1. Monopolistic Competition
Chapter 11

2. In This Chapter…
Distinguishing Features of Monopolistically Competitive Markets
Profit Maximizing Price and Output Decisions
11.3. Problems of Monopolistically Competitive Markets

3. 11.1. Distinguishing Features of Monopolistically Competitive Markets

4. Structure
Monopolistic competition is a market in which many firms produce similar goods or services but each maintains some independent control of its own price.

5. Structure
A distinguishing structural characteristic of monopolistic competition is that there are “many” firms in the industry.
“Many” is somewhere between the “few” of oligopolies and the “hordes” that characterize perfect competition.

6. Low Concentration
Low concentration ratios are common in monopolistic competition.
Concentration ratio – The proportion of total industry output produced by the largest firms (usually the four largest).

7. Market Power
Each producer in monopolistic competition is large enough to have some market power.
Market Power – The ability to alter the market price of a good or service.

8. Market Power
A monopolistically competitive firm confronts a downward-sloping demand curve for its output.

9. Independent Production Decisions
Modest changes in the output or price of any single firm will have no perceptible influence on the sales of any other firm.

10. Independent Production Decisions
The relative independence of monopolist competitors means that they don’t have to worry about retaliatory responses to every price or output change.

11. Low Entry Barriers
Another characteristic of monopolistic competition is the presence of low barriers to entry.
Barriers to entry – Obstacles that make it difficult or impossible for would-be producers to enter a particular market, such as patents.

12. Behavior
Monopolistic competition has distinctive behavior.

13. Product Differentiation
One of the most notable features of monopolistically competitive behavior is product differentiation.
Product differentiation - Features that make one product appear different from competing products in the same market.

14. Brand Image Each firm has a distinct identity – a brand image.
Consumers perceive its output to be somewhat different than others in the industry.

15. Brand Loyalty
By differentiating their products, monopolistic competitors establish brand loyalty.
Brand loyalty gives producers greater control over the price of their products.

16. Brand Loyalty
Each firm only has a monopoly on its brand image.
It still competes with other firms offering close substitutes.

17. Brand Loyalty
Brand loyalty makes the demand curve facing the firm less price-elastic.
Brand loyalty implies that consumers shun substitute goods even when they are cheaper.

18. Brand Loyalty
Each monopolistically competitive firm will establish some consumer loyalty.
A symptom of brand loyalty is the price differences between computers which are essentially the same.

19. 11.2. Profit Maximizing Price and Output Decisions

20. Short-Run Price and Output
The monopolistically competitive firm’s production decision is similar to that of a monopolist.
Production decision - The selection of the short-run rate of output (with existing plant and equipment).

21. Short-Run Price and Output
As always, the profit-maximizing rate of output is achieved by producing the quantity where MR = MC.

22. Entry and Exit
With low barriers to entry, new firms will enter the market if there is economic profit.
Economic profit – The difference between total revenues and total economic costs.

23. Entry and Exit
When firms enter a monopolistically competitive industry:
Thus, in the long run, there are no economic profits in monopolistic competition.
The market supply curve shifts to the right.
The demand curves facing individual firms shift to the left.

24. Equilibrium in Monopolistic Competition
Price or Cost (dollars per unit) MR qa pa F MC
ATC
Quantity (units per period)
Demand K
The short run ca

25. Effects of Entry on Industry and Firm
Price (per unit)
Quantity (units per time period)
Initial demand facing firm
Effect of entry on the
monopolistically competitive firm
Price (per unit)
Quantity (units per time period)
Market demand
Initial market supply
Effect of entry on the industry
New entry
Later market supply
Reduced market share p1 p2
Later demand facing film MR

26. Equilibrium in Monopolistic Competition
Price or Cost (dollars per unit) MR qa pa F MC
ATC
Quantity (units per period)
Demand K
The short run ca
Quantity(units per period)
ATC MC
Price or Cost (dollars per unit)
Initial demand
The long run
Later MR qg pg G
Later demand

27. 11.3. Problems of Monopolistically Competitive Markets

28. Inefficiency
Monopolistic competition tends to be less efficient in the long run than a perfectly competitive industry.

29. Excess Capacity
Because of the industry-wide excess capacity, each firm produces a rate of output that is less than its minimum ATC.
I.e., the same level of industry output could be produced at lower cost with fewer firms.
The Industry has excess capacity…

30. Flawed Price Signals
The monopolistically competitive firm will always price its output above the level of marginal cost.

31. Flawed Price Signals
Monopolistic competition results in both production inefficiency (above-minimum average cost) and allocative inefficiency (wrong mix of output).

32. Advertising Wars: No Cease-Fire
In truly (perfectly) competitive industries, firms compete on the basis of price.
Imperfectly competitive firms engage in nonprice competition – the most prominent form being advertising.

33. Advertising Wars: No Cease-Fire
Advertising may be more responsible for brand loyalty than the taste of the product.
Having a recognizable name is worth billions in sales.