Monopolistic Competition Tutorial 10

Monopolistic Competition Market Structure Market structures differ on three important dimensions: The number of firms Product differentiation Entry conditions Perfect Competition Monopolistic Competition Oligopoly Monopoly Number of firms Many Few One Product differentiation Homogeneous Differentiated Homogeneous or differentiated No close substitute Entry condition Free entry Limited entry No entry Page 2

Monopolistic Competition Monopolistically competitive market has three distinguishing features: Many firms Differentiated product Based on physical attributes (tastes, quality…),services, time and location, brand name, … Perfect substitutes? Free entry Zero economic profit (in the long run) As ALL firms select an output level to maximize economic profits, to analyze the firm’s output choice, we need: The firm’s cost curves The demand curve facing the firm. Page 3

Demand Curve facing a Monopolistically Competitive Firm The demand curve facing a monopolistically competitive firm is the is downward sloping. P DA: shows the relationship between P and quantity demanded for firm A’s product, ceteris paribus. Is it a reasonable assumption? How would other firms be affected if firm A lowers its price? DA How would firm A be affected if all other firms lower their price? MRA q Page 4

Monopolistic Competition MC P* AC DA MRA q q* Page 5

Monopolistic Competition The key difference between monopolistically competitive markets and differentiated oligopoly us free entry. As there are no barriers to entry, so firms will enter the market until economic profit drops to zero. MC p AC E p* D1 D2 MR1 MR2 q q* Page 6

Discussion Question 1 The Chinese beer market is a fragmented market with the top four breweries controlling only 45% of the total market share. China Resources Snow Breweries is the top brewery in China, with a nationwide market share of 15%, followed by Tsingtao at 13%, Yanjing at 10% and InBev at 7%. The Chinese beer market has become increasingly competitive; with companies spending much more on strong advertising campaigns to boost sales. Page 7

How about the unsuccessful case? Discussion Question 1 Assume the China beer market is currently in its long run equilibrium. Discuss the possible outcomes for Tsingtao in short run if it launches a one-off advertising campaign. P Tsingtao How about the unsuccessful case? MC AC1 P1 P0 AC0 MR1 D1 MR0 D0 q0 q1 Beer (Q) Page 8

Discussion Question 1 Suppose the advertising program in part (a) is successful, explain what would happen in the long run. P Tsingtao MC P1 AC1 P2 AC0 D2 MR2 MR1 D1 q2 q1 Beer (Q) Page 9

Discussion Question 1 However, suppose all firms realize the successful story of Tsingtao and follow it to launch advertising campaign, how would it affect the market? P Tsingtao How would it affect the demand for Tsingtao? Is spending on advertising wasteful? MC AC1 P0 AC0 MR0 D0 q0 Beer (Q) Page 10

Discussion Question 2 The world luxury cloth industry is highly fragmented, the top ten luxury cloth firms produce about one fifth of world sales. In recent years, more and more luxury cloth firms are relocating their production to China and other Asian countries where labor costs are lower. Burberry, one of the luxury brands in the industry, is also planning to close its factory in Wales in England, and move its production machines to China. Since about three hundred workers are expected to be laid off from this factory in Wales, many British, including Prince Charles, protest against its relocation plan Page 11

Discussion Question 2 What would be the economic effects of relocating the production from Wales to China on Burberry? Explain. P Burberry MC0 Other potential effects? MC1 AC0 P0 AC1 P1 P2 D0 MR0 D1 Q q0 q1 MR1 Page 12

Discussion Question 2 Suppose Burberry abandons its relocation plan, what might be the economic effects on it when its competitors continue to relocate their production to China? Explain . P Burberry MC0 AC0 P0 P1 D0 MR0 D1 Q q1 q0 MR1 Page 13

Welfare Analysis: Monopolistic Competition Are monopolistic competition inefficient? Underproduction Deadweight loss in the diagram? Why government seldom regulates monopolistic competition? The size of the deadweight loss is relatively small. Variety to consumers Page 14