1. Monopolistic Competition
Chapter 23
Monopolistic Competition

2. Learning Objectives
When you have completed this chapter you will be familiar with:
The monopolistic competitor in the short and long run.
Product differentiation.
The characteristics of monopolistic competition.
Price discrimination.

3. Monopolistic Competition Defined
A monopolistically competitive industry has many firms selling a differentiated product.
Differentiated means the buyer, for whatever reason, makes a difference between one product and another.
Identical means the buyer makes no difference between one product and anther product.
No one firm has any significant influence on price.

4. The Monopolistic Competitor in the Short Run
Can make a profit or take a loss.
As only one firm in a crowded industry it has a very elastic demand curve.
No one firm can get too far out of line on price because buyers can always purchase a substitute from some one else.

5. Monopolistic Competitor Making a Profit in the Short Run
What are P* and Q*?
Set Q* where MC = MR
P* = $15
Q* = 60

6. Monopolistic Competitor Taking a Loss in the Short Run
What are P* and Q*?
To minimize losses, still set Q* where MC = MR
P* = $11
Q* = 42

7. Monopolistic Competitor Breaking Even in the Long Run
What are P* and Q*?
Set Q* where MC = MR
P* = $12.25
Q* = 40
Note: the ATC curve is
tangent to the D curve
at Q*

8. Questions for Further Thought and Discussion
Top graph: what is this monopolistic competitive firm doing?
Taking a loss
Bottom graph: solve for P*, Q*, and Profit
P* = $10
Q* = 8.25
Profit =
(10.25 – 9.40) x 8.25 = $7.01

9. The Monopolistic Competitor vs. the Perfect Competitor in the Long Run
Both break even, but …
the Monopolistic Competitor charges more and sells less.
P MC > PPC and Q*MC < Q*PC

10. Product Differentiation
Product differentiation is crucial to monopolistic competition.
The monopolistic competitor tries to set his/her product apart from the competition.
Product differentiation takes place in the buyer’s mind.
If a buyer sees no difference, there is no difference.
In the real world, buyers usually do differentiate.
Americans are provided with a wider variety of products and services than people in other countries.

11. Advertising and the Bases for Product Differentiation
Advertising tries to make the demand curve for the product more inelastic:
Physical differences
Convenience
Ambience
Reputations
Appeals to vanity
Unconscious fears and desires
Snob appeal
Customized products

12. Product Differences
Product differentiation does not necessarily mean there are any physical differences among products.
They might all be the same, but how they are sold may make all the difference.
There are, of course, some very real physical product differences.
Buyers often differentiate based on real physical differences, but differentiation is still taking place in the buyer’s mind, and it may or may not be based on real physical differences.

13. Price Discrimination
Price discrimination occurs when a seller charges 2 or more prices for the same good or service.
Sometimes it’s bad and sometimes it’s not bad at all.
Price discrimination is often disguised as a subsidy to the poor.
To practice price discrimination, a seller needs to be able to:
Distinguish between at least 2 sets of buyers.
Prevent one set of buyers from reselling the product to another set.

14. Examples of Price Discrimination
Doctors often charge rich patients more than poor patients.
They may have one price for those with insurance and another price for those without insurance.
Movies in the evening cost more than those in the early afternoon.
Senior citizen, youth, and student discounts
New and used cars
Youth fares on airlines
Evening meals in restaurants often cost more than the same meal at lunch.

15. Motives for Price Discrimination
In most cases, price discrimination is basically a mechanism for rationing goods and services.
The main motivation is to raise profits.
The greater the price discrimination, the greater the profits because buyers lose some of their “consumer surplus”.
If price discrimination were carried to its logical conclusion, we would have perfect price discrimination.
Buyers would lose all of their “consumer surplus”.

16. Monopolistic Competitor Charging One Price

17. Monopolistic Competitor Practicing Price Discrimination

18. Is the Monopolistic Competitor Inefficient?
From a purely economic standpoint . . .Yes!
Firms do not produce at the minimum point of ATC.
There may be too many firms in most industries.
Are there too many beauty parlors? Not if you want to get your hair done on Friday afternoon or Saturday morning.
Are there too many restaurants? Not on Friday and Saturday evenings.
There may probably be over-differentiation.
Would Americans want the drab businesses that characterize Eastern Europe?
Would Americans want only one brand of toothpaste or one brand and model of a car?
In America, it would be hard to imagine a no-frills world.

19. Closing Thoughts
More than 99% of the over 39 million business firms in the U.S. are monopolistic competitors.
While monopolistic competitors do compete with respect to price, they compete still more vigorously with respect to ambience, service, and the rest of the intangibles that attract customers.

20. Current Issue: Selling Status
Starbucks does a great job of selling status.
$2.20 for hot chocolate!?! Add a few cents worth of white chocolate mocha and you get to pay $1.00 more.
This enables Starbucks to smoke out customers who are less sensitive about price.
But under what conditions can this continue???

21. Current Issue: Selling Status
Some restaurants segregate diners by status.
There is usually a wait in the lower tiered section of 15 minutes or more.
The higher tiered section gets immediate seating. Why?
The foods the same in both sections.
The price in the higher tiered section is twice what is in the lowered tiered section.
The bottom line is that by selling status you can really boost your profits.