Monopolistic Competition Many firms selling Products that are similar but not identical © 2000 Claudia Garcia - Szekely 1

Characteristics Many firms: no firm can influence the market price based on size alone (Competitive) Firms differentiate their products (Monopolistic) There are no barriers to entry (Competitive) © 2000 Claudia Garcia - Szekely 2

Many Sellers When there are many sellers, they do not take into account rivals’ reactions. The existence of many sellers makes collusion difficult. Monopolistically competitive firms act independently of each other. © 2000 Claudia Garcia - Szekely 3

Monopolistic Competitive Markets Books CD’s Movies Computer Games Restaurants Hockey lessons Cookies Furniture 4 Monopolistic Competition lies between extremes: Perfect Competition and Monopoly.

PERFECTLY COMPETITIVE FIRMS COMPETE ONLY IN PRICE Multiple Dimensions of Competition in Monopolistic Competitive Markets © 2000 Claudia Garcia - Szekely 5

Multiple Dimensions of Competition: Firms compete at many levels Product differentiation ◦ Competing on perceived quality: advertising Service and distribution outlets. © 2000 Claudia Garcia - Szekely 6 Firms will continue to advertise as long as the marginal benefits of advertising exceed its marginal costs. Firms will continue to open outlets as long as the marginal benefits exceed its marginal costs

Monopolistic Competition Many firms competing for the same group of customers 7 Each firm faces a downward sloping demand curve (as in Monopoly) Firms can enter/exit the market freely Number of firms adjusts until economic profits are zero (as in PC). Each producer is small relative to the size of the market. Each firm produces a slightly different product

© 2000 Claudia Garcia - Szekely 8 Like a Perfectly Competitive firm: It supplies only a portion (share) of the market demand Market Demand P Q Like a Monopolist: The firm has some market power thus it faces a downward sloping demand curve Q Firm’s Demand Market Demand P TotalShare Total Total Market Demand Demand perceived by the firm Flatter: More elastic: More Substitutes for specific brand Steeper: Less Elastic: Fewer Substitutes

The Short Run © 2000 Claudia Garcia - Szekely 9 d MR Like in Perfect Competition and Monopoly : The firm chooses the Profit Maximizing Output level at MR = MC MC P mc q mc Firm’s share of total Demand

The Short Run © 2000 Claudia Garcia - Szekely 10 d MR Like in Perfect Competition if P > ATC firms enjoy positive profits MC P mc q mc ATC

Profits Attract New Firms Existing firms see their share of the market shrink ◦ The firm’s demand curve shifts left. Existing firms increase advertising (and costs) in their effort to defend market share. ◦ The firm’s ATC curve shifts upwards… © 2000 Claudia Garcia - Szekely 11

Long Run 12 Profit Like in Perfect Competition and Monopoly : firms may earn Profits or incur losses. ATC 0 Like in Perfect Competition: Profits attract new firms into the market The firm’s market share decreases and its ATC increase due to extra advertising costs Demand and Costs shift until Profits disappear d MR 0 MC P mc q 0 ATC 1 MR 1 q1q1 P mc

MC ATC q pc P=MC Min ATC No excess Capacity: ATC is min. Markup Over MC ATC > min Excess Capacity: ATC > min P=MR MCmc MC P mc d MR q mc v.s Perfect Competition Monopolistic Competition

Markup Over MC ATC > min MCmc MC P mc d MR q mc v.s MonopolyMonopolistic Competition Excess Capacity: ATC > min MC M MC PMPM D MR qMqM Profit Market Share Market Demand Monopolist can make profits in the long run! Monopolistic competitors can NOT!

Advertising and Monopolistic Competition Firms in a perfectly competitive market have no incentive to advertise Monopolistic competitors have a strong incentive to do so. © 2000 Claudia Garcia - Szekely 15

INCREASING MARKET SHARE IS RELEVANT FOR A MONOPOLISTIC COMPETITOR BUT NOT FOR A PC FIRM. Comparing Perfect and Monopolistic Competition © 2000 Claudia Garcia - Szekely 16

Advertising Shifts demand curve to the right and makes it more inelastic. Advertising shifts the ATC curve up. © 2000 Claudia Garcia - Szekely 17

Does Advertising Help or Hurt Society? There is a sense of trust in buying brands we know to be reliable. If consumers are willing to pay for reliability it’s a benefit to them. © 2000 Claudia Garcia - Szekely 18

Percentage of value of shipments by largest firms in selected industries. 4 LARGEST 8 LARGEST 20 LARGEST TOTAL INDUSTRY FIRMS FIRMS FIRMS # FIRMS Travel trailers/ campers Mattresses/ bedsprings Wood office furniture Book publishing Pharmaceutical preparations Misc. plastic products

21 Perfectly competitive firm Monopoly Monopolistic Competition Is entry into the market free or restricted? Is exit out of the industry free or restricted? How does the firm choose the output level? Does the firms charge one price? Or does it price discriminate? Shape of Demand faced by the firm Are producers price takers or price setters? Is MR greater than, less than or equal to Price? WHY? Do producers want to maximize profit or do they produce for some other reason? Do producers react to prices? In other words: is there a Supply curve in this market? Is the price charged greater than, smaller than or equal to MC? Can firm(s) make profit in the short run? Can firm(s) make profit in the long run? Can firm(s) incur a loss in the short run? Can firm(s) incur a loss in the long run?

© 2000 Claudia Garcia - Szekely 22

© 2000 Claudia Garcia - Szekely 23 For the following 5 slides calculate: 1.Profit maximizing output level 2.Price charged by the monopolist 3.Total Revenue 4.Total Cost 5.Variable Cost 6.Fixed Cost 7.Profit or Loss 8.Number of units the firm should produce in the short run and explain why? 9.Number of units the firm should produce in the long run and explain why? 10.In the long run, (exit/entry)______ will cause the firm’s share of the market to (increase/decrease) _______ and the firm will reduce advertising 11.In the long run the firm’s costs will (decrease/increase)_______ and the firm’s share of the market will (increase/decrease) ______ until loss is driven to _______.

D MR

D MR

D MR Q

D MR Q

D MR Q

D MR Calculate: 1.Profit maximizing output level =150 2.Price charged by each firm =13 3.Total Revenue = Total Cost=18*150= Variable Cost=14*150= Fixed Cost =(14-18)*150= Profit or Loss=(13-18)*150= Number of units the firm should produce in the short run and explain why? 0 shut down because FC(600) < loss if the firms produce 150 units (750) 9.Number of units the firm should produce in the long run and explain why? 0 exit because the firms incur a loss 10. In the long run, exit will cause the firm’s share of the market to increase and the firm will reduce advertising 11.In the long run the firm’s costs will decrease and the firm’s share of the market will increase until loss is driven to zero.

D MR Calculate: 1.Profit maximizing output level = Price charged by each fim = 13 3.Total Revenue = 13*150 = Total Cost = 18*150 = Variable Cost = 13*150 = Fixed Cost = (18-13)*150 = Profit or Loss = (13-18)*150= Number of units the firm should produce in the short run and explain why? =indifferent between 0 and 150 because the FC(750) = Loss (750) if the firm produces 150 units 9.Number of units the firm should produce in the long run and explain why? = zero (exit) because the firms incur a loss 10.In the long run, exit will cause the firm’s share of the market to increase and the firm will reduce advertising 11.In the long run the firm’s costs will decrease and the firm’s share of the market will increase until loss is driven to zero.

Calculate: 1.Profit maximizing output level = Price charged by each firm = 10 3.Total Revenue = 150*10= Total Cost = 11*150 = Variable Cost = 7*150 = Fixed Cost = (11-7)*150= Profit or Loss =(10-11)&150= Number of units the firm should produce in the short run and explain why? = 150 because FC (600) > loss (150) 9.Number of units the firm should produce in the long run and explain why? = 0 (exit) because firms incur a loss 10.In the long run, exit will cause the firm’s share of the market to increase and the firm will reduce advertising 11.In the long run the firm’s costs will decrease and the firm’s share of the market will increase until loss is driven to zero. D MR Q

D MR Q Calculate: 1.Profit maximizing output level =150 2.Price charged by each firm = 13 3.Total Revenue = 13*150 = Total Cost = 13*150= Variable Cost = 10*150= Fixed Cost = (13-10)*150 = Profit or Loss = 0 8.Number of units the firm should produce in the short run and explain why? = 150 because the FC(450) > loss (0) if the firms produce 150 units 9.Number of units the firms should produce in the long run and explain why? = 0 because the firms incur a loss 10.In the long run, exit may cause the firm’s share of the market to increase and the firm may reduce advertising 11.In the long run the firm’s costs may decrease and the firm’s share of the market may increase until loss is driven to zero.

Calculate: 1.Profit maximizing output level = Price charged by each firm = 20 3.Total Revenue = 20*300 = Total Cost = 17*300= Variable Cost = 13*300 = Fixed Cost = (17-13)*300= Profit or Loss = (20-17)*300=900 8.Number of units the firm should produce in the short run and explain why? = 300 because it makes a positive profit 9.Number of units the firm should produce in the long run and explain why? = 300 because it makes a positive profit 10.In the long run, entry will cause the firm’s share of the market to decrease and the firm will increase advertising 11.In the long run the firm’s costs will increase and the firm’s share of the market will decrease until profit is driven to zero. D MR Q