ch15slecture by bjdpkx

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									Monopolistic Competition   CHAPTER
                                     15
CHAPTER CHECKLIST
When you have completed your study of this
chapter, you will be able to
1   Describe and identify monopolistic competition.

2   Explain how a firm in monopolistic competition
    determines its output and price in the short run and
    the long run.
3   Explain why advertising costs are high and why
    firms use brand names in monopolistic competition.
    15.1 WHAT IS MONOPOLISTIC COMPETITION?


Monopolistic competition is a market structure in
which
   • A large number of firms compete.
   • Each firm produces a differentiated product.
   • Firms compete on price, product quality, and
     marketing.
   • Firms are free to enter and exit.
       15.1 WHAT IS MONOPOLISTIC COMPETITION?


Large Number of Firms
  Like perfect competition, the market has a large number
  of firms. Three implications are

     • Small market share
     • No market dominance
     • Collusion impossible
       15.1 WHAT IS MONOPOLISTIC COMPETITION?


Product Differentation
  Product differentiation is making a product that is
  slightly different from the products of competing firms.

  A differentiated product has close substitutes but it does
  not have perfect substitutes.

  When the price of one firm’s product rises, the quantity
  demanded of that firm’s product decreases.
       15.1 WHAT IS MONOPOLISTIC COMPETITION?


Competing on Quality, Price, and Marketing
  Quality
  Design, reliability, after-sales service, and buyer’s ease
  of access to the product.
  Price
  Because of product differentiation, the demand curve
  for the firms’ product is downward sloping.
  Marketing
  Advertising and packaging
       15.1 WHAT IS MONOPOLISTIC COMPETITION?




 Entry and Exit
  No barriers to entry.
  So the firm cannot make economic profit in the long run.
      15.1 WHAT IS MONOPOLISTIC COMPETITION?


 Identifying Monopolistic Competition
  Two indexes:
     • The four-firm concentration ratio
     • The Herfindahl-Hirschman Index
     15.1 WHAT IS MONOPOLISTIC COMPETITION?


The Four-Firm Concentration Ratio
The four-firm concentration ratio is the percentage
of the value of sales accounted for by the four largest
firms in the industry.
The range of concentration ratio is from almost zero for
perfect competition to 100 percent for monopoly.
   • A ratio that exceeds 60 percent is an indication of
     oligopoly.
   • A ratio of less than 40 percent is an indication of a
     competitive market—monopolistic competition.
    15.1 WHAT IS MONOPOLISTIC COMPETITION?


The Herfindahl-Hirschman Index
The Herfindahl-Hirschman Index (HHI) is the square
of the percentage market share of each firm summed
over the largest 50 firms in a market.
Example, four firms with market shares as 50 percent,
25 percent, 15 percent, and 10 percent.
HHI = 502 + 252 + 152 + 102 = 3,450
A market with an HHI less than 1,000 is regarded as
competitive and between 1,000 and 1,800 is moderately
competitive.
     15.1 WHAT IS MONOPOLISTIC COMPETITION?


Limitations of Concentration Measures
The two main limitations of concentration measures
alone as determinants of market structure are their
failure to take proper account of
    • The geographical scope of a market
    • Barriers to entry and firm turnover
       15.2 OUTPUT AND PRICE DECISIONS

  How, given its costs and the demand for its jeans, does
  Tommy Hilfiger decide the quantity of jeans to produce
  and the price at which to sell them?
The Firm’s Profit-Maximizing Decision
  The firm in monopolistic competition makes its output
  and price decision just like a monopoly firm does.
  Figure 15.1 on the next slide illustrates this decision.
          15.2 OUTPUT AND PRICE DECISIONS


1. Profit is maximized
   when MR = MC
2. The profit-maximizing
  output is 125 pairs of
  Tommy jeans per day.
3. The profit-maximizing
  price is $75 per pair.
ATC is $25 per pair, so
4. The firm makes an
  economic profit of
  $6,250 a day.
       15.2 OUTPUT AND PRICE DECISIONS

Profit Maximizing Might Be Loss Minimizing
  Some firms in monopolistic competition have a tough
  time making a profit.
  A burst of entry into an industry can limit the demand for
  each firm’s own product.
  Figure 15.2 on the next slide illustrates a firm incurring a
  loss in the short run.
          15.2 OUTPUT AND PRICE DECISIONS


1. Loss minimized when
   MC = MR
2. The loss-minimizing
  output is 40,000
  customers and
3. The price is $40 per
  month, which is less
  than ATC.

4. The firm incurs an
  economic loss.
       15.2 OUTPUT AND PRICE DECISIONS

Long Run: Zero Economic Profit
  Economic profit induces entry and economic loss
  induces exit, as in perfect competition.
  Entry decreases the demand for the product of each
  firm.
  Exit increases the demand for the product of each firm.
  In the long run, economic profit is competed away and
  firms earn normal profit.
  Figure 15.3 on the next slide illustrates long-run
  equilibrium.
           15.2 OUTPUT AND PRICE DECISIONS


1. The output that
  maximizes profit is 75
  pairs of Tommy jeans a
  day.
2. The price is $50 per
  pair. Average total cost
  is also $50 per pair.

3. Economic profit is
  zero.
       15.2 OUTPUT AND PRICE DECISIONS

Monopolistic Competition and Perfect
 Competition
  The two key differences between monopolistic
  competition and perfect competition are that in
  monopolistic competition, there is
     • Excess capacity
     • A markup of price over marginal cost
     15.2 OUTPUT AND PRICE DECISIONS

Excess Capacity
A firm has excess capacity if the quantity it produces
is less that the quantity at which average total cost is a
minimum.
A firm’s efficient scale is the quantity of production at
which average total cost is a minimum.
Markup
A firm’s markup is the amount by which price exceeds
marginal cost.
          15.2 OUTPUT AND PRICE DECISIONS

1. The efficient scale is 100
  pairs of jeans a day.

2. The firm produces less
  than the efficient scale and
  has excess capacity.
3. Price exceeds 4. marginal
  cost by the amount of 5. the
  markup.
6. Deadweight loss arise.
         15.2 OUTPUT AND PRICE DECISIONS

In perfect competition,

1. The efficient quantity is
   produced and

2. Price equals marginal
   cost.
         15.2 OUTPUT AND PRICE DECISIONS

Is Monopolistic Competition Efficient
  Deadweight Loss
  Because price exceeds marginal cost, monopolistic
  competition creates deadweight loss—an indicator of
  inefficiency.
  Making the Relevant Comparison
  Price exceeds marginal cost because of product
  differentiation. But product variety is valued.
  The Bottom Line
  The bottom line is ambiguous. But compared to the
  alternative, monopolistic competition looks efficient.
       15.3 DEVELOPMENT AND MARKETING

 Innovation and Product Development
  Wherever economic profits are earned, imitators
  emerge.
  To maintain economic profit, a firm must seek out new
  products.
  Cost Versus Benefit of Product Innovation
  The firm must balance the cost and benefit at the
  margin.
     15.3 DEVELOPMENT AND MARKETING

Efficiency and Product Innovation
Regardless of whether a product improvement is real or
imagined, its value to the consumer is its marginal
benefit, which equals the amount the consumer is
willing to pay.
The marginal benefit to the producer is the marginal
revenue, which in equilibrium equals marginal cost.
Because price exceeds marginal cost, product
improvement is not pushed to its efficient level.
       15.3 DEVELOPMENT AND MARKETING

Advertising
  Firms in monopolistic competition spend a large amount
  on advertising and packaging their products.
  Advertising Expenditures
  A large proportion of the prices that we pay cover the
  cost of selling a good.
  Figure 15.5 on the next slide shows some estimates of
  marketing expenditures for some familiar markets.
15.3 DEVELOPMENT AND MARKETING
     15.3 DEVELOPMENT AND MARKETING

Selling Costs and Total Costs
Advertising expenditures increase the costs of a
monopolistically competitive firm above those of a
perfectly competitive firm or a monopoly.
Advertising costs are fixed costs.
Advertising costs per unit decrease as production
increases.
Figure 15.6 on the next slide illustrates the effects of
selling costs on total cost.
           15.3 DEVELOPMENT AND MARKETING


1. When advertising
  costs are added to . . .

2. … the average total
  cost of production,
  …

3. … average total
  cost increases by a
  greater amount at
  small outputs than
  at large outputs.
           15.3 DEVELOPMENT AND MARKETING


4. If advertising enables
  sales to increase
  from 25 pairs of jeans
  a day to 100 pairs a
  day, it lowers the
  average total cost
  from $60 a pair to
  $40 a pair.
     15.3 DEVELOPMENT AND MARKETING

Selling Costs and Demand
Advertising and other selling efforts change the demand
for a firm’s product.
The effects are complex:
   • A firm’s own advertising increases the demand for
     its product.
   • Advertising by all firms might decrease the
     demand for any one firm’s product and make
     demand more elastic.
The price and markup might fall.
       15.3 DEVELOPMENT AND MARKETING

Figure 15.7 shows the
possible effect of
advertising.
With no advertising,
demand is low but the
markup is large.
        15.3 DEVELOPMENT AND MARKETING


With advertising, average
total cost increases and the
ATC curve becomes ATC1.
Demand decreases and
becomes more elastic.
Profit-maximizing output
increases, the price falls,
and the markup shrinks.
       15.3 DEVELOPMENT AND MARKETING

Using Advertising to Signal Quality
  Some advertising is very costly and has almost no
  information content about the item being advertised.
  Such advertising is used to signal high quality.
  A signal is an action taken by an informed person or
  firm to send a message to uninformed people.
  Signaling works because it is profitable to signal high
  quality and deliver it but unprofitable to signal a high
  quality product and not deliver it.
       15.3 DEVELOPMENT AND MARKETING

Brand Names
  Brand names are also used to provide information
  about the quality of a product.
  It is costly to establish a widely recognized brand name.
  Like costly advertising, a brand name signals high
  quality.
  Brand names work because it is unprofitable to incur
  the cost of creating a brand name and then deliver a
  low quality product.
       15.3 DEVELOPMENT AND MARKETING

Efficiency of Advertising and Brand Names
  Advertising and brand names that provide information
  about the quality of products enable buyers to make
  better choices.
  Advertising and brand name can be efficient if the
  marginal cost of the information equals its marginal
  benefit.
  The final verdict on the efficiency of monopolistic
  competition is ambiguous.
                   Selling Costs in YOUR Life

When you buy a new
pair of running shoes,
you’re buying
Materials that cost $9
Production costs of $8
U.S. import duty of $3
Selling costs of $50
                     Selling Costs in YOUR Life

 Running shoes are
 not unusual.

Almost everything
you buy includes a
selling cost
component that
exceeds one half of
the total cost.

The table provides a
detailed breakdown
of the cost of a pair
of running shoes.

								
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