1. Monopolistic Competition1

2. Topics to be Discussed Monopolistic Competition Oligopoly
Price Competition
Competition Versus Collusion: The Prisoners’ Dilemma
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3. Topics to be Discussed
Implications of the Prisoners’ Dilemma for Oligopolistic Pricing
Cartels
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4. Monopolistic Competition
Characteristics
1) Many firms
2) Free entry and exit
3) Differentiated product
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5. Monopolistic Competition
The amount of monopoly power depends on the degree of differentiation.
Examples of this very common market structure include:
Toothpaste
Soap
Cold remedies
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6. Monopolistic Competition
Toothpaste
Crest and monopoly power
Procter & Gamble is the sole producer of Crest
Consumers can have a preference for Crest---taste, reputation, decay preventing efficacy
The greater the preference (differentiation) the higher the price.
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7. Monopolistic Competition
Question
Does Procter & Gamble have much monopoly power in the market for Crest?
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8. Monopolistic Competition
The Makings of Monopolistic Competition
Two important characteristics
Differentiated but highly substitutable products
Free entry and exit
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9. A Monopolistically Competitive Firm in the Short and Long Run
$/Q
Short Run
$/Q
Long Run MC AC MC AC
DSR
MRSR
QSR
PSR
DLR
MRLR
QLR
PLR
Quantity
Quantity 12

10. A Monopolistically Competitive Firm in the Short and Long Run
Observations (short-run)
Downward sloping demand--differentiated product
Demand is relatively elastic--good substitutes
MR < P
Profits are maximized when MR = MC
This firm is making economic profits
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11. A Monopolistically Competitive Firm in the Short and Long Run
Observations (long-run)
Profits will attract new firms to the industry (no barriers to entry)
The old firm’s demand will decrease to DLR
Firm’s output and price will fall
Industry output will rise
No economic profit (P = AC)
P > MC -- some monopoly power
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12. Comparison of Monopolistically Competitive Equilibrium and Perfectly Competitive Equilibrium
Perfect Competition
Monopolistic Competition
$/Q
$/Q
Deadweight
loss MC AC MC AC
DLR
MRLR
QMC P QC PC
D = MR
Quantity
Quantity 17

13. Monopolistic Competition
Monopolistic Competition and Economic Efficiency
The monopoly power (differentiation) yields a higher price than perfect competition. If price was lowered to the point where MC = D, consumer surplus would increase by the yellow triangle.
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14. Monopolistic Competition
Monopolistic Competition and Economic Efficiency
With no economic profits in the long run, the firm is still not producing at minimum AC and excess capacity exists.
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15. Monopolistic Competition
Questions
1) If the market became competitive, what would happen to output and price?
2) Should monopolistic competition be regulated?
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16. Monopolistic Competition
Questions
3) What is the degree of monopoly power?
4) What is the benefit of product diversity?
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17. Monopolistic Competition in the Market for Colas and Coffee
The markets for soft drinks and coffee illustrate the characteristics of monopolistic competition.
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18. Elasticities of Demand for Brands of Colas and Coffee
Brand Elasticity of Demand
Colas: Royal Crown -2.4
Coke -5.2 to -5.7
Ground Coffee: Hills Brothers -7.1
Maxwell House -8.9
Chase and Sanborn -5.6
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19. Elasticities of Demand for Brands of Colas and Coffee
Questions
1) Why is the demand for Royal Crown more price inelastic than for Coke?
2) Is there much monopoly power in these two markets?
3) Define the relationship between elasticity and monopoly power.
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