1. Monopolistic Competition
Hall and Lieberman, 3rd edition, Thomson South-Western, Chapter 10

2. Overview What you will learn in this lecture
Three fundamental characteristics
Short run equilibrium
Long run equilibrium
Excess capacity
Non price competition

3. Motivation of Imperfect Competition
Advertising is everywhere in the economy
In perfect competition and monopoly firms do little, if any, advertising
Why?
Where, then, is all the advertising coming from?
We must consider firms that are neither perfect competitors nor monopolists

4. The Concept of Imperfect Competition
Refers to market structures between perfect competition and monopoly
there is more than one seller, but too few to create a perfectly competitive market
products may not be standardized
no free entry and exit
Types of imperfectly competitive markets
Monopolistic competition
Oligopoly

5. Monopolistic Competition
Hybrid of perfect competition and monopoly
Three fundamental characteristics
Many buyers and sellers
Sellers offer a differentiated product
Sellers can easily enter or exit the market
Examples

6. I. Many Buyers and Sellers
Under monopolistic competition, an individual buyer is a price taker
But an individual seller, in spite of having many competitors, decides what price to charge
Assume that no interaction among firms in market
Each firm only supplies a small part of the market, that none of them needs to worry that its actions will be noticed—and reacted to—by others

7. II. Sellers Offer a Differentiated Product
Each seller produces a somewhat different product from the others
Faces a downward-sloping demand curve
In this sense is more like a monopolist than a perfect competitor
When it raises its price a modest amount, quantity demanded will decline (but not all the way to zero)

8. II. Sellers Offer a Differentiated Product
What makes a product differentiated?
Quality of product
Tastes – a subjective matter
Whether their perception is accurate or not
Difference in location
Thus, whenever a firm faces a downward-sloping demand curve, we know buyers perceive its product as differentiated
Firm chooses its price

9. III. Easy Entry and Exit
This feature is shared by monopolistic competition and perfect competition
Plays the same role in both
Ensures firms earn zero economic profit in long-run
However, no barrier stops any firm from copying the successful business of other firms

10. Monopolistic Competition in the Short-Run
Individual monopolistic competitor behaves very much like a monopoly
Key difference is the availability of substitutes
When a monopolistic competitor raises its price, its customers have one additional option
Can buy similar good from some other firm

11. Monopolistically competitive firm making positive economic profit$ MC P0
ATC
Demand Q0 MR
Quantity

12. Monopolistic Competition in the Long-Run
Free entry condition
Continue to occur, and demand curve will continue to shift leftward
Till the time when each firm earns zero economic profit
In real world, monopolistic competitors often earn economic profit or loss in the short-run
But—given enough time—profits attract new entrants, and losses result in an industry shakeout, until firms are earning zero economic profit

13. Monopolistically competitive firm making positive economic profit: invites entry, firm demand shifts inward $ MC P0
ATC
Demand Q0 MR
Quantity

14. Monopolistically competitive firm making positive economic profit: entry continues until profits are zero $ MC P0
ATC P1
Demand Q1 Q0
Quantity MR

15. At equilibrium, P = ATC (zero profit) and MR = MC$ MC
ATC P0 Q0 MR
Quantity

16. Features of monopolistically competitive industries
Economy is not efficient - excess capacity
too little output produced to achieve minimum cost per unit
costly to consumers
equilibrium price is above minimum ATC
More firms (varieties) than necessary for least cost production
Benefits
Consumers usually benefit from product differentiation
May tempt you to leap to a conclusion
Consumers are better off under perfect competition; however
In order to get beneficial results of perfect competition, all firms must produce identical output

17. Non-price Competition
Definition: Any action a firm takes to increase demand for its output—other than cutting its price
Example: better service, product guarantees, free home delivery, more attractive packaging
another reason why monopolistic competitors earn zero economic profit in long-run
Costly
Must pay for advertising, for product guarantees, for better staff training
Shift each firm’s ATC curve upward