1. 1 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting

2. 2 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting

3. 3 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting CHAPTER 12 Monopolistic Competition: The Competitive Model in a More Realistic Setting Fernando Quijano Prepared by: The coffeehouse market is competitive because it is inexpensive to open a new store. Hundreds of firms in the United States operate coffeehouses.

4. 4 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Monopolistic Competition: The Competitive Model in a More Realistic Setting 12.1.Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market Explain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves. 12.2How a Monopolistically Competitive Firm Maximizes Profit in the Short Run Explain how a monopolistically competitive firm maximizes profit in the short run. 12.3What Happens to Profits in the Long Run? Analyze the situation of a monopolistically competitive firm in the long run. 12.4Comparing Perfect Competition and Monopolistic Competition Compare the efficiency of monopolistic competition and perfect competition. 12.5How Marketing Differentiates Products Define marketing and explain how firms use it to differentiate their products. 12.6What Makes a Firm Successful? Identify the key factors that determine a firm’s success. Chapter Outline and Learning Objectives CHAPTER 12

5. 5 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Monopolistic competition A market structure in which barriers to entry are low and many firms compete by selling similar, but not identical, products. Monopolistic Competition: The Competitive Model in a More Realistic Setting

6. 6 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting The Demand Curve for a Monopolistically Competitive Firm FIGURE 12-1 The Downward-Sloping Demand for Caffè Lattes at a Starbucks Explain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves. 12.1 LEARNING OBJECTIVE Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market If a Starbucks increases the price of caffè lattes, it will lose some, but not all, of its customers. In this case, raising the price from $3.00 to $3.25 reduces the quantity of caffè lattes sold from 3,000 to 2,400. Therefore, unlike a perfect competitor, a Starbucks store faces a downward-sloping demand curve.

7. 7 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Marginal Revenue for a Firm with a Downward-Sloping Demand Curve Table 12-1 CAFFÈ LATTES SOLD PER WEEK (Q) PRICE (P) TOTAL REVENUE (TR = P x Q) AVERAGE REVENUE (AR = TR/Q) MARGINAL REVENUE (MR = ΔTR/ΔQ) 0 1 2 3 4 5 6 7 8 9 10 $6.00 5.50 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 $0.00 5.50 10.00 13.50 16.00 17.50 18.00 17.50 16.00 13.50 10.00 ― $5.50 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 ― $5.50 4.50 3.50 2.50 1.50 0.50 –0.50 –1.50 –2.50 –3.50 Explain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves. 12.1 LEARNING OBJECTIVE Demand and Marginal Revenue at a Starbucks Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market

8. 8 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Marginal Revenue for a Firm with a Downward-Sloping Demand Curve FIGURE 12-2 How a Price Cut Affects a Firm’s Revenue Explain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves. 12.1 LEARNING OBJECTIVE If the local Starbucks reduces the price of a caffè latte from $3.50 to $3.00, the number of caffè lattes it sells per week will increase from 5 to 6. Its marginal revenue from selling the sixth caffè latte will be $0.50, which is equal to the $3.00 additional revenue from selling 1 more caffè latte (the area of the green box) minus the $2.50 loss in revenue from selling the first 5 caffè lattes for $0.50 less each (the area of the red box). Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market

9. 9 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting FIGURE 12-3 The Demand and Marginal Revenue Curves for a Monopolistically Competitive Firm Marginal Revenue for a Firm with a Downward-Sloping Demand Curve Any firm that has the ability to affect the price of the product it sells will have a marginal revenue curve that is below its demand curve. We plot the data from Table 12-1 to create the demand and marginal revenue curves. After the sixth caffè latte, marginal revenue becomes negative because the additional revenue received from selling 1 more caffè latte is smaller than the revenue lost from receiving a lower price on the caffè lattes that could have been sold at the original price. Explain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves. 12.1 LEARNING OBJECTIVE Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market

10. 10 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting How a Monopolistically Competitive Firm Maximizes Profit in the Short Run FIGURE 12-4 Maximizing Profit in a Monopolistically Competitive Market Explain how a monopolistically competitive firm maximizes profit in the short run. 12.2 LEARNING OBJECTIVE

11. 11 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Will Apple maximize profits if it produces 800,000 iPhones per month? Does Minimizing Cost Maximize Profits? Solved Problem 12-2 Average cost reaches a minimum at a quantity of 800,000, but profits are maximized at a quantity of 600,000. YOUR TURN: For more practice, do related problem 2.6 at the end of this chapter. Explain how a monopolistically competitive firm maximizes profit in the short run. 12.2 LEARNING OBJECTIVE

12. 12 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting What Happens to Profits in the Long Run? How Does the Entry of New Firms Affect the Profits of Existing Firms? FIGURE 12-5 How Entry of New Firms Eliminates Profits Panel (a) shows that in the short run Starbucks can charge a price above average total cost (point A) and make a profit, shown by the green rectangle. But this profit attracts new firms to enter the market, which shifts the demand and marginal revenue curves to the curves labeled “Long run” in panel (b). At point B, Starbucks breaks even. Analyze the situation of a monopolistically competitive firm in the long run. 12.3 LEARNING OBJECTIVE

13. 13 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Table 12-2 The Short Run and the Long Run for a Monopolistically Competitive Firm How Does the Entry of New Firms Affect the Profits of Existing Firms? What Happens to Profits in the Long Run? Analyze the situation of a monopolistically competitive firm in the long run. 12.3 LEARNING OBJECTIVE

14. 14 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting The Rise and Decline of Starbucks Making the Connection YOUR TURN: Test your understanding by doing related problem 3.6 at the end of this chapter. Starbucks: No longer different enough? In a monopolistically competitive industry, maintaining profits in the long run is very difficult. Analyze the situation of a monopolistically competitive firm in the long run. 12.3 LEARNING OBJECTIVE

15. 15 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Is Zero Economic Profit Inevitable in the Long Run? What Happens to Profits in the Long Run? A firm’s profits will be eliminated in the long run only if a firm stands still and fails to find new ways of differentiating its product or fails to find new ways of lowering the cost of producing its product. Analyze the situation of a monopolistically competitive firm in the long run. 12.3 LEARNING OBJECTIVE Don’t Let This Happen to YOU! Don’t Confuse Zero Economic Profit with Zero Accounting Profit YOUR TURN: Test your understanding by doing related problem 3.4 at the end of this chapter.

16. 16 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Can It Be Profitable to Be the High-Price Seller? Solved Problem 12-3 YOUR TURN: For more practice, do related problem 3.7 at the end of this chapter. Because the greater demand more than offsets the higher costs, the hhgregg store makes a larger profit. Analyze the situation of a monopolistically competitive firm in the long run. 12.3 LEARNING OBJECTIVE

17. 17 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Monopolistically competitive firms charge a price greater than marginal cost. Monopolistically competitive firms do not produce at minimum average total cost. Monopolistic competition and perfect competition share the characteristic that in long-run equilibrium, firms earn zero economic profits. However, there are two important differences between long- run equilibrium in the two markets: Compare the efficiency of monopolistic competition and perfect competition. 12.4 LEARNING OBJECTIVE Comparing Perfect Competition and Monopolistic Competition

18. 18 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Excess Capacity under Monopolistic Competition FIGURE 12-6 Comparing Long-Run Equilibrium under Perfect Competition and Monopolistic Competition Comparing Perfect Competition and Monopolistic Competition A monopolistically competitive firm has excess capacity: If it increased its output, it could produce at a lower average cost. Compare the efficiency of monopolistic competition and perfect competition. 12.4 LEARNING OBJECTIVE

19. 19 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Economists have debated whether monopolistically competitive markets being neither productively nor allocatively efficient results in a significant loss of well-being to society in these markets compared with perfectly competitive markets. How Consumers Benefit from Monopolistic Competition Consumers benefit from being able to purchase a product that is differentiated and more closely suited to their tastes. Is Monopolistic Competition Inefficient? Compare the efficiency of monopolistic competition and perfect competition. 12.4 LEARNING OBJECTIVE Comparing Perfect Competition and Monopolistic Competition

20. 20 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Abercrombie & Fitch: Can the Product Be Too Differentiated? Did Abercrombie and Fitch narrow its target market too much? Making the Connection YOUR TURN: Test your understanding by doing related problem 4.6 at the end of this chapter. Compare the efficiency of monopolistic competition and perfect competition. 12.4 LEARNING OBJECTIVE A firm whose strategy of product differentiation succeeds will experience increases in same-store sales.

21. 21 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting How Marketing Differentiates Products Marketing All the activities necessary for a firm to sell a product to a consumer. Brand Management Brand management The actions of a firm intended to maintain the differentiation of a product over time. Define marketing and explain how firms use it to differentiate their products. 12.5 LEARNING OBJECTIVE

22. 22 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting If the increase in revenue that results from the advertising is greater than the increase in costs, the firm’s profits will rise. Advertising How Marketing Differentiates Products Define marketing and explain how firms use it to differentiate their products. 12.5 LEARNING OBJECTIVE Defending a Brand Name A firm can apply for a trademark, which grants legal protection against other firms using its product’s name.

23. 23 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Google Tries (and Fails) to Measure the Effectiveness of Radio Advertising Making the Connection Does spending on radio advertising attract customers? YOUR TURN: Test your understanding by doing related problem 5.7 at the end of this chapter. Define marketing and explain how firms use it to differentiate their products. A firm’s optimal level of advertising occurs where the marginal cost of advertising equals the marginal revenue earned from advertising. 12.5 LEARNING OBJECTIVE

24. 24 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting What Makes a Firm Successful? FIGURE 12-7 What Makes a Firm Successful? Identify the key factors that determine a firm’s success. 12.6 LEARNING OBJECTIVE The factors under a firm’s control—the ability to differentiate its product and the ability to produce it at lower cost— combine with the factors beyond its control to determine the firm’s profitability.

25. 25 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Although not first to market, Bic ultimately was more successful than the firm that pioneered ballpoint pens. Is Being the First Firm in the Market a Key to Success? Making the Connection YOUR TURN: Test your understanding by doing related problem 6.6 at the end of this chapter. Identify the key factors that determine a firm’s success. 12.6 LEARNING OBJECTIVE The firms that were first to introduce a product ultimately lost out to latecomers who did a better job of providing consumers with products that were more reliable, less expensive, more convenient, or otherwise provided greater value.

26. 26 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Starbucks Faces McCompetition AN INSIDE LOOK >> The effect of entry on price, quantity, and profits at Starbucks.

27. 27 of 27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 12: Monopolistic Competition: The Competitive Model in a More Realistic Setting Brand management Marketing Monopolistic competition KEY TERMS