1. Monopolistic Competition
Books CD’s Movies Computer Games
Restaurants Hockey lessons Cookies Furniture
Monopolistic Competition lies between extremes: Perfect Competition and Monopoly.
© 2000 Claudia Garcia - Szekely

2. Monopolistic Competition
Can’t react to rival’s actions
Can’t make agreements to set prices
Act independently of rivals
Many Firms
Each firm faces its own downward sloping demand curve
Set their own price
Differentiated
Products
Free entry
Long Run profits are zero
Perfect
Information
Firms cannot charge higher prices than competitors
© 2000 Claudia Garcia - Szekely

3. Like a Monopolist The firm faces a downward sloping demand curve
Like a Perfectly Competitive firm It supplies only a portion (share) of the market demand
Market Demand P Q
Total Market Demand
Fewer Substitutes for Hamburgers
Steeper: Less Elastic: Fewer Substitutes
Market Demand P
Demand perceived by the firm
Firm’s Demand
Flatter: More elastic: More Substitutes for specific brand
More Substitutes for Burger King Hamburgers Q
Firm’s Share
Total
Total
© 2000 Claudia Garcia - Szekely

4. Profit Maximizing Output LevelMC
Like in Perfect Competition and Monopoly : The firm chooses the Profit Maximizing Output level where MR = MC
Pmc d
Firm’s share of total Demand
qmc MR
© 2000 Claudia Garcia - Szekely
© 2000 Claudia Garcia - Szekely

5. © 2000 Claudia Garcia - Szekely
The Short Run MC
Like in Perfect Competition and Monopoly if P > ATC firms enjoy profits
ATC
Pmc
Profit d
qmc MR
© 2000 Claudia Garcia - Szekely
© 2000 Claudia Garcia - Szekely

6. Profits Attract New Firms
Existing firms’ market share shrinks
The firm’s demand curve shifts left
Existing firms increase advertising costs to defend market share
The firm’s ATC curve shifts upwards
© 2000 Claudia Garcia - Szekely
© 2000 Claudia Garcia - Szekely

7. Market share (demand) and Costs shift until Profits disappear
Long Run
Like in Perfect Competition Profits attract new firms into the market
MC1
MC0
ATC1
ATC0
The firm’s market share decrease and its ATC increase due to higher advertising costs
Pmc
Pmc
Profit
Market share (demand) and Costs shift until Profits disappear d d q1 q0
MR1
MR0
© 2000 Claudia Garcia - Szekely

8. Losses force Firms to Exit
Remaining firms’ market share increase
The firm’s demand curve shifts right
Existing firms can decrease advertising costs not necessary to defend market share anymore
The firm’s ATC curve shifts down
© 2000 Claudia Garcia - Szekely
© 2000 Claudia Garcia - Szekely

9. ATC0
Like in Perfect Competition and Monopoly: firms may incur losses
ATC1
Loss
Pmc
Pmc
Like in Perfect Competition: Losses cause firms to exit
The firm’s market share increase
its ATC decrease due to lower advertising costs d1 d0 q0 q1
MR1
MR0
Demand and Costs shift until Losses disappear
© 2000 Claudia Garcia - Szekely

10. Monopolistic Competition v.s Perfect Competition
To improve Efficiency: Fewer firms, each producing more at the lowest ATC
v.s Perfect Competition
Markup Over MC MC
ATC MC P d MR
qmc
P=MR
P=MC
ATC > min MC
Min ATC
qpc
Excess Capacity: ATC > min
No excess Capacity: ATC is min.
© 2000 Claudia Garcia - Szekely

11. Monopolistic Competition Excess Capacity: should produce more
v.s Monopoly
ATC > min MC
Monopolist can make profits in the long run! MC
PMC PM
Profit
Markup Over MC
Monopolistic competitors can NOT make profit in the long run
Market Demand
Market Share
MC MC
MCM d D
qMC qM MR MR
Excess Capacity: should produce more
© 2000 Claudia Garcia - Szekely

12. Advertising and Monopolistic Competition
Firms in a perfectly competitive market have no incentive to advertise: can sell any amount at the same price
To sell more units, Monopolistic Competitors must drop the price or advertise to shift demand to the right.
© 2000 Claudia Garcia - Szekely
© 2000 Claudia Garcia - Szekely

13. Perfectly competitive firm Monopoly
Perfectly competitive firm
Monopoly
Monopolistic Competition
Is entry into the market free or restricted?
Is exit out of the industry free or restricted?
How does the firm choose the output level?
Does the firms charge one price? Or does it price discriminate?
Shape of Demand faced by the firm
Are producers price takers or price setters?
Is MR greater than, less than or equal to Price? WHY?
Do producers want to maximize profit or do they produce for some other reason?
Do producers react to prices? In other words: is there a Supply curve in this market?
Is the price charged greater than, smaller than or equal to MC?
Can firm(s) make profit in the short run?
Can firm(s) make profit in the long run?
Can firm(s) incur a loss in the short run?
Can firm(s) incur a loss in the long run?

14. © 2000 Claudia Garcia - Szekely