Monopolistic Competition Chapter 17 [with marginalia] gmagma

The Four Types of Market Structure MonopolyOligopolyMonopolistic Competition Perfect Competition Tap water Cable TV Tennis balls Crude oil Novels Movies Wheat Milk Number of Firms? Type of Products? Many firms One firm Few firms Differentiated products Identical products

Monopolistic Competition oMarkets that have some features of competition and some features of monopoly. oAttributes of Monopolistic Competition oMany sellers oThere are many firms competing for the same group of customers. oProduct examples include books, CDs, movies, computer games, restaurants, piano lessons, cookies, furniture, etc. oProduct differentiation oEach firm produces a product that is at least slightly different from those of other firms. oRather than being a price taker, each firm faces a downward- sloping demand curve. oFree entry and exit oFirms can enter or exit the market without restriction. oThe number of firms in the market adjusts until economic profits are zero.

Monopolistic Competitors in the Short Run... (a) Firm Makes a Profit Quantity 0 Price Demand MR ATC Profit MC Profit- maximizing quantity Price Average total cost

Monopolistic Competitors in the Short Run... Quantity 0 Price Demand MR Losses (b) Firm Makes Losses MC ATC Average total cost Loss- minimizing quantity Price

Monopolistic Competition in the Short Run oShort-run economic profits encourage new firms to enter the market. This: oIncreases the number of products offered. oReduces demand faced by firms already in the market. oIncumbent firms’ demand curves shift to the left. oDemand for the incumbent firms’ products fall, and their profits decline.

Monopolistic Competition in the Short Run II oShort-run economic losses encourage firms to exit the market. This: oDecreases the number of products offered. oIncreases demand faced by the remaining firms. oShifts the remaining firms’ demand curves to the right. oIncreases the remaining firms’ profits. oThe Long-Run Equilibrium oFirms will enter and exit until the firms are making exactly zero economic profits.

A Monopolistic Competitor in the Long Run... Quantity Price 0 Demand MR ATC MC Profit-maximizing quantity P=ATC Two Characteristics of Long- Run Equilibrium As in a monopoly, price exceeds marginal cost. Profit maximization requires marginal revenue to equal marginal cost. The downward-sloping demand curve makes marginal revenue less than price. As in a competitive market, price equals average total cost. Free entry and exit drive economic profit to zero.

Excess Capacity o There is no excess capacity in perfect competition in the long run. oFree entry results in competitive firms producing at the point where average total cost is minimized, which is the efficient scale of the firm. o There is excess capacity in monopolistic competition in the long run. oIn monopolistic competition, output is less than the efficient scale of perfect competition. For a competitive firm, price equals marginal cost. o Therefore, monopolistic competition is “inefficient.”

Excess Capacity... Quantity (a) Monopolistically Competitive Firm(b) Perfectly Competitive Firm Quantity Price P = MR (demand curve) MC ATC Price Demand MC ATC Excess capacity Quantity produced Efficient scale P = MC Quantity produced = Efficient scale P

Advertising Monopolistic Competition is Characterized by Advertising. Is this good or bad? Has the quality of Presidential Candidates improved now that advertising is used? Are resources allocated to advertising wasted?