making profit. This will likely take demand from existing firms and drive profit to zero for firms. This firm shown has zero ATC P* AVC D Q* MR economic profit. Do you know why?

6. comments Since each firm is a “monopoly” of its own product the demand curve slopes downward. Profits may be positive in the short run, but this profit will attract other firms to enter the market and profit will be driven to zero in the long run. In competition in the long run AC is at a minimum, while in monopolistic competition AC is not at a minimum. Monopolistically competitive industries have been criticized as being wasteful because AC in not at a minimum. This is a situation known as excess capacity. Others say that is the price we pay for having differentiated products. Another point is that since P = MC we have the same kind of deadweight loss that exists in monopoly.

7. Advertising Another detail about monopolistic competition is that there may be some non-price competition in the form of advertising so that each firm can gain consumers from the other firms. Recall in competition that a firm’s demand curve was horizontal – what is called perfectly elastic meaning the % change in the quantity is huge given even a small % change in price. In a monopoly the demand was downward sloping and since there are no close substitutes for a monopoly product, by definition, the demand is considered somewhat steep (although production occurs in the elastic range for a monopoly). Effective advertising makes the monopolistically competitive firm’s demand move out and become steeper.

8. Product Variety A donut is a donut, right? No way! We have variety. In monopolistic competition a firm will think in the following way. If I can develop a new variety of product maybe people will come to me more and I will make more money. SO, this development will cost money and if I think the increased revenue will outweigh the cost, then I will go for it!