Microeconomics ECON 2302 Summer I, 2011 Marilyn Spencer, Ph.D. Professor of Economics Chapter 12

Announcement: 3rd Bonus Quiz 3 points possible View the film, “American Gangster.” Send an email that explains his: Supply chain management through vertical integration (CH 13) Brand management (CH.12) You might be able to find this film online by going to: www.projectfreetv.com. Email your explanation (approx. 50-100 words) to marilyn.spencer@tamucc.edu, before class, June 28.

12 CHAPTER Monopolistic Competition: The Competitive Model in a More Realistic Setting The coffeehouse market is competitive because it is inexpensive to open a new store. Hundreds of firms in the United States operate coffeehouses.

12 CHAPTER Monopolistic Competition: The Competitive Model in a More Realistic Setting Chapter Outline and Six (6) Learning Objectives 12.1 Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market Explain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves. 12.2 How a Monopolistically Competitive Firm Maximizes Profit in the Short Run Explain how a monopolistically competitive firm maximizes profit in the short run. 12.3 What Happens to Profits in the Long Run? Analyze the situation of a monopolistically competitive firm in the long run.

12 Chapter Outline and Learning Objectives, cont. 12.4 Comparing Perfect Competition and Monopolistic Competition Compare the efficiency of monopolistic competition and perfect competition. 12.5 How Marketing Differentiates Products Define marketing and explain how firms use it to differentiate their products. 12.6 What Makes a Firm Successful? Identify the key factors that determine a firm’s success.

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.

12.1 LEARNING OBJECTIVE Explain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves. Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market The Demand Curve for a Monopolistically Competitive Firm If a Starbucks increases the price of caffè lattes, it will lose some, but not all, of its customers. In this case, raising the price from $3.00 to $3.25 reduces the quantity of caffè lattes sold from 3,000 to 2,400. Therefore, unlike a perfect competitor, a Starbucks store faces a downward-sloping demand curve. FIGURE 12-1 The Downward-Sloping Demand for Caffè Lattes at a Starbucks

MR for a Firm with a Downward-Sloping Demand Curve Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market: MR 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) 1 2 3 4 5 6 7 8 9 10 $6.00 5.50 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 $0.00 10.00 13.50 16.00 17.50 18.00 ― $5.50 0.50 –0.50 –1.50 –2.50 –3.50

MR for a Firm with a Downward-Sloping Demand Curve Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market: MR for a Firm with a Downward-Sloping Demand Curve If the local Starbucks reduces the price of a caffè latte from $3.50 to $3, the number of caffè lattes it sells per week will increase from 5 to 6. Its MR from selling the 6th caffè latte will be $0.50, which is equal to the $3 additional revenue from selling 1 more caffè latte (the area of the green box) minus the $2.50 loss in revenue from selling the first 5 caffè lattes for $0.50 less each (the area of the red box). FIGURE 12-2 How a Price Cut Affects a Firm’s Revenue

MR for a Firm with a Downward-Sloping Demand Curve Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market: MR for a Firm with a Downward-Sloping Demand Curve Any firm that has the ability to affect the price of the product it sells will have a MR curve that is below its D curve. Data from Table 12-1 create the D and MR curves. After the 6th caffè latte, MR becomes negative because the additional revenue received from selling 1 more caffè latte is < the revenue lost from receiving a lower price on the caffè lattes that could have been sold at the original price. FIGURE 12-3 The D and MR Curves for a Monopolistically Competitive Firm

How a Monopolistically Competitive Firm Maximizes p in the Short Run 12.2 LEARNING OBJECTIVE Explain how a monopolistically competitive firm maximizes profit in the short run. How a Monopolistically Competitive Firm Maximizes p in the Short Run Maximizing Profit in a Monopolistically Competitive Market FIGURE 12-4

Does Minimizing Cost Maximize Profits? Solved Problem 12-2 Will Apple maximize profits if it produces 800,000 iPhones per month? Average cost reaches a minimum at a quantity of 800,000, but profits are maximized at a quantity of 600,000.

What Happens to Profits in the Long Run? 12.3 LEARNING OBJECTIVE Analyze the situation of a monopolistically competitive firm in the long run. How Does the Entry of New Firms Affect the p of Existing Firms? FIGURE 12-5 How Entry of New Firms Eliminates Profits Panel (a) shows that in the SR, Starbucks can charge a P above ATC (point A) and make a p, shown by the green rectangle. But this p attracts new firms to enter the market, which shifts the D and MR curves to the curves labeled “Long run” in panel (b). At point B, Starbucks breaks even.

What Happens to Profits in the Long Run? How Does the Entry of New Firms Affect the p of Existing Firms? Table 12-2 The Short Run and the Long Run for a Monopolistically Competitive Firm

Starbucks: No longer different enough? Making the Connection The Rise and Decline of Starbucks In a monopolistically competitive industry, maintaining profits in the long run is very difficult. Starbucks: No longer different enough?

What Happens to Profits in the Long Run? Is Zero Economic Profit Inevitable in the Long Run? 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. Don’t Let This Happen to YOU! i Don’t Confuse Zero Economic p with Zero Accounting p

12-3 Solved Problem Can It Be Profitable to Be the High-Price Seller? Because the greater demand more than offsets the higher costs, the hhgregg store makes a larger profit.

Comparing Perfect Competition and Monopolistic Competition 12.4 LEARNING OBJECTIVE Compare the efficiency of monopolistic competition and perfect competition. Comparing Perfect Competition and Monopolistic Competition 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: • Monopolistically competitive firms charge a price greater than marginal cost. • Monopolistically competitive firms do not produce at minimum average total cost.

Comparing Perfect Competition and Monopolistic Competition Excess Capacity under Monopolistic Competition Comparing Long-Run Equilibrium under Perfect Competition and Monopolistic Competition FIGURE 12-6 A monopolistically competitive firm has excess capacity: If it increased its output, it could produce at a lower average cost.

Is Monopolistic Competition Inefficient? Comparing Perfect Competition and Monopolistic Competition Is Monopolistic Competition Inefficient? 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. 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.

Did Abercrombie and Fitch narrow its target market too much? Making the Connection Abercrombie & Fitch: Can the Product Be Too Differentiated? A firm whose strategy of product differentiation succeeds will experience increases in same-store sales. Did Abercrombie and Fitch narrow its target market too much?

How Marketing Differentiates Products 12.5 LEARNING OBJECTIVE Define marketing and explain how firms use it to differentiate their products. How Marketing Differentiates Products Marketing All the activities necessary for a firm to sell a product to a consumer. Brand Management The actions of a firm intended to maintain the differentiation of a product over time.

How Marketing Differentiates Products Advertising If the increase in revenue that results from the advertising is greater than the increase in costs, the firm’s profits will rise. Defending a Brand Name A firm can apply for a trademark, which grants legal protection against other firms using its product’s name.

Does spending on radio advertising attract customers? Making the Connection Google Tries (and Fails) to Measure the Effectiveness of Radio Advertising A firm’s optimal level of advertising occurs where the marginal cost of advertising equals the marginal revenue earned from advertising. Does spending on radio advertising attract customers?

What Makes a Firm Successful? 12.6 LEARNING OBJECTIVE Identify the key factors that determine a firm’s success. What Makes a Firm Successful? FIGURE 12-7 What Makes a Firm Successful? The factors under a firm’s control—the ability to differentiate its product and the ability to produce it at lower cost—combine with the factors beyond its control to determine the firm’s profitability.

Is Being the First Firm in the Market a Key to Success? Making the Connection Is Being the First Firm in the Market a Key to Success? The firms that were first to introduce a product ultimately lost out to latecomers who did a better job of providing consumers with products that were more reliable, less expensive, more convenient, or otherwise provided greater value. Although not first to market, Bic ultimately was more successful than the firm that pioneered ballpoint pens.

The effect of entry on price, quantity, and profits at Starbucks. AN INSIDE LOOK >> Starbucks Faces McCompetition The effect of entry on price, quantity, and profits at Starbucks.

Monopolistic competition KEY TERMS Brand management Marketing Monopolistic competition

Assignment to prepare for Ch. 13: Pre-read Ch. 13, including: Review Questions: 3rd ed., p. 452 1.1—1.3; p 454 2.1, 2.3—2.5; (2nd ed., p. 464, 1.1 – 1.3; p. 466, 2.1, 2.3, 2.4 & 2.5; (1st edition: 1-4, 6-8 & 10 on pp. 436-43) Problems and Applications: 3rd ed., p. 453 1.10; p 454, 2.6, 2.7; p 455 2.10; p456, 2.17, 2.20; (2nd ed., p. 465, 1.10; p. 466, 2.6, 2.7 & 2.10; p. 467, 2.17; p. 468, 2.19; and: The city is considering auctioning licenses that would allow one or two vendors to sell ice cream on the local beach. If the city licenses two vendors, will it receive more in total license fees than if it sells a license to only one vendor? Will people who use the beach be better off if the city licenses two vendors or one vendor? Suppose the city licenses two vendors but announces that every year it will sell licenses to two new vendors. The same vendor may not hold a license more than once every five years. Would this make any difference to the prices the vendors change? (1st edition: 1, 2, 3, 4, 11, 15 & 21 on pp. 437-440).