Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 23 MONOPOLISTIC COMPETITION

23-2 Learning Objectives After this chapter, you should be able to: 1. Differentiate between the monopolistic competitor in the short run and the long run. 2. Define and examine product differentiation. 3. List and discuss the characteristics of monopolistic competition. 4. Define and illustrate price discrimination. 5. Assess the efficiency of the monopolistic competitor.

23-3 Monopolistic Competition Defined A monopolistically competitive industry has many firms selling a differentiated product.  Differentiated means the buyer, for whatever reason, sees a difference between one product and another. Identical means the buyer sees no difference between one product and anther product.  No one firm has any significant influence on price.

23-4 The Monopolistic Competitor in the Short Run: Can make a profit or take a loss. Is only one firm in a crowded industry and has a very elastic demand curve. No one firm can get too far out of line on price because buyers can always purchase a substitute from some one else.

23-5 Monopolistic Competitor Making a Profit in the Short Run What are P* and Q*? P* = $15 Q* = 60 Set Q* where MC = MR

23-6 Monopolistic Competitor Taking a Loss in the Short Run What are P* and Q*? P* = $11 Q* = 42 To minimize losses, still set Q* where MC = MR

23-7 Monopolistic Competitor Breaking Even in the Long Run What are P* and Q*? P* = $12.25 Q* = 40 Set Q* where MC = MR Note: the ATC curve is tangent to the D curve at Q*

23-8 Questions for Further Thought and Discussion Top graph: what is this monopolistic competitive firm doing?  Taking a loss Bottom graph: solve for P*, Q*, and Profit  P* = $10  Q* = 8.25  Profit =  (10.25 – 9.40) x 8.25 = $7.01

23-9 The Monopolistic Competitor vs. the Perfect Competitor in the Long Run Both break even, but … the Monopolistic Competitor charges more and sells less. P MC > P PC and Q* MC < Q* PC

23-10 Product Differentiation Product differentiation is crucial to monopolistic competition.  The monopolistic competitor tries to set his/her product apart from the competition.  Product differentiation takes place in the buyer’s mind. If a buyer sees no difference, there is no difference. In the real world, buyers usually do differentiate.  Americans are provided with a wider variety of products and services than people in other countries.

23-11 Advertising and the Bases for Product Differentiation Advertising tries to make the demand curve for the product more inelastic:  Physical differences  Convenience  Ambience  Reputations  Appeals to vanity  Unconscious fears and desires  Snob appeal  Customized products

23-12 Product Differences Product differentiation does not necessarily mean there are any physical differences among products.  They might all be the same, but how they are sold may make all the difference. There are, of course, some very real physical product differences.  Buyers often differentiate based on real physical differences, but differentiation is still taking place in the buyer’s mind, and it may or may not be based on real physical differences.

23-13 Price Discrimination Price discrimination occurs when a seller charges two or more prices for the same good or service.  Sometimes it’s bad and sometimes it’s not bad at all.  Price discrimination is often disguised as a subsidy to the poor. To practice price discrimination, a seller needs to be able to:  Distinguish between at least 2 sets of buyers.  Prevent one set of buyers from reselling the product to another set.

23-14 Examples of Price Discrimination Doctors often charge wealthy patients more than poor patients.  They may have one price for those with insurance and another price for those without insurance. Movies in the evening cost more than those in the early afternoon (matinee). Senior citizen, youth, and student discounts. New and used cars. Youth fares on airlines. Evening meals in restaurants often cost more than the same meal at lunch.

23-15 Motives for Price Discrimination In most cases, price discrimination is basically a mechanism for rationing goods and services. The main motivation is to raise profits.  The greater the price discrimination, the greater the profits because buyers lose some of their “consumer surplus”.  If price discrimination were carried to its logical conclusion, we would have perfect price discrimination. Buyers would lose all of their “consumer surplus”.

23-16 Monopolistic Competitor Charging One Price

23-17 Monopolistic Competitor Practicing Price Discrimination P = $8 P = $6.50

23-18 Is the Monopolistic Competitor Inefficient? From a purely economic standpoint...Yes!  Firms do not produce at the minimum point of ATC.  There may be too many firms in the industries. Are there too many beauty parlors? Not if you want to get your hair done on Friday afternoon or Saturday morning. Are there too many restaurants? Not on Friday and Saturday evenings.  There may probably be over-differentiation. Would Americans want the drab businesses that characterize Eastern Europe? Would Americans want only one brand of toothpaste or one brand and model of a car?  In America, it would be hard to imagine a no-frills world.

23-19 Closing Thoughts More than 99% of the over 30 million business firms in the U.S. are monopolistic competitors. While monopolistic competitors do compete with respect to price, they compete still more vigorously with respect to ambience, service, and the rest of the intangibles that attract customers.

23-20 Economics in Action: Selling Status Starbucks does a great job of selling status.  $2.20 for hot chocolate!?! Add a few cents worth of white chocolate mocha and you get to pay $1.00 more.  This enables Starbucks to smoke out customers who are less sensitive about price.  But under what conditions can this continue?

23-21 Economics in Action: Selling Status Some restaurants segregate diners by status.  There is usually a wait in the lower tiered section of 15 minutes or more.  The higher tiered section gets immediate seating. Why? The foods the same in both sections. The price in the higher tiered section is twice what is in the lowered tiered section. The bottom line is that by selling status you can really boost your profits.