2. CHAPTER 13 Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market How a Monopolistically Competitive Firm Maximizes Profit in the Short Run What Happens to Profits in the Long Run? Comparing Monopolistic Competition and Perfect Competition How Marketing Differentiates Products What Makes a Firm Successful? Monopolistic Competition: The Competitive Model in a More Realistic Setting

3. Characteristics Firms face low entry barriers Differentiated Products -they face a downward sloping demand curve -no Long Run Profits -Non-price Competition Price Taker Many Small Firms Monopolistic Competition

4. Product Differentiation Monopolistically competitive firms produce differentiated products – products that differ in design, dependability, location, ease of purchase, etc. Rival firms produce similar products (good substitutes) and therefore each firm confronts a highly elastic demand curve.

5. © 2013 Pearson Education, Inc. Publishing as Prentice Hall The Demand Curve for a Monopolistically Competitive Firm The Downward- Sloping Demand for Caffè Lattes at a Starbucks If a Starbucks increases prices, it will lose some, but not all, of its customers. Here, 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.

6. McHits or McMisses? Hulaburger - 1962 Filet o Fish - 1963 Strawberry shortcake - 1966 Big Mac - 1968 Hot Apple Pie - 1968 Egg McMuffin - 1975 Drive Thru - 1975 Chicken McNuggets - 1983 Extra Value Meal - 1991 McLean Deluxe - 1991 Arch Deluxe - 1996 55-cent Special - 1997 Big Xtra - 1999 McRib, Sundaes and others ?? Big Mac Big N Tasty Big N Tasty w/ Cheese Quarter Pounder w/ Cheese Double Quarter Pounder w/ Cheese Crispy Chicken Chicken McGrill Filet-O-Fish Double Cheeseburger Cheeseburger Hamburger Chicken McNuggets (4) Chicken McNuggets (6) Chicken McNuggets (9) McSalad Shaker Chef Salad McSalad Shaker Garden Salad McSalad Shaker Grilled Chicken Caeser Salad

7. Fish Supreme Chicken Parmesan Sandwich 2/3 lb. Monster Thickburger® 1/3 lb. Low Carb Thickburger® Little Thick Cheeseburger 1/4 lb. Little Thickburger® 1/3 lb. Cheeseburger Chili Cheese Thickburger® 1/3 lb. Original Thickburger® 1/3 lb. Mushroom 'N' Swiss Thickburger® 1/3 lb. Bacon Cheese Thickburger® Big Chicken Fillet Sandwich Charbroiled Chicken Club Sandwich Charbroiled BBQ Chicken Sandwich Big Hot Ham 'N' Cheese™ Regular Hamburger Regular Cheeseburger Double Cheeseburger 5-Piece Chicken Breast Strips 7-Piece Chicken Breast Strips Big Shef Double Jr. Cheesebur ger Deluxe 1/4 lb.* Single 1/2 lb.* Double with Cheese 3/4 lb.* Triple with Cheese Baconator ® Jr. Hamburge r Jr. Bacon Cheesebur ger Jr. Cheesebur ger Deluxe Jr. Cheesebur ger Double Stack Deluxe Double Stack Triple Stack Homestyle Chicken Go Wrap Grilled Chicken Go Wrap Spicy Chicken Go Wrap Crispy Chicken Deluxe Chicken Club Ultimate Chicken Grill Spicy Chicken Sandwich Homestyle Chicken Fillet 10-piece Chicken Nuggets Premium Fish Fillet Sandwich Crispy Chicken Sandwich

8. Double Jr. Cheeseburger Deluxe 1/4 lb.* Single 1/2 lb.* Double with Cheese 3/4 lb.* Triple with Cheese Baconator®Jr. Hamburger Jr. Bacon Cheeseburger Jr. Cheeseburger Deluxe Jr. CheeseburgerDouble StackDeluxe Double StackTriple Stack Homestyle Chicken Go Wrap Grilled Chicken Go Wrap Spicy Chicken Go Wrap Crispy Chicken Deluxe Chicken Club Ultimate Chicken Grill Spicy Chicken Sandwich Homestyle Chicken Fillet 10-piece Chicken Nuggets Premium Fish Fillet Sandwich Crispy Chicken Sandwich

9. Price and Output A monopolistically competitive firm will expand output as long as marginal revenue exceeds marginal cost. Price will be lowered and output expanded until MR = MC The price charged by the firm will be greater than its marginal cost.

10. d Price Quantity/time P2P2 P1P1 MR q1q1 q2q2 Increase in Total Revenue Reduction in Total Revenue Marginal Revenue in Monopolistic Competition Initial price P 1 & output q 1. Total revenue (TR) = P 1 * q 1. 1. As price falls from P 1 to P 2, output increases from q 1 to q 2, two conflicting influences on TR. 1. TR will rise because of an increase in the number of units sold (q 2 - q 1 ) * P 2. 2. TR will decline [(P 1 - P 2 ) * q 1 ] as q 1 units once sold at the higher price (P 1 ) are now sold at the lower price (P 2 ). Depending on the size of the shaded regions, total revenue may increase or decrease.

11. ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ 0 1 2 3 4 5 6 7 8 9 10 Output Total Cost Marginal Cost Price (AR) Quantity Marginal Revenue 50 80 90 110 140 180 230 290 360 440 530 0 1 2 3 4 5 6 7 8 9 10 120 110 100 90 80 70 60 50 40 30 20 ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ 0 110 200 270 320 350 360 350 320 270 200 30 10 20 30 40 50 60 70 80 90 Total Revenue 110 90 70 50 30 10 -10 -30 -50 -70 ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ 80 45 37 35 36 38 41 45 49 53 ATC ___ ___ ___ ___ ___ ___ ___ ___ ___

12. Marginal Cost Price (AR) Quantity Marginal Revenue 0 1 2 3 4 5 6 7 8 9 10 120 110 100 90 80 70 60 50 40 30 20 30 10 20 30 40 50 60 70 80 90 110 90 70 50 30 10 -10 -30 -50 -70 80 45 37 35 36 38 41 45 49 53 ATC

13. Cost Output 60 50 40 30 20 10 12 34 5 6 0 789 70 80 90 100 110 120

14. Cost Output 60 50 40 30 20 10 12 34 5 6 0 789 70 80 90 100 110 120

15. Price Quantity 10 8 30 45 50 0 24 MC ATC MR D = AR 1. Firm’s profit maximizing output? 2. What price will they charge? 3. Firm’s revenue? Total Cost? Total Profit? 4. How will things change in time?

16. d MR MC ATC Price and Output: Short Run Profit Quantity/time q C Economic Profits A monopolistic competitor maximizes profits by producing where MR = MC, at output level q and charges a price P along the demand curve for that output level. At q the average total cost is C. Because the price is greater than the average total cost per unit (P > C) the firm is making economic profits equal to the area ( [ P - C ] * q ) What impact will economic profits have if this is a typical firm? Price P

17. Profits and Losses in the Long Run Economic profits attract competition. New firms will expand supply and lower price. Individual demand curves will shift inward until the economic profits are eliminated. Economic losses cause firms to leave the market. Demand for the remaining firms’ output will rise until the losses have been eliminated, ending the incentive to exit. Firms can make either profits or losses in the short run, but only zero economic profit in the long run.

18. Because entry and exit are free, competition will eventually drive prices down to the level of ATC. Quantity/time q P d MR MC ATC Price and Output: Long Run When profits (losses) are present, the demand curve will shift inward (outward) until the zero profit equilibrium is restored. The price searcher establishes its output level where MC = MR. At q the average total cost is equal to the market price. Zero economic profit is present. No incentive for firms to either enter or exit the market is present. C = P Price

19. Entry or Exit? Supply Profits Case 1: Prices rise

20. Price Quantity $6 $5 $4 $3 $2 $1 10203040 50 60 0 Demand SR Profits 1. Increased Demand, Price goes up 2. Firms enter, Demand faced by each firm decreases 3. Price goes down 4. No LR Profits ATC MC

21. Entry or Exit? Supply Profits Case 2: Prices fall

22. Price Quantity $6 $5 $4 $3 $2 $1 10203040 50 60 0 Demand SR Losses 1. Demand falls, Price goes down ATC 2. Firms leave, Demand faced by each firm increases 3. Price goes up 4. No LR Losses MC

23. © 2013 Pearson Education, Inc. Publishing as Prentice Hall The SR and the LR for a Monopolistically Competitive Firm Relationship between Price and Average Total Cost Profit and LossElasticity of Demand Curve Relationship between Price and Marginal Cost Short Run P > MC Long Run P > MC Short Run P > MC Short Run Economic profit Short Run Less elastic demand curve or P < ATC or Economic loss Long Run P = MC Long Run Zero economic profit Long Run More elastic demand curve

24. Price Quantity/Time Pure Comp Mono comp Price Quantity/Time d MC ATC d MR MC ATC P2P2 q2q2 P1P1 q1q1 LR equilibrium for both. P = ATC and there are no economic profits. In monopolistic competition, firms face a downward-sloping demand curve, its profit- maximizing price exceeds MC. In Monopolistic Competition, output is too small to minimize ATC in long-run equilibrium. Comparing Competitive Markets

25. Price Quantity/Time Pure Comp Mono comp Price Quantity/Time d Price MC ATC d MC ATC P2P2 P1P1 Price MR q2q2 q1q1 Even though the two markets have the same cost structure, the price in the monopolistic competitor’s market is higher than that in the price-taker’s market ( P 2 > P 1 ). Some consider this price discrepancy a sign of inefficiency; others perceive it as a premium society pays for variety and convenience (product differentiation). Comparing Competitive Markets

26. Allocative Efficiency Allocative efficiency is achieved when the most desired goods are produced at the lowest possible cost. The Minimum point on the ATC curve: ATC > marginal cost at the minimum point No allocative efficiency in Monopolistic Competition.

27. Product Differentiation (again) Monopolistically competitive firms produce differentiated products – products that differ in design, dependability, location, ease of purchase, etc.

28. Marketing All the activities necessary for a firm to sell a product to a consumer. Brand management The actions of a firm intended to maintain the differentiation of a product over time. Advertising If the increase in revenue that results from advertising is greater than the increase in costs, the firm’s profits will rise. Defending a Brand Name A firm can apply for a trademark, which grants legal protection against other firms using its product’s name. Methods of Differentiation

29. © 2013 Pearson Education, Inc. Publishing as Prentice Hall What Makes a Firm Successful? Ability to differentiate its product Producing at a lower average cost than competing firms Some profitability factors are not directly under the firm’s control.

31. Right after you graduate, you get a job in production management and you are responsible for the entire company on weekends. Here are the costs of production for the company: QuantityAverage Total Cost 500$200 501$201 Your current level of production is 500 units and all 500 have been ordered by regular customers. One weekend, the phone rings. It is a customer who wants to buy one unit of your product. This means increasing production to 501 units. The customer offers to buy it for $450. Should you accept the offer? What is the net change in the firm’s profit?

32. QuantityAverage Total Cost 500$200 501$201 $100,701 - $100,000 = $701 Marginal Cost = $701 Marginal Revenue = ??Marginal Cost = ?? Marginal Revenue = $450 Profit or Loss L o s s Total Cost (Q x ATC) $100,000 $100,701 You’re Fired!!!

33. In a monopolistically competitive market, the firms will a. be able to choose their price, and the entry barriers into the market will be low. b. be able to choose their price, and the entry barriers into the market will be high. c. have to accept the market price for their product, and the entry barriers into the market will be low. d. have to accept the market price for their product, and the entry barriers into the market will be high. A profit-maximizing monopolistically competitive firm will expand output to the point where a. total revenue equals total cost. b. MR = MC c. P = ATC. d. P = MC. In the long run, neither perfectly competitive or monopolistically competitive firms will be able to earn economic profits because a. entry barriers into these markets are high, raising the costs of each firm. b. the government will dictate moderate prices for these firms. c. competition will force prices down to the level of per-unit production costs. d. marginal revenue is always less than marginal cost when barriers to entry are low.

34. If a market is in long-run equilibrium, which of the following conditions will be present in a perfectly competitive market but absent from a monopolistically competitive market? a.P = ATC b.MR = MC c.P = MC d.MR < P As long as a market is contestable, then even if it has only a few sellers, the a. threat of new firms will prevent the prices from rising above the competitive level. b. producers will be able to charge prices that are high enough to produce long-run economic profits. c. producers will not face new competition because the barriers to entry are high. d. market will never be expected to come close to the competitive result.

35. If firms in a monopolistically competitive market are currently earning economic losses, then in the long run, a. new firms will enter the market, and the current firms will experience a decrease in demand for their products until zero economic profit is again restored. b. new firms will enter the market, and the current firms will experience an increase in demand for their products until zero economic profit is again restored. c. some existing firms will exit the market, and the remaining firms will experience an increase in demand for their products until zero economic profit is again restored. d. some existing firms will exit the market, and the remaining firms will experience a decrease in demand for their products until zero economic profit is again restored. Compared to the outcome when the firms are price takers, monopolistically competitive markets will result in a. a wider variety of products and higher prices. b. less product variety and higher prices. c. a wider variety of products and lower prices. d. less product variety and lower prices.

36. What price should this monopolistically competitive firm charge in order to maximize profits? a.$5 b.$7c. $8d. $10 What is the maximum economic profit this firm depicted in Figure 2 will be able to earn? 0 b.$20c. $30 d. $100 If the cost and demand conditions of this monopolistically competitive firm, what will happen in the future? a. Firms will go out of business, and the market price will rise. b. The current market price will tend to persist into the future. c. New firms will enter the market, and demand facing this firm will decline. d. The firms in this industry probably will collude in order to increase their profitability. d. $10 b. $20