Perfect Competition and Monopolistic Competition Professor Kyle Anderson Managerial Economics Kelley School of Business Indiana University

Perfectly Competitive Markets Many buyers and sellers Identical products Perfect information No transaction costs Free entry and exit into the market

Perfectly Competitive Markets QM $ D S Firm Qf $ Df Pe

Perfectly Competitive Firm MC $ Qf ATC AVC Pe Pe = Df = MR Qf*

Perfectly Competitive Markets QM $ D S Pe Firm Qf $ Df S* Entry Pe* Df*

Perfectly Competitive Firm MC $ Qf ATC AVC Pe Pe = Df = MR Pe = Df = MR Pe = Df = MR Qf* Qf* Qf*

30 Seconds of Economic History “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest” Many buyers and sellers Identical products Perfect information No transaction costs Free entry and exit into the market Adam Smith 9 8 10 7 13 12 11 5 1 End 2 3 14 4 6 16 26 25 27 28 30 29 24 23 18 17 19 20 22 21 15

Setting Output in Perfect Comp. Maximize profits  MR = MC TC= 2000+3Q2 P=$120 MC = 6Q, MR=120 6Q=120, Q=20 Revenue = $2400 Profits = 2400 – (2000+3(20)2)= -800 Stay open or shut down?

Monopolistic Competition Monopoly Perfect Competition Differentiated product Downward sloping demand Many firms No (low) barriers to entry Intense competition between firms with slightly differentiated products. Firms can use differentiation to price above marginal costs, but long run profits are low due to competition and copying.

Pizza Industry

Strategies for Monopolistic Comp. Seek to achieve product differentiation or product superiority. Try to create loyal consumers. The less easily copied, the better.

Perfect Comp. & Monopolistic Comp. In both cases, barriers to entry are low or non-existent. As a result, economic profits will be low. Product differentiation leads to some prospects for economic profits, especially to the extent that it can’t be copied.