Monopolistic Competition Topic 7(a)

Contents 1. Characteristics of MC 2. Short run profit maximisation 3. Long run equilibrium 4. Assessment of MC 5. Product differentiation and Advertising

Characteristics of MC Large number of small firms so individual decisions have little or no impact on other firms’ decisions Differentiated products similar but not identical Low barriers to entry low economies of scale low set-up costs

Price and Output Determination The Firm’s Demand Curve in MC is: Highly elastic, Why? More close substitutes than a pure monopolist Not perfect substitutes (as is the case with perfect competition) Elasticity depends on number of rivals degree of product differentiation

Short-Run Price and Output Determination Rules for Profit maximization same as under Perfect Competition MR = MC (where MC cuts MR from below) Short Run: P ≥ AVC Long Run : P ≥ ATC

Economic Profits Short-Run Price and Output Determination: Short-Run Profits Q D P Price and Costs MR MC Q AC

Losses Q D P Price and Costs MR MC Q ATC Short-Run Price and Output Determination: Short-Run Losses

Long Run How much to produce? MR = MC Firms tend to break even, i.e. normal profit Tangency solution: profit-maximising firm will produce an output when its demand curve is at a tangent to its ATC curve When ATC = Price

Long run Equilibrium

Long-Run Equilibrium Why do monopolistically competitive firms tend to break even in the long run? Profits attract new entrants Losses encourage exits Some complications Some product differentiation Some entry is partially restricted Some economic losses may be tolerated by firms in the long run

Assessment of MC (vs. PC) Higher price, lower output lower consumer surplus like monopoly P > MC No allocative eff. P = AC like PC but P ≠ min AC No productive eff.

Monopolistic Competition & Economic Efficiency Productive inefficiency: Minimum ATC is not necessarily chosen excess capacity Allocative inefficiency: price does not necessarily equal MC Good feature product variety

Non-price Competition (ie. competition not based on price) Product differentiation: Real and/or perceived differences created by factors such as: quality, brands, service, location, advertising and packaging Advantages More choice Innovation => Better products Avoid price war Disadvantages Too much choice? Superficial product changes – waste of resources

Non-price Competition - Advertising Firm Advantages of Advertising influences consumer preferences (the power of persuasion) makes demand more price inelastic Increases market power, market share Disadvantages of Advertising Increases cost of production

Non-price Competition – Advertising (cont.) Society Advantages of Advertising Provides information Promotes competition Advertising revenue – cheaper media (television, newspapers etc) for users Disadvantages of Advertising Misleading or false information Waste of resources if overall market demand stays constant Creates barriers to entry (financial, brand loyalty) Media bias towards advertisers