Monopolistic Competition Monopoly –one firm –faces downward sloping demand curve Competition –many firms –face flat demand curve –free entry and exit over time Key Rationale: Product Differentiation

The Best Thing About Monopolistic Competition: NO NEW DIAGRAMS ! Yahoo! Hooray!

Watch how a graph of a typical monopolistically competitive firm is sketched: It looks just like a monopoly

The trick behind the treat of the monopolistic competition diagram shift the demand curve and thus the marginal revenue curve of the typical firm as other firms enter and exit the industry if there are economic profits: –demand shifts in as other firms enter if there are economic losses (negative profits) –demand shifts out as other firms exit

Here there are either profits or losses

Here economic profits are zero: no incentive to exit or enter

Now let’s watch what happens as we move the D and MR curves

In Long Run Equilibrium: Excess Average Total Costs

Long run equilibrium of a monopolistically competitive industry economic profits are driven to zero, but –(1) average total cost (ATC) not at a minimum –(2) price is greater than marginal cost (P>MC) –(3) there is deadweight loss can view the above three disadvantages as the “cost of variety”

Summary and Review: Predictions from Three Models

Oligopoly Few firms (duopoly = two) Strategic considerations come into play –game theory to concentrate on strategic considerations we focus on a case where one good is produced –but in reality oligopoly can have product differentiation too (Coke and Pepsi)

Four Types of Models/Industries

The Prisoners’ Dilemma Game: What set of strategies is an equilibrium for Pete and Ann?

A Duopoly as a Prisoners’ Dilemma Game

The prisoners’ dilemma analogy suggests a tendency toward competition Non cooperative outcome –prisoners confess –firms charge low price Cooperative outcome –prisoners remain silent –firms charge high price

End of Lecture