microeconomic
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MiCh16MonopolisticCompetition.pptxMonopolistic Competition
CHAPTER
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PowerPoint Slides prepared by:
V. Andreea CHIRITESCU
Eastern Illinois University
N. GREGORY MANKIW PRINCIPLES OF MICROECONOMICS Eight Edition
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Monopolistic Competition
Imperfect competition
Between perfect competition and monopoly
Oligopoly
Monopolistic competition
Oligopoly
Few sellers
Offer similar or identical products
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Monopolistic Competition
Concentration ratio
Percentage of total output in the market supplied by the four largest firms
Oligopolies, highly-concentrated industries (concentration ratio %)
Major household appliances (90%)
Tires (91%), Light bulbs (92%)
Soda (94%)
Wireless telecommunications (95%)
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Monopolistic Competition
Monopolistic competition
Many sellers
Product differentiation
Not price takers
Downward sloping demand curve
Free entry and exit
Zero economic profit in the long run
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Figure 1 The Four Types of Market Structure
Economists who study industrial organization divide markets into four types—monopoly, oligopoly, monopolistic competition, and perfect competition.
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Short Run Equilibrium
Profit maximization
Produce the quantity where marginal revenue = marginal cost
Price: on the demand curve
If P > ATC: profit
If P < ATC: loss
Similar to monopoly
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Figure 2 Monopolistic Competitors in the Short Run
Monopolistic competitors, like monopolists, maximize profit by producing the quantity at which marginal revenue equals marginal cost. The firm in panel (a) makes a profit because, at this quantity, price is greater than average total cost. The firm in panel (b) makes losses because, at this quantity, price is less than average total cost.
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Price
Quantity
0
(a) Firm makes profit
Profit
MC
ATC
Profit-maximizing
quantity
(b) Firm makes losses
MR
Demand
Price
Price
Quantity
0
Losses
MC
ATC
Loss-minimizing
quantity
ATC
MR
Demand
Price
ATC
Long Run Equilibrium
If firms are making profit in short run
New firms - incentive to enter the market
Increase number of products
Reduces demand faced by each firm
Demand curve shifts left
Each firm’s profit declines until: zero economic profit
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Figure 3 A Monopolistic Competitor in Long Run
In a monopolistically competitive market, if firms are making profits, new firms enter, causing the demand curves for the incumbent firms to shift to the left. Similarly, if firms are making losses, some of the firms in the market exit, causing the demand curves of the remaining firms to shift to the right. Because of these shifts in demand, monopolistically competitive firms eventually find themselves in the long-run equilibrium shown here. In this long-run equilibrium, price equals average total cost, and each firm earns zero profit.
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Price
Quantity
0
MC
ATC
Profit- maximizing
quantity
MR
Demand
Price = ATC
Long Run Equilibrium
Zero economic profit
Demand curve
Tangent to average total cost curve
At quantity where marginal revenue = marginal cost
Price = average total cost
Price exceeds marginal cost
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Long Run Equilibrium
Monopolistic versus perfect competition
Monopolistic competition
Quantity: not at minimum ATC (excess capacity)
P > MC, markup over marginal cost
Perfect competition
Quantity: at minimum ATC (efficient scale)
P = MC
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Figure 4 Monopolistic versus Perfect Competition
Panel (a) shows the long-run equilibrium in a monopolistically competitive market, and panel (b) shows the long-run equilibrium in a perfectly competitive market. Two differences are notable. (1) The perfectly competitive firm produces at the efficient scale, where average total cost is minimized. By contrast, the monopolistically competitive firm produces at less than the efficient scale. (2) Price equals marginal cost under perfect competition, but price is above marginal cost under monopolistic competition.
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Price
Quantity
0
(a) Monopolistically Competitive Firm
MC
ATC
Quantity
produced
MC
(b) Perfectly Competitive Firm
MR
Demand
Price
Price
Quantity
0
Efficient
scale
Markup
MC
ATC
Quantity produced
= Efficient scale
P=MR
(demand curve)
P=MC
Excess capacity
Welfare of Society
Sources of inefficiency
Markup of price over marginal cost
Deadweight loss of monopoly pricing
Too much or too little entry
Product-variety externality (positive externality on consumers)
Business-stealing externality (negative externality on existing firms)
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Advertising
Incentive to advertise
When firms sell differentiated products and charge prices above marginal cost
Advertise to attract more buyers
Advertising spending
Highly differentiated goods: 10-20% of revenue
Industrial products: Little advertising
Homogenous products: No advertising
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Advertising
Debate over advertising
Wasting resources?
Valuable purpose?
The critique of advertising
Firms advertise to manipulate people’s tastes
Psychological rather than informational
Creates a desire that otherwise might not exist
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Advertising
The critique of advertising
Impedes competition
Increase perception of product differentiation
Foster brand loyalty
Makes buyers less concerned with price differences among similar goods
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Advertising
The defense of advertising
Provide information to customers
Customers - make better choices
Enhances the ability of markets to allocate resources efficiently
Fosters competition
Customers - take advantage of price differences
Allows new firms to enter more easily
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Advertising and the price of eyeglasses
What effect does advertising have on the price of a good?
Consumers – view products as being more different than they otherwise would
Markets less competitive
Firms’ demand curves less elastic
Higher prices
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Advertising and the price of eyeglasses
What effect does advertising have on the price of a good?
Consumers – easier to find firms with the best prices
Markets – more competitive
Firms’ demand curves more elastic
Lower prices
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Advertising and the price of eyeglasses
1972, economist Lee Benham
States that prohibited advertising
Average price = $33 ($248 in 2012 dollars)
States that did not restrict advertising
Average price = $26 ($196 in 2012 dollars)
Advertising
Reduced average prices
Fosters competition
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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Advertising
Advertising as a signal of quality
Little apparent information
Real information offered – a signal
Willingness to spend large
amount of money
= signal about quality of the product
Content of advertising = irrelevant
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Is it rational for consumers to be impressed that Jennifer Aniston is endorsing this product?
Advertising
Brand names
Spend more on advertising and charge higher prices than generic substitutes
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Advertising
Critics of brand names
Products – not differentiated
Irrationality: consumers are willing to pay more for brand names
Defenders of brand names
Consumers – information about quality
Firms – incentive to maintain high quality
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Table 1 Monopolistic Competition: Between Perfect Competition and Monopoly
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