Monopolistic Competition

Starter Draw a table comparing the key characteristics of PC and MC Under PC Under MC

Syllabus aims Understand the characteristics of a monopolistically competitive market and be able to use these to explain the behaviour of firms in this market structure. Students should be able to carry out diagrammatic analysis of the market structure in both the short and long run. Students should understand the importance of advertising and differentiation for the model of monopolistic competition and be able to contrast this with other market structures. Students should be able to explain and evaluate the efficiency of monopolistic competition.

Lesson aims Review characteristics of MC Recognise the importance of advertising and differentiation In MC Diagrammatically explain short and long run equilibrium in MC To explain and evaluate the efficiency of monopolistic competition.

Key characteristics of Monopolistic Competition What’s the difference to PC? There are many producers and many consumers in a market - the concentration ratio is low & they act independently. The barriers to entry and exit into and out of the market are low The firms are short run profit maximisers. Consumers see that there are non-price differences among the competitors’ products i.e. there is product differentiation Producers have some control over price - they are “price makers” rather than “price takers.”

Key characteristics In detail…. Get into the pattern of how we analyse markets: Define characteristics Behaviour of firms The diagrams Assess efficiency

Product differentiation Firms produce differentiated products, although there are substitutes for each firm’s products. There is a downward sloping D curve – and elastic! Each firm tries to build brand loyalty to create loyal customers. There tends to be heavy advertising

Ease of entry & exit There are ‘no’ barriers to entry & exit. The existence of short term abnormal profits gives incentives for other companies to start up. The existence of short term losses give incentives for companies to close down!

Low concentration ratios Monopolistic Competition - Intro Low concentration ratios What is the concentration ratio of a monopoly? What is the concentration ratio of a duopoly? What is the concentration ratio of a oligopoly? What concentration ratio ‘border line’ will there be for a monopolistic competitive market? No concentration: 0% means perfect competition or at the very least monopolistic competition. If for example CR4=0 %, the 4 largest firm in the industry would not have any significant market share. • Total concentration: 100% means an extremely concentrated oligopoly. If for example CR1= 100%, we talk of a monopoly. • Low concentration: 0% to 50% This category ranges from perfect competition to oligopoly. • Medium concentration: 50% to 80% An industry in this range is likely an oligopoly. • High concentration: 80% to 100% This category ranges from oligopoly to monopoly Mr Mercer's Notes

Low concentration ratios Monopolistic Competition - Intro Low concentration ratios Under MC concentration ratio tends to be low so many firms operating in the market. A price change by one will have negligible effects on the demand for rival products No concentration: 0% means perfect competition or at the very least monopolistic competition. If for example CR4=0 %, the 4 largest firm in the industry would not have any significant market share. Total concentration: 100% means an extremely concentrated oligopoly. If for example CR1= 100%, we talk of a monopoly. Low concentration: 0% to 50%. This category ranges from perfect competition to oligopoly. Medium concentration: 50% to 80%. An industry in this range is likely an oligopoly. High concentration: 80% to 100%. This category ranges from oligopoly to monopoly No concentration: 0% means perfect competition or at the very least monopolistic competition. If for example CR4=0 %, the 4 largest firm in the industry would not have any significant market share. • Total concentration: 100% means an extremely concentrated oligopoly. If for example CR1= 100%, we talk of a monopoly. • Low concentration: 0% to 50% This category ranges from perfect competition to oligopoly. • Medium concentration: 50% to 80% An industry in this range is likely an oligopoly. • High concentration: 80% to 100% This category ranges from oligopoly to monopoly Mr Mercer's Notes

Advertising Is there any differentiation between these three? Is there any opportunity for differentiation? How have these brands attempted to influence you as a consumer?

Role of Advertising in MC Firms produce differentiated products Face downward sloping demand curves Build up brand loyalty Gives them some influence over price => engage in heavy advertising to maintain brand loyalty When we analyse markets we look at how firms BEHAVE under different market conditions

The diagrams!

Diagrams – your go Side by side Draw the curve for profit maximisation under monopoly Draw the curve for profit maximisation under PC I’ll start you off…

The role of advertising in monopolistic competition With abnormal profits and ‘no’ barriers to entry Companies use significant advertising to encourage brand loyalty & customer There is a lot of product differentiation As more companies enter the market – the individual company’s Demand curve might shift LEFT – due to substitution effect So the companies spend MORE money on advertising – which will push up their AC curve

Dual effect The inward shift of the Demand curve The outward shift of the MC curve ….. Will result in a Normal profit scenario

The effect of advertising Short run equilibrium under MC Long run equilibrium under MC

Normal profit under monopolistic competition At any other output ATC >AR, so the firm will make losses.

Is there ever an equilibrium? Strong brand loyalty can have the effect of making demand less sensitive to price. The long run equilibrium may be reached with normal profits being made. The reality is that a stable equilibrium is never reached - new products come and go all of the time, some do better than others. Existing products within a market will typically go through a product life cycle which affects the volume and growth of sales.

Efficiencies

Productive efficiency No – since Qm rather than Qo There is a market shortage They are also not maximising their economies of scale

Allocative efficiency? No since Pm > MC In a truly competitive market the Po would exist – so there is misuse of the consumer surplus Consumers are over charged and firms produce under their capacity

Dynamic Efficiency There are profits for product development. There is an incentive for the companies to invest in R&D & new ideas…. As the product is always being developed So YES – there is an incentive to be dynamically efficient.

Wasteful advertising? It can increase costs The debate over the environmental impact of packaging is linked strongly to this aspect of monopolistic competition.

Plenary Post-its List 4 characteristics of MC Draw the LR equilibrium

Peter Smith p51 diagram ex 3.1 & Anderton Textbook p344 Q2 Due Oct 18 Homework Peter Smith p51 diagram ex 3.1 & Anderton Textbook p344 Q2 Due Oct 18