The Kinked Demand Curve Q* P* Quantity Price, cost marginal revenue X W Y D Z MR MC Any marginal cost in this region 2. … corresponds to this level of output Tacit collusion outcome If production increases beyond Q*, other firms will retaliate and produce more too  firm will gain very few sales. If production decreases, firm does not expect rivals to do the same  firm will lose relatively large # of sales.

Warm-up: November 4, 2016 Leo manages the Wonderful Wok stand in the food court of a big shopping mall. He offers the only Chinese food there, but there are more than a dozen alternatives, from burgers to pizza to burritos. 1. How much market power does Leo have? (power to set prices) 2. How would you describe Leo’s situation? Is this perfect competition? Monopoly? Oligopoly?

Monopolistic Competition: 1. Large # of sellers ex: vendors in food court, hotels in Anaheim, clothing stores at the mall 2. Differentiated products ex: Chinese vs. burgers vs. pizza vs. Mexican 3. Free entry and exit in the long run

Product Differentiation Differentiation by style/type Example: (again) vendors in food court Let’s say chinese food is $7/plate, but a burger meal is $5. Would you ever choose the more expensive meal? Why?

Other examples of differentiation by style/type: vs

Differentiation by Location Example: gas stations in a city (gas is not monop comp though) The gas is the same (more or less) but location matters to consumers Differentiation by pay method: 1997 June 2008

Differentiation by Quality VS

Understanding Monopolistic Competition  Because each firm is offering a distinct product, it faces a downward-sloping demand curve and has some market power—the ability within limits to determine the price of its product.  However, a monopolistically competitive firm does face competition: the amount of its product it can sell depends on the prices and products offered by other firms in the industry.

D P Profit Loss MR P ATC (a) A Profitable Firm (b) An Unprofitable Firm Q P P P Quantity ATC P D U MR U MC ATC Q U P U Quantity ATC U Profit-maximizing quantity Loss-minimizing quantity MC Price, cost, marginal revenue The MC Firm in the Short Run What does this diagram remind you of??

Monopolistic Competition in the Long Run  If the typical firm earns positive profits, new firms will enter the industry in the long run, shifting each existing firm’s demand curve to the left. If the typical firm incurs losses, some existing firms will exit the industry in the long run, shifting the demand curve of each remaining firm to the right.  In the long run, equilibrium of a monopolistically competitive industry, the zero-profit-equilibrium, firms just break even. The typical firm’s demand curve is just tangent to its average total cost curve at its profit-maximizing output. What does this remind you of??

So, here’s what happens: 1.Firm is profiting (yay!) 2.Outsiders see this, they enter the market to get some of your profits (boo!) 3.The new competition takes some of your customers – demand for your product falls (  ) 4.Firms enter until all firms break even in the long run.

Entry and Exit Shift Existing Firm’s Demand Curve and Marginal Revenue Curve (a) Effects of Entry(b) Effects of Exit Exit shifts the existing firm’s demand curve and its marginal revenue curve rightward. MR D 1 D 1 D 2 D 2 Entry shifts the existing firm’s demand curve and its marginal revenue curve leftward. Price, marginal revenue Quantity

MR D MC ATC Z Q P=ATC Point of tangency Price, cost, marginal revenue Quantity The Long-Run Zero-Profit Equilibrium

Partner practice: 1.Currently a monopolistically competitive industry, composed of firms with U-shaped average total cost curves, is in long-run equilibrium. Describe how the industry adjusts, in both the short and long run, in each of the following situations. A. A technological change that increases fixed cost for every firm in the industry. Illustrate this with a graph. B. A technological change that decreases marginal cost for every firm in the industry (you can try the graph, good luck) 2. Why, in the long run, is it impossible for firms in a monopolistically competitive industry to create a monopoly by joining together to form a single firm? 3.The market for clothes is monopolistically competitive. What impact will fewer firms in the industry have on you as a consumer? Address the following issues: a.Variety of clothes b.Differences in quality of service c.Price

Warm-up: December 9, 2013 Use the three conditions for M.C. to determine if the following firms are likely to be operating as monopolistic competitors. If not, are they more like monopoly? Oligopoly? PC? 1.A local band that plays for weddings, parties, etc. 2.Minute Maid, a producer of individual-serving juice boxes 3.Your local dry cleaner 4.A farmer who produces soybeans

Warm-up: December 10, 2012

Is Monopolistic Competition Inefficient?  Firms in a monopolistically competitive industry have excess capacity: they produce less than the output at which average total cost is minimized.  Price exceeds marginal cost, so some mutually beneficial trades are unexploited.  The higher price consumers pay because of excess capacity is offset to some extent by the value they receive from greater diversity.  Hence, it is not clear that this is actually a source of inefficiency.

Question: Why don’t milk companies advertise?

Controversies About Product Differentiation No discussion of product differentiation is complete without spending at least a bit of time on the two related issues—and puzzles—of advertising and brand names.

Why do firms advertise? What types of messages are conveyed through advertisements? What makes certain advertisements effective? Which of the following advertisements are economically useful?

What is the effect of brand names on consumers?

Which Burberry bag is the real deal?

Is there really any difference??

Brand names can also convey information: Example: On a long road trip, you stop in a small town to stay the night. You have the option of staying at a Holiday Inn or the Happi Inn. Which are you most likely to choose?

1.In which of the following cases is advertising likely to be economically useful? Economically wasteful? a.Ads on the benefits of aspirin b.Ads on the benefits of Bayer aspirin c.Ads on the benefit of drinking orange juice d.Ads on the benefit of drinking Tropicana orange juice e.Ads that state how long a plumber or an electrician has been in business 2.Some analysts have stated that a successful brand name is like a barrier to entry. Explain the reasoning behind this statement.