The Theory of the Firm Monopolistic Competition Profit maximization in short & long runs Non-price competition Efficiencies Comparison to other theories Most info from Blink & Dorton or Tragakes

RECAP: What would CR1= 100% be? A monopoly! What would CR4 = 0% be? Perfect competition (or perhaps monopolistic competition)

RECAP: Intro to Monopolistic Competition Supposed to be more realistic (between 2 extremes of monopoly/perfect competition) Key Characteristics Fairly large # of (small) firms No barriers to entry Free to enter and leave whenever Substantial control over market price If a firm raises price, doesn’t lose all sales (perfect c.) but loses more sales than the monopolist Slightly differentiated products Physical, quality, location, services, advertising differences Which are similar to perfect competition?

What is monopolistic about monopolistic competition? Firms have some ability to set price.

RECAP: Intro to Monopolistic Competition Examples Apparel Detergent Publishing Furniture Italian restaurants Mechanics Jewelers

RECAP: How is Monopolistic Competition different to Perfect Competition ? The most significant difference from perfect competition, is that in monopolistic competition, there is product differentiation. As the products are differentiated there will some extent of brand loyalty. Could the person who sells dumplings on the street have a “brand?” Sure! (Brands don’t have to be official…this seller’s “brand” could be great food & friendly service)

B/c of this loyalty: People can set their own prices (“price makers”), leading to a ________ sloping demand curve NEGATIVELY BUT…It will still mostly be an elastic curve b/c there are many substitutes available!

Recap: UNDERSTANDING TOTAL REVENUE Is this what happens if price is constant? (Note: This is when firms have no control over the price) What happens if price is variable? (Note: This is when firms have control over the price)

How different are these compared to monopolies? Same in short run, but different in long run WHY??? ONLY NORMAL PROFITS HAPPEN IN LONG RUN B/C NO BARRIERS TO ENTRY (ANYONE CAN GET IN/OUT) Abnormal profits attract new entrants, losses get firms to leave

Long Run Equilibrium in Monopolistic Competition Why does this graph show normal profit? Why does monopolistic competition have only normal profit in the long run? What about this graph makes it monopolistic competition? (instead of perfect comp.) Why is Q the profit-maximizing point?

Monopolistic Competition vs. Perfect Competition IN THE LONG RUN ONLY PROFIT MAXIMIZATION PROFIT MAXIMIZATION PRODUCTIVELY EFFICIENT ALLOCATIVELY EFFICIENT

Long Run Equilibrium in Monopolistic Competition DOES EITHER PRODUCTIVE OR ALLOCATIVE EFFICIENCY OCCUR WHEN PROFIT IS MAXIMIZED IN THE LONG RUN IN MONOPOLISTIC COMPETITION? Does either MC = AR (allocative efficiency) OR MC = AC (productive efficiency) occur at the profit-maximizing point (where MR = MC) No! DO MONOPOLISTIC COMPETITORS PRODUCE @ AN EFFICIENT LEVEL? No! (But they do maximize profits where MC = MR)

MONOPOLISTIC COMPETITION What are the causes of the inefficiencies in monopolistic competition & a monopoly? MONOPOLISTIC COMPETITION MONOPOLY B/C consumers desire variety and are willing to pay different prices Which is better? Allocative inefficiency but differentiated products (monopolistic competition) OR Allocative efficiency but homogenous products (perfect competition) B/C firm has ability to restrict output & increase price as in a monopoly

Types of monopolistic competition PRICE COMPETITION NON-PRICE COMPETITION Rivalry between producers based solely on price, usually when selling identical or extremely similar products Examples? Competition between producers based on all except the price by focusing on product differentiation. Examples? Advertising Packaging Product Development/Quality Quality/Amount of Service

RESTUARANT EXAMPLE OF MONOPOLISTIC COMEPTITION

RECAP: COMPETITION THEORIES