Monopolistic CompetitionMonopolistic Competition

Many firms selling Products that are similar but not identical

© 2000 Claudia Garcia - Szekely1

Characteristics Characteristics Many firms: no firm can influence the market price based on size alone (Competitive)

Firms differentiate their products (Monopolistic)

There are no barriers to entry (Competitive)

© 2000 Claudia Garcia - Szekely2

Many SellersMany SellersWhen there are many sellers, they do not take into account rivals’ reactions.

The existence of many sellers makes collusion difficult.

Monopolistically competitive firms act independently of each other.

© 2000 Claudia Garcia - Szekely3

Monopolistic Competitive Monopolistic Competitive MarketsMarketsBooksCD’sMoviesComputer Games

RestaurantsHockey lessonsCookiesFurniture

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Monopolistic Competition lies between extremes: Perfect Competition and Monopoly.

PERFECTLY PERFECTLY COMPETITIVE FIRMS COMPETITIVE FIRMS COMPETE COMPETE ONLYONLY IN IN PRICEPRICE

Multiple Dimensions of Competition in Monopolistic Competitive Markets

© 2000 Claudia Garcia - Szekely5

Multiple Dimensions of Multiple Dimensions of Competition: Firms compete at Competition: Firms compete at many levelsmany levels

Product differentiation◦Competing on perceived quality:

advertising

Service and distribution outlets.

© 2000 Claudia Garcia - Szekely6

Firms will continue to advertise as long as the marginal benefits of advertising exceed its marginal costs.

Firms will continue to open outlets as long as the marginal benefits exceed its marginal costs

Monopolistic CompetitionMonopolistic CompetitionMany firms competing for the

same group of customers

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Each firm faces a downward sloping demand curve (as in Monopoly)

Firms can enter/exit the market freely Number of firms adjusts until

economic profits are zero (as in PC).

Each producer is small relative to the size of the market.

Each firm produces a slightly different product

© 2000 Claudia Garcia - Szekely8

Like a Perfectly Competitive firm: It supplies only a portion (share) of the market demand

Market Demand

P

Q

Like a Monopolist: The firm has some market power thus it faces a downward sloping demand curve

Q

Firm’s Demand

Market Demand

P

TotalShareTotal

Total Market DemandDemand

perceived by the firm

Flatter: More elastic: More

Substitutes for specific brand

Steeper: Less Elastic: Fewer

Substitutes

The Short RunThe Short Run

© 2000 Claudia Garcia - Szekely9

d

MR

Like in Perfect Competition and Monopoly : The firm chooses the Profit Maximizing Output level at MR = MC

MC

Pmc

qmc

Firm’s share of

total Demand

The Short RunThe Short Run

© 2000 Claudia Garcia - Szekely

10

d

MR

Like in Perfect Competition if P > ATC firms enjoy positive profits

MC

Pmc

qmc

ATC

Profits Attract New Firms Profits Attract New Firms

Existing firms see their share of the market shrink◦The firm’s demand curve shifts left.

Existing firms increase advertising (and costs) in their effort to defend market share.◦The firm’s ATC curve shifts upwards…

© 2000 Claudia Garcia - Szekely11

Long RunLong Run

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Profit

Like in Perfect Competition and Monopoly : firms may earn Profits or incur losses.ATC0

Like in Perfect Competition: Profits attract new firms into the market

The firm’s market share decreases and its ATC increase due to extra advertising costsDemand and Costs shift

until Profits disappear

d

MR0

MC

Pmc

q0

ATC1

MR1

q1

Pmc

MCATC

qpc

P=MC

Min ATC

No excess Capacity: ATC is min.

Markup OverMC

ATC > min

Excess Capacity: ATC > min

P=MR

MCmc

MC

Pmc

d

MR

qmc

v.s Perfect CompetitionMonopolistic Competition

Markup OverMC

ATC > min

MCmc

MC

Pmc

d

MR

qmc

v.s MonopolyMonopolistic Competition

Excess Capacity: ATC > min

MCM

MC

PM

D

MR

qM

ProfitM

arket Share

Market Demand

Monopolist can

make profits in

the long run!

Monopolistic

competitors can

NOT!

Advertising and Monopolistic Advertising and Monopolistic CompetitionCompetition

Firms in a perfectly competitive market have no incentive to advertise

Monopolistic competitors have a strong incentive to do so.

© 2000 Claudia Garcia - Szekely15

INCREASING MARKET SHARE IS INCREASING MARKET SHARE IS

RELEVANT FOR A MONOPOLISTIC RELEVANT FOR A MONOPOLISTIC

COMPETITOR BUT NOT FOR A PC COMPETITOR BUT NOT FOR A PC

FIRM.FIRM.

Comparing Perfect and Monopolistic Competition

© 2000 Claudia Garcia - Szekely16

AdvertisingAdvertising

Shifts demand curve to the right and makes it more inelastic.

Advertising shifts the ATC curve up.

© 2000 Claudia Garcia - Szekely17

Does Advertising Help or Does Advertising Help or Hurt Society?Hurt Society?

There is a sense of trust in buying brands we know to be reliable.

If consumers are willing to pay for reliability it’s a benefit to them.

© 2000 Claudia Garcia - Szekely18

Percentage of value of shipments by Percentage of value of shipments by largest firms in selected industries. largest firms in selected industries.

4 LARGEST 8 LARGEST 20 LARGEST TOTAL

INDUSTRY FIRMS FIRMS FIRMS # FIRMS

Travel trailers/ 34 50 66 384

campers

Mattresses/ 33 38 47 721

bedsprings

Wood office 26 37 50 625

furniture

Book 24 38 62 2182

publishing

Pharmaceutical 22 36 65 640

preparations

Misc. plastic 6 9 14 7767

products

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  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?

© 2000 Claudia Garcia - Szekely22

© 2000 Claudia Garcia - Szekely23

For the following 5 slides calculate:1.Profit maximizing output level2.Price charged by the monopolist3.Total Revenue4.Total Cost5.Variable Cost6.Fixed Cost7.Profit or Loss8.Number of units the firm should produce in the short run and explain why?9.Number of units the firm should produce in the long run and explain why?10.In the long run, (exit/entry)______ will cause the firm’s share of the market to (increase/decrease) _______ and the firm will reduce advertising11.In the long run the firm’s costs will (decrease/increase)_______ and the firm’s share of the market will (increase/decrease) ______ until loss is driven to _______.

D

MR

6

10

1314

18

22

100 150 200

D

MR

6

10

1314

18

22

100 150 200

D

MR Q

6

10

1314

100 150 200

D

MR Q

6

10

1314

16

100 150 200

D

MR Q200

20

500

10

17

28

300 400

15

22

13

D

MR

6

10

13

14

18

22

100 150 200

Calculate:1.Profit maximizing output level =1502.Price charged by each firm =133.Total Revenue =19504.Total Cost=18*150=27005.Variable Cost=14*150=21006.Fixed Cost =(14-18)*150=-6007.Profit or Loss=(13-18)*150= -7508.Number of units the firm should produce in the short run and explain why? 0 shut down because FC(600) < loss if the firms produce 150 units (750)9.Number of units the firm should produce in the long run and explain why? 0 exit because the firms incur a loss10. In the long run, exit will cause the firm’s share of the market to increase and the firm will reduce advertising11.In the long run the firm’s costs will decrease and the firm’s share of the market will increase until loss is driven to zero.

D

MR

6

10

13

14

18

22

100 150 200

Calculate:1.Profit maximizing output level = 1502.Price charged by each fim = 133.Total Revenue = 13*150 = 19504.Total Cost = 18*150 = 27005.Variable Cost = 13*150 = 19506.Fixed Cost = (18-13)*150 = 7507.Profit or Loss = (13-18)*150= -7508.Number of units the firm should produce in the short run and explain why? =indifferent between 0 and 150 because the FC(750) = Loss (750) if the firm produces 150 units9.Number of units the firm should produce in the long run and explain why? = zero (exit) because the firms incur a loss10.In the long run, exit will cause the firm’s share of the market to increase and the firm will reduce advertising11.In the long run the firm’s costs will decrease and the firm’s share of the market will increase until loss is driven to zero.

Calculate:1.Profit maximizing output level = 1502.Price charged by each firm = 103.Total Revenue = 150*10= 15004.Total Cost = 11*150 = 16505.Variable Cost = 7*150 = 10506.Fixed Cost = (11-7)*150= 6007.Profit or Loss =(10-11)&150=-1508.Number of units the firm should produce in the short run and explain why? = 150 because FC (600) > loss (150)9.Number of units the firm should produce in the long run and explain why? = 0 (exit) because firms incur a loss10.In the long run, exit will cause the firm’s share of the market to increase and the firm will reduce advertising11.In the long run the firm’s costs will decrease and the firm’s share of the market will increase until loss is driven to zero.

D

MR Q

4

7

10

11

100 150 200

6

D

MR Q

6

10

13

14

16

100 150 200

Calculate:1.Profit maximizing output level =1502.Price charged by each firm = 133.Total Revenue = 13*150 =19504.Total Cost = 13*150= 19505.Variable Cost = 10*150=15006.Fixed Cost = (13-10)*150 = 4507.Profit or Loss = 08.Number of units the firm should produce in the short run and explain why? = 150 because the FC(450) > loss (0) if the firms produce 150 units9.Number of units the firms should produce in the long run and explain why? = 0 because the firms incur a loss10.In the long run, exit may cause the firm’s share of the market to increase and the firm may reduce advertising11.In the long run the firm’s costs may decrease and the firm’s share of the market may increase until loss is driven to zero.

Calculate:1.Profit maximizing output level = 3002.Price charged by each firm = 203.Total Revenue = 20*300 = 60004.Total Cost = 17*300=51005.Variable Cost = 13*300 = 39006.Fixed Cost = (17-13)*300=12007.Profit or Loss = (20-17)*300=9008.Number of units the firm should produce in the short run and explain why? = 300 because it makes a positive profit9.Number of units the firm should produce in the long run and explain why? = 300 because it makes a positive profit10.In the long run, entry will cause the firm’s share of the market to decrease and the firm will increase advertising11.In the long run the firm’s costs will increase and the firm’s share of the market will decrease until profit is driven to zero.

D

MR Q

200

20

500

10

17

28

300 400

15

22

13