© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Fernando & Yvonn Quijano Prepared by: Chapter 12 Monopolistic Competition: The Competitive Model in a More Realistic Setting

© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 2 of 24 Starbucks: Growth through Product Differentiation 12.1Explain why a monopolistically competitive firm has downward- sloping demand and marginal revenue curves. 12.2Explain how a monopolistically competitive firm maximizes profits in the short run. 12.3Analyze the situation of a monopolistically competitive firm in the long run. 12.4Compare the efficiency of monopolistic competition and perfect competition. 12.5Define marketing and explain how firms use it to differentiate their products. 12.6Identify the key factors that determine a firm’s success. Learning Objectives The coffeehouse market is monopolistically competitive rather than perfectly competitive.

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 3 of 25 Monopolistic Competition: The Competitive Model in a More Realistic Setting Monopolistic competition A market structure in which barriers to entry are low and many firms compete by selling similar, but not identical, products.

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 4 of 25 Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market Learning Objective 12.1 The Demand Curve for a Monopolistically Competitive Firm FIGURE 12-1 The Downward-Sloping Demand for Caffè Lattes at a Starbucks

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 5 of 25 Learning Objective 12.1 Marginal Revenue for a Firm with a Downward-Sloping Demand Curve Table 12-1 Demand and Marginal Revenue at a Starbucks CAFFÈ LATTES SOLD PER WEEK (Q) PRICE (P) TOTAL REVENUE (TR = P x Q) AVERAGE REVENUE (AR = TR/Q) MARGINAL REVENUE (MR = ΔTR/ΔQ) $ $ ― $ ― $ –0.50 –1.50 –2.50 –3.50 Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 6 of 25 Learning Objective 12.1 Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market Marginal Revenue for a Firm with a Downward-Sloping Demand Curve FIGURE 12-2 How a Price Cut Affects a Firm’s Revenue

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 7 of 25 Learning Objective 12.1 Marginal Revenue for a Firm with a Downward-Sloping Demand Curve FIGURE 12-3 The Demand and Marginal Revenue Curves for a Monopolistically Competitive Firm Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 8 of 25 How a Monopolistically Competitive Firm Maximizes Profits in the Short Run Learning Objective 12.2 FIGURE 12-4 Maximizing Profit in a Monopolistically Competitive Market

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 9 of 25 Solved Problem 12-2 How Not to Maximize Profits at a Publishing Company Learning Objective 12.2 If you were a manager at a publishing firm, how would you determine whether producing one more copy of a book will increase your profits?

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 10 of 25 What Happens to Profits in the Long Run? Learning Objective 12.3 How Does the Entry of New Firms Affect the Profits of Existing Firms? FIGURE 12-5 How Entry of New Firms Eliminates Profits Don’t Let This Happen to YOU! Don’t Confuse Zero Economic Profit with Zero Accounting Profit

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 11 of 25 Learning Objective 12.3 Table 12-2 The Short Run and the Long Run for a Monopolistically Competitive Firm What Happens to Profits in the Long Run? How Does the Entry of New Firms Affect the Profits of Existing Firms?

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 12 of 25 Learning Objective 12.3 The Rise and Fall of Apple’s Macintosh Computer Making the Connection Macintosh lost its differentiation, but still has a loyal— if relatively small—following.

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 13 of 25 Solved Problem 12-3 The Short Run and the Long Run for the Macintosh Learning Objective 12.3

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 14 of 25 A firm’s profits will be eliminated in the long run only if a firm stands still and fails to find new ways of differentiating its product or fails to find new ways of lowering the cost of producing its product. Learning Objective 12.3 What Happens to Profits in the Long Run? Is Zero Economic Profit Inevitable in the Long Run?

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 15 of 25 Learning Objective 12.3 Staying One Step Ahead of the Competition: Eugène Schueller and L’Oréal Making the Connection Unlike many monopolistically competitive firms, L’Oréal has earned economic profits for a very long time.

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 16 of 25 Comparing Perfect Competition and Monopolistic Competition Monopolistically competitive firms charge a price greater than marginal cost. Monopolistically competitive firms do not produce at minimum average total cost. Learning Objective 12.4 Monopolistic competition and perfect competition share the characteristic that in long-run equilibrium, firms earn zero economic profits. However, there are two important differences between long- run equilibrium in the two markets:

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 17 of 25 Learning Objective 12.4 Excess Capacity under Monopolistic Competition FIGURE 12-6 Comparing Long-Run Equilibrium under Perfect Competition and Monopolistic Competition Comparing Perfect Competition and Monopolistic Competition

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 18 of 25 Economists have debated whether monopolistically competitive markets being neither productively nor allocatively efficient results in a significant loss of well-being to society in these markets compared with perfectly competitive markets. Learning Objective 12.4 How Consumers Benefit from Monopolistic Competition Consumers benefit from being able to purchase a product that is differentiated and more closely suited to their tastes. Is Monopolistic Competition Inefficient? Comparing Perfect Competition and Monopolistic Competition

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 19 of 25 Learning Objective 12.4 Abercrombie & Fitch: Can the Product Be Too Differentiated? Making the Connection Did Abercrombie and Fitch narrow its target market too much?

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 20 of 25 How Marketing Differentiates Products Marketing All the activities necessary for a firm to sell a product to a consumer. Learning Objective 12.5 Brand Management Brand management The actions of a firm intended to maintain the differentiation of a product over time.

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 21 of 25 If the increase in revenue that results from the advertising is greater than the increase in costs, the firm’s profits will rise. Learning Objective 12.5 Advertising Defending a Brand Name A firm can apply for a trademark, which grants legal protection against other firms using its product’s name. How Marketing Differentiates Products

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 22 of 25 What Makes a Firm Successful? Learning Objective 12.6 FIGURE 12-7 What Makes a Firm Successful?

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 23 of 25 Learning Objective 12.6 Is Being the First Firm in the Market a Key to Success? Making the Connection Although not first to market, Bic ultimately was more successful than the firm that pioneered ballpoint pens.

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 24 of 25 An Inside LOOK Can Dunkin’ Donuts Really Compete with Starbucks? Brewing Battle: Dunkin’ Donuts Tries to Go Upscale, but Not too Far

Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 25 of 25 Brand management Marketing Monopolistic competition K e y T e r m s