2 In This Chapter…Distinguishing Features of Monopolistically Competitive MarketsProfit Maximizing Price and Output Decisions11.3. Problems of Monopolistically Competitive Markets
3 11.1. Distinguishing Features of Monopolistically Competitive Markets
4 StructureMonopolistic competition is a market in which many firms produce similar goods or services but each maintains some independent control of its own price.
5 StructureA 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 ConcentrationLow 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 PowerEach 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 PowerA 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 BarriersAnother 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 BehaviorMonopolistic 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 LoyaltyBy differentiating their products, monopolistic competitors establish brand loyalty.Brand loyalty gives producers greater control over the price of their products.
16 Brand LoyaltyEach firm only has a monopoly on its brand image.It still competes with other firms offering close substitutes.
17 Brand LoyaltyBrand 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 LoyaltyEach 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 ExitWith 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 ExitWhen 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)MRqapaFMCATCQuantity (units per period)DemandKThe short runca
25 Effects of Entry on Industry and Firm Price (per unit)Quantity (units per time period)Initial demand facing firmEffect of entry on themonopolistically competitive firmPrice (per unit)Quantity (units per time period)Market demandInitial market supplyEffect of entry on the industryNew entryLater market supplyReduced market sharep1p2Later demand facing filmMR
26 Equilibrium in Monopolistic Competition Price or Cost (dollars per unit)MRqapaFMCATCQuantity (units per period)DemandKThe short runcaQuantity(units per period)ATCMCPrice or Cost (dollars per unit)Initial demandThe long runLater MRqgpgGLater demand
27 11.3. Problems of Monopolistically Competitive Markets
28 InefficiencyMonopolistic competition tends to be less efficient in the long run than a perfectly competitive industry.
29 Excess CapacityBecause 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 SignalsThe monopolistically competitive firm will always price its output above the level of marginal cost.
31 Flawed Price SignalsMonopolistic 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.