1. Monopolistic Competition and Advertising12
Monopolistic Competition and Advertising
Pre-class music: Advertising in Super Bowl Commercials (See Tip #418)
Instead of playing the usual pre-class music, you could introduce this chapter by playing a montage of famous/funny commercials (possibly a top 10 commercial list on YouTube) to prime your class for a discussion on the importance of advertising.
Pre-class video: Kohl’s commercial, “Black Friday” (See Tip #437)
You could also start out your lecture on this chapter by showing this Kohl’s commercial, which parodies Rebecca Black’s polarizing song “Friday.”
The key concepts covered in this commercial include:
Product differentiation
Advertising

2. What Is Monopolistic Competition?
Market structure:
Many different firms
Products are differentiated
Free entry and exit
Product differentiation
Process that firms use to make a product more attractive by contrasting its unique qualities with competing products
Lecture notes:
Some examples of monopolistic competition can include:
Fast-food restaurants
Clothing retailers
Gas stations
Hair salons
Product differentiation:
Goods are imperfect substitutes—“the same but different.”
Note that differentiation can be real or spurious.
A firm’s goal here is to convince consumers that its product is better than the competitors’.
A highly differentiated product may even command a higher demand and price.

3. Comparing Market Structures
Perfectly Competitive Markets
Monopolistic Competition
Monopoly
Many sellers
One seller
Similar products
Differentiated products
A unique product without close substitutes
Free entry and exit
Low barriers to entry and exit
Barriers to entry and exit
Lecture notes:
So far, we have talked about two “extreme” market structures.
Perfect competition:
Each firm has zero market power and is a price taker.
Each firm faces a horizontal demand curve.
Because of free entry, a competitive firm earns zero economic profits in the long run.
Monopoly:
A monopoly has market power and is a price maker.
It faces a downward-sloping demand curve.
Because of barriers, a monopoly can earn economic profits in the long run.
Monopolistic competition:
Many sellers like perfect competition.
Since firms sell a differentiated product, firms face downward-sloping demand curve like a monopoly.
Each firm has some market power, but it is limited since there are many sellers.
Monopolistic competition would be closer to perfect competition than monopoly.

4. Product Differentiation—1
What are some ways firms differentiate their products?
Style or type
Location
Quality
Lecture notes:
Style or type:
Abercrombie & Fitch and Hollister target a young/trendy demographic.
Ann Taylor, Bon-Ton, and J.C. Penney aim for a more adult consumer type.
Dick’s Sports and Big Five Sport
Restaurants of all ethnic types to satisfy different consumer tastes
Location:
Even if the product is very similar, convenient locations may give some firms pricing power.
Quality:
Quality differentiation allows firms to capture consumers that have not only different tastes but also different incomes or willingness to pay.
[Crosswalk: © TravelCollection/Alamy Stock Photo;; Urban Outfitters: © Jen Grantham/iStockphoto.com; Chipotle: Marcnorman | Dreamstime.com; Taco Bell: © swalls/i-Stock.com]

5. Differences among the Three Market Types
Perfect competition:
Low prices
Efficient level of output
Monopoly:
High prices
Inefficient level of output
Monopolistic competition: ?
Lecture tip:
You may want to preview the answers:
Prices are higher than under perfect competition but lower than under monopoly.
Outcome is inefficient, but welfare loss is smaller than under monopoly.
Although inefficient compared to perfect competition, consumers get products that better match their tastes.

6. Monopolistic Competition in the Short Run
Image: Animated Figure 12.1
Lecture notes:
Here, we want to show:
How a monopolistically competitive firm decides how much output to produce to maximize profits
Whether the firm makes a profit or a loss
Note that in both diagrams, the cost curves are the same, but the demand in the right diagram is lower than in the left diagram.
Also note that it looks like a monopoly diagram. The key difference is that here, the demand curve is relatively elastic since there are many sellers.
First and second clicks:
Labels the profit-maximizing price, output, and ATC in both diagrams.
Third click:
Shades in the profit box.
Fourth click:
Shades in the loss box.

7. Monopolistic Competition in the Long Run—1
In the short run, a monopolistically competitive firm may earn profits or losses.
What will occur in the long run?
Why?
Lecture notes:
Since there is free entry and exit:
If there are short-run profits, new firms will enter.
A firm’s demand curve will decrease and become more elastic.
Entry will continue until profits are equal to zero.
If there are short-run losses, new firms will exit.
A firm’s demand curve will increase and become less elastic.
Exit will continue until profits are equal to zero.

8. Monopolistic Competition in the Long Run—2
Image: Animated Figure 12.2
Lecture notes:
Before clicking through the slide, ask students where to draw the ATC curve.
Note that the demand curve is drawn just tangent to the average total cost curve.
At this point, P = ATC, and profits are zero.

9. Monopolistic Competition and Competitive Markets—1
Price, Marginal Cost and Long-Run ATC Cost
Perfect competition: P = MC
Monopolistic competition: P > MC
Markup: P - MC
Perfect competition: P = min ATC
Monopolistic competition: P > min ATC
Lecture tip:
First, state the general rules (listed on the PowerPoint slide above), and then show the figures on next slide.
Markups are possible when a firm enjoys some market power and sells a differentiated product.
The more differentiated a product is, the higher the markup for that product.

10. Conclusion Monopolistic competition
Exists when many competing firms produce differentiated products
Has features of both perfect competition and monopoly
Is closer to perfect competition than monopoly in terms of prices, output, and efficiency
Is prevalent throughout our economy
Lecture notes:
We’ve now discussed three out of four market structures. The fourth market structure, oligopoly, will be discussed in the next chapter.
Here is a recap of some of the points made in this chapter:
Monopolistic competition is a market characterized by free entry and many firms selling differentiated products.
Differentiation by style or type, location, or quality
Monopolistic competitors are price makers.
P > MC, and produce with excess capacity.
Although inefficient, monopolistic competition is largely beneficial since firms produce a variety of goods.
In the long run, monopolistically competitive firms make zero positive economic profits.
Advertising performs useful functions.
Information, location, new products, and quality differences
However, advertising also increases costs and may be misleading.