1. Monopolistic Competition and Advertising
Chapter 17
Monopolistic Competition and Advertising

2. Outline Sources of Product Differentiation
The Monopolistic Competition Model
The Economics of Advertising

3. Introduction
Monopolistic competition combines some features of competitive markets with some features of monopoly.
Monopolistic competition is a market with:
Many sellers.
Free entry and exit.
Product differentiation.
Monopolistic competitors face a downward sloping demand curve. 3

4. Definition Monopolistic competition:
a market with a large number of firms selling similar but not identical products.

5. Product Differentiation
COSTI IOSIF/SHUTTERSTOCK
Can you tell the difference?

6. Product Differentiation
COSTI IOSIF/SHUTTERSTOCK
How about now?

7. Product Differentiation
Products can be differentiated along any dimension that people care about, such as taste, style, features, or location.
Differentiated products are often highly advertised.
Firms want consumers to perceive their products as different and better because that increases their market power. 7

8. Self-Check Under monopolistic competition, there are/is: Many firms.
A few firms.
One firm.
Answer: a – under monopolistic competition, there are many firms.

9. Monopolistic Competition
Short Run
In the short run, a monopolistic competitor can make profits like a monopolist.
Price MC P
Profit AC
Demand Q
Quantity MR

10. Monopolistic Competition
Long Run
Firms enter → ↓market share
Demand curve shifts left
Entry continues until P = AC
Price
The firm produces QLR and makes zero profits but P > MC. MC P AC
Demand MR
Q LR
Quantity

11. Monopolistic Competition
Long Run
Price
The firm produces QLR and makes zero profits but P > MC. MC P AC
Demand MR
Q LR
Quantity

12. Monopolistic Competition
A monopolistically competitive firm can reduce output and raise the price without losing all of its customers.
Product differentiation means the firm is able to charge P > MC.
It also means that a firm does not produce at the minimum of its AC curve.
In the longer run, consumers are better off because of new features and products. 12

13. Monopolistic Competition
Price
Price
P = AC
Profits = 0
P = AC, Profits = 0
Minimum AC MC MC AC
PMC AC PC
P = MR
Demand
QMC
Quantity QC
Quantity MR
Comparing Monopolistic competition and Competition.

14. Self-Check
Firms in which of the following markets will produce at the minimum AC:
Monopoly.
Monopolistic competition.
Competition.
Answer: c – a competitive firm will produce at the minimum average cost.

15. Economics of Advertising
Monopolies, oligopolies, and monopolistically competitive firms use advertising to differentiate their products and build brand identity.
Informative advertising is about price, quality, and availability.
Persuasive advertising is about changing people’s minds and moving the market towards monopoly. 15

16. Economics of Advertising
There is evidence that advertising lowers prices and improves consumer welfare.
Advertising can also signal that the seller expects the product to be a success.
Persuasion can give us tastes that appear silly or unjustified.
Persuasion also can deepen our enjoyments and our memories. 16

17. Economics of Advertising
In a blind taste test, subjects were given labeled and unlabeled glasses of Coke.
They reported greater enjoyment from drinking the labeled Coke.
Brain scans showed activity in the memory regions of the brain.
INTERFOTO/ALAMY 17

18. Economics of Advertising
Persuasive advertising can create market power by brand differentiation.
Advertising helps people enjoy a lot of products.
Ads make Google search, newspapers, and cable TV cheaper. 18

19. Takeaway
A monopolistically competitive industry has many sellers, free entry, and differentiated products.
Each firm retains a downward-sloped demand curve and Price remains above MC.
Free entry drives price down to P = MC, where economic profits = 0.
Firms do not produce at the minimum AC.

20. Takeaway
Advertising can inform consumers about price, quality, and availability.
Advertising can also increase perceptions of product differentiation, which allows firms to increase prices.