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									Monopolistic Competition




     Hall and Lieberman, 3rd edition,
     Thomson South-Western, Chapter 10




                                         1
Overview
   What you will learn in this lecture
     Three fundamental characteristics
     Short run equilibrium

     Long run equilibrium

     Excess capacity

     Non price competition




                                          2
Motivation of Imperfect Competition

       Advertising is everywhere in the economy
       In perfect competition and monopoly firms
        do little, if any, advertising
           Why?
       Where, then, is all the advertising coming
        from?
           We must consider firms that are neither
            perfect competitors nor monopolists




                                                      3
The Concept of Imperfect Competition
       Refers to market structures between
        perfect competition and monopoly
         there is more than one seller, but too
          few to create a perfectly competitive
          market
         products may not be standardized

         no free entry and exit

       Types of imperfectly competitive
        markets
         Monopolistic competition
         Oligopoly


                                                   4
Monopolistic Competition
       Hybrid of perfect competition and
        monopoly
           Three fundamental characteristics
              Many  buyers and sellers
              Sellers offer a differentiated product

              Sellers can easily enter or exit the
               market
       Examples


                                                        5
I. Many Buyers and Sellers
    Under monopolistic competition, an
     individual buyer is a price taker
        But an individual seller, in spite of having
         many competitors, decides what price to
         charge
    Assume that no interaction among firms in
     market
        Each firm only supplies a small part of the
         market, that none of them needs to worry
         that its actions will be noticed—and reacted
         to—by others
                                                        6
II. Sellers Offer a Differentiated Product
        Each seller produces a somewhat
         different product from the others
        Faces a downward-sloping
         demand curve
          In this sense is more like a
           monopolist than a perfect
           competitor
          When it raises its price a modest
           amount, quantity demanded will
           decline (but not all the way to zero)
                                                   7
II. Sellers Offer a Differentiated Product
      What makes a product differentiated?
          Quality of product
          Tastes – a subjective matter
               Whether their perception is accurate or not
          Difference in location
      Thus, whenever a firm faces a downward-
       sloping demand curve, we know buyers
       perceive its product as differentiated
          Firm chooses its price


                                                              8
III. Easy Entry and Exit

       This feature is shared by monopolistic
        competition and perfect competition
         Plays the same role in both
         Ensures firms earn zero economic
          profit in long-run
         However, no barrier stops any firm
          from copying the successful business
          of other firms



                                                 9
Monopolistic Competition in the Short-Run

         Individual monopolistic competitor
          behaves very much like a monopoly
         Key difference is the availability of
          substitutes
             When a monopolistic competitor
              raises its price, its customers have
              one additional option
                Canbuy similar good from some
                other firm


                                                     10
     Monopolistically competitive firm making
 $
     positive economic profit
                         MC



P0
                              ATC



                                         Demand




              Q0         MR         Quantity


                                                  11
Monopolistic Competition in the Long-Run
      Free entry condition
          Continue to occur, and demand curve will
           continue to shift leftward
          Till the time when each firm earns zero
           economic profit
      In real world, monopolistic competitors often
       earn economic profit or loss in the short-run
          But—given enough time—profits attract new
           entrants, and losses result in an industry
           shakeout, until firms are earning zero
           economic profit


                                                        12
     Monopolistically competitive firm making
 $   positive economic profit: invites entry, firm
     demand shifts inward
                            MC



P0
                                 ATC



                                             Demand




                Q0          MR          Quantity


                                                      13
     Monopolistically competitive firm making
$
     positive economic profit: entry continues until
     profits are zero    MC



P0
                              ATC
P1




                              Demand


          Q1   Q0                      Quantity
                     MR

                                                  14
     At equilibrium, P = ATC (zero profit) and
$
     MR = MC
                          MC



                               ATC
P0




          Q0      MR                  Quantity


                                                 15
Features of monopolistically
competitive industries
    Economy is not efficient - excess capacity
       too little output produced to achieve minimum
        cost per unit
       costly to consumers

       equilibrium price is above minimum ATC

    More firms (varieties) than necessary for least cost
     production
    Benefits
       Consumers usually benefit from product
        differentiation



                                                            16
    Non-price Competition
   Definition: Any action a firm takes to increase
    demand for its output—other than cutting its
    price
        Example: better service, product guarantees,
         free home delivery, more attractive packaging
   another reason why monopolistic competitors
    earn zero economic profit in long-run
   Costly
      Must pay for advertising, for product
       guarantees, for better staff training
      Shift each firm’s ATC curve upward


                                                         17

								
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