AP Economics Chapter 25 Notes Monopolistic Competition

I. Monopolistic Competition A. Definition > large # of sellers, selling similar but not identical products. 1. Firms act independently of each other. B. There is product differentiation (unlike PC). 1. Therefore, there is non-price competition (advertising) C. Firms can enter/exit easily (ex. T-25.1)

II. Profit Max Price & Output A. Output will be where MR=MC (similar to PC & M). Price is where it hits the D curve (same as M, short run). C. In the long run, only normal profits are made (same as PC). 1. Why? Because firms will enter/exit industry until econ profits are 0. (see P.519 graphs)

III. Economic Efficiency A. MC are not: 1. Alloc. Effic. Because they don’t produce at where P=MC. 2. Prod. Effic. Because not producing at P = minimum ATC. B. Excess Capacity present because they are not producing efficiently>>> at bottom of ATC.Resources are being underused(p.521)

IV. Non Price Competition A. Consumer offered greater types, styles, brands, and quality of products. This is an advantage to consumers. 1. Note: Since more # of choices, there is an excess cap. problem. B. Three Factors in seeking profit max: 1. Product attributes/features. 2. Product Price. 3. Advertising.

V. Oligopoly A. Definition > few large firms producing same (steel) or different (cars) products. 1. Mutually interdependent on price, quantity, and advertising. B. Two ways to measure market dominance: 1. Concentration Ratio a. % total ind. sales by oligopoly firms. b. Limitations i. Firms may dominate regional, not national.

ii. Interind. competition may be present – limits dominance. 2. Herfindahl Index a. H.I. = (%S 1 ) ² + (%S 3 ) ² + (%S 4 ) ² …. i. High index = dominance by 2 firms. ii. Low index + dominance by 4 firms. C. Causes of Oligopoly 1. Econ of Scale/ Mergers 2. Barrier to Entry > ex. $, patents, access to raw materials.

VI. Game Theory Behavior A. Definition > Each firm’s action is interdependent with another firm’s action. 1. If firm U has an  pr. strat., firm R have  pr. strat. And vice versa and will  or  their strat. so they match each other. a. There is a possibility of collusion, which is illegal- against U.S. Anti-Trust Laws. 2.Note: # in boxes are profit pay offs for each firm, depending on high or low strat.

VII. Profit Max Output & Price A. Where MR=MC (same as M and MC). B. 3 Models to explain distinct O characteristics that affect Profit Max Output & Price. 1. “Kinked Demand Curve” (p.528) a. If you lower price below equil. price, rivals will match price cut (D is inelastic on price cuts because Revenue will not  when price  ) Thus, your MR will decrease drastically.

b. If you raise your price above equil. price, rivals will not match it and your MR and your D will  (D is elastic on price increases = P , D  ). 2. Collusion & Cartel Agreements > restrict output and agree on a price. a. Advantages > lowers uncert., increases profit, similar to M. b. Cartel > written collusion c. You can cheat and make more. 3. Price Leadership > implied agreement where largest firm sets price and others follow.