Market Structures: Monopolistic Competition

Imperfect Competition The spectrum of competition: Perfect Comp  Monopoly Monop. Comp.-- Oligopoly Assumptions underlying Monopolistic Competition –Differentiated products Differentiated products leads to some market power over price or a downward slping demand curve –Many buyers and sellers –Free entry and exit –Perfect knowledge

Short-run Vs. Long-run Supply Decisions In the short-run, the firm is able to set prices like a monopolistic. P>MR so MR=MC implies that P>MC. A firm can make profits, breakeven or make losses. In the long-run, free entry and exit will eliminate economic profits or losses. In either case, the monopolistically competitive firm produces a level of output where LRAC are greater than LRAC minimum or the efficient scale and sets price above MC.

Monopoly Competition and Economic Welfare Compared to competitive markets, monopolistic competition results in an output level where there is –Excess capacity – LRAC >LRAC min –P>MC - or MB>MC –So, Deadweight Welfare Loss exists Welfare loss is due to product differentiation –If differentiation is real, the welfare is small –If differentiation is the result of advertising which does not contribute anything to consumer satisfaction, it represents welfare loss

Advertising Advertising is costly, the question is - does it add anything of value to the consumer? –informative advertising which contributes to competition –Advertising aimed at creating perceived differences or brand loyalty –Breakfast cereals and kids versus supermarket ads Advertising and the prisoner’s dilemma – self- canceling ads.