1. Monopolistic Competition
Chapter 23
Monopolistic Competition
23-1
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Objectives The monopolistic competitor in the short and long runs
Product differentiation
The characteristics of monopolistic competition
Price discrimination
23-2
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

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
23-3
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

4. The Monopolistic Competitor in the Short Run
The monopolistic competitor 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
23-4
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

5. The Monopolistic Competitor in the Short Run
The monopolistic competitor 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
Monopolistic competitor
Monopoly D MR MR D
23-5
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

6. Monopolistic Competitor Making a Profit in the Short Run
Price is $15
ATC is $12.10
Total Profit=(Price-ATC) X Output
=($15-$12.10) X 60
=($2.90) X 60
= $174
Output is 60
23-6
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

7. Monopolistic Competitor Taking a Loss in the Short Run
ATC is $12.80
Price is $11
Total Profit=(Price-ATC) X Output
=($11-$12.80) X 42
=(-$1.80) X 42
= -$75.60
Output is 42
23-7
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

8. Monopolistic Competitor Breaking Even in the Long Run
At the output level associated with MC=MR, the ATC curve is tangent to the demand curve
Output is 40
23-8
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

9. Monopolistic Competitor Breaking Even in the Long Run
Price is $12.25
ATC is $12.25
Total Profit=(Price-ATC) X Output
=($12.25-$12.25) X 40
=( 0 ) X 40
= 0
Output is 40
23-9
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

10. Monopolistic Competitor Breaking Even in the Long Run
Price is $12.10
ATC is $12.10
Total Profit=(Price-ATC) X Output
=($12.10-$12.10) X 42
=( 0 ) X 42
= 0
The monopolistic competitor makes zero economic profits in the long run
23-10
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

11. Monopolistic Competitor Breaking Even in the Long Run
Price is $12.10
ATC is $12.10
Total Profit=(Price-ATC) X Output
=($12.10-$12.10) X 42
=( 0 ) X 42
= 0
Because the monopolistic competitor does not produced at the minimum point of its ATC, the perfect competitor is more efficient than the monopolistic competitor
23-11
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

12. Product Differentiation
Product differentiation is crucial to monopolistic 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 wide variety of products and services
People in other countries rarely get to make all the consumer choices that Americans do and consequently do not engage in nearly as much product differentiation
23-12
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

13. The Basis for Product Differentiation
Physical differences
Convenience
Ambience
Reputations
Appeals to vanity
Unconscious fears and desires
Snob appeal
Customized products
23-13
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

14. The Typical Monopolistic Competitor
The monopolistic competitor tries to set his or her product apart from the competition
The main way of doing this is through advertising
When this is done successfully, the demand curve becomes more vertical or inelastic
Buyers are willing to pay more for a product or service because they believe it is much better than their other choices
23-14
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

15. 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 buyers mind, and it may or may not be based on real physical differences
23-15
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

16. Price Discrimination
Price discrimination occurs when a seller charges two 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
23-16
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

17. Some 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
23-17
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

18. Practicing Price Discrimination
The firm that practices price discrimination must be able to distinguish between two or more separate groups of buyers
Price discriminators must also be able to prevent buyers from reselling the product or service
For example, if a fifteen-year-old could resell his youth fare seat to an adult who could then use it, the price discrimination effort would fail
23-18
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

19. Motives for Price Discrimination
In most cases, price discrimination is basically a mechanism for rationing goods and services
The main motivation for price discrimination 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
The buyers would lose all of their “consumer surplus”
23-19
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

20. A&P’s Price Discrimination Scheme in the 1940s
Hypothetical Demand Schedule for Canned Peas
Price QD TR TC Total Profit
$ $50 $20 $30.00
A&P had an ATC of $.20 a can
If A&P could charge only one price it would be $.50 a can
23-20
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

21. A&P’s Price Discrimination Scheme in the 1940s
A&P still has an ATC of $.20 a can
Hypothetical Demand Schedule for Canned Peas by Grade
Grade Price QD TR TC Total Profit
A $ $ $ $30.00 B C
Total Profit $ 41.00
By keeping its markets separate rather than charging a single price, A&P was able to make much larger profits
23-21
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

22. Is the Monopolistic Competitor Inefficient?
From a purely economic standpoint . . .Yes!
The firms do not produce at the minimum point on the 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 Sunday
There may probably be over differentiation
Would Americans want the drab businesses that characterize Eastern Europe and the old Soviet Union?
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
23-22
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

23. Closing Thoughts
More than 99 percent of the over 23 million business firms in the United States 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
23-23
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.