1. Monopolistic Competition
Chinese Food
Funeral Services
Monopolistic Competition
Characteristics of Monopolistic Competition
1. Many sellers
2. Product differentiation
3. Free entry and exit

2. The Market for Chinese Food in NYC
Many sellers: Citysearch lists 1,832 Chinese restaurants in NYC
2. Product differentiation: For people who want it…
bland
spicy
Kosher
fast
3. Free entry and exit: restaurants are constantly opening and closing.

3. Cost Rating→$ (21 reviews) (9 reviews) (1 reviews) (7 reviews)
$ (under $20)
$$ ($21-$30)
$$$ ($31-$40)
$$$$ (above $40)
Source: CitySearch
Source: CitySearch

4. Differentiated Products
Each Chinese restaurant produces meals that are slightly different from those of other Chinese restaurants.
Rather than being a price taker, each Chinese restaurant faces a downward-sloping demand curve.
Free Entry or Exit
Firms can enter or exit the market without restriction.
The number of firms in the market adjusts until economic profits are zero.

5. Price ($ per meal) MC D

6. MC P
=ATC
ATC D MR Qπ

7. Over the last few years, a large number of Chinese from Fujian Province have been smuggled into New York City.
Their “desperation” makes “them highly desirable as laborers” (NYTimes, 7/22/2001).
Indeed, signs litter the windows of Chinese restaurants advertising jobs for “hard-working Fujianese,” including the front window of the Silk Road Palace.

8. MC2 Total Revenue = A+B Total Cost = B Econ Profits = A A ATC2 B D MR
ATC(Qπ2) D MR
Qπ2

9. Short-run economic profits encourage new Chinese Restaurants to enter the market. This:
Increases the variety in Chinese meals.
Reduces demand faced by restaurants already in the market.
Incumbent restaurants’ demand curves shift to the left.
Demand for the incumbent restaurants’ meals fall, and their profits decline.

10. The Long-Run Equilibrium
Chinese restaurants will enter and exit until the firms are making exactly zero economic profits.

11. MC2 ATC2 MR3 D3 Qπ3 P3= The demand curve is tangent to the ATC curve.
And this tangency lies vertically above the intersection of MR and MC.
MR3 D3
Qπ3

12. Monopolistic versus Perfect Competition
There are two noteworthy differences between monopolistic and perfect competition:
Excess capacity
Markup over marginal cost

13. MC2 ATC2 MR3 D3 Qπ3 P3= The demand curve is tangent to the ATC curve.
And this tangency lies vertically above the intersection of MR and MC.
MR3 D3
Qπ3

14. Monopolistic versus Perfect Competition
Excess Capacity
Free entry results in competitive firms producing at the point where average total cost is minimized, which is the efficient scale of the firm. .
In monopolistic competition, output is less than the efficient scale of perfect competition.

15. Monopolistic versus Perfect Competition
(a) Monopolistically Competitive Firm
(b) Perfectly Competitive Firm
Price
Price MC
ATC MC
ATC
Demand MR P
Quantity
produced
Efficient
scale P = MC MR
(demand
curve)
Quantity produced =
Efficient scale
Quantity
Quantity

16. Monopolistic versus Perfect Competition
Markup over Marginal Cost
For a competitive firm, price equals marginal cost.
For a monopolistically competitive firm, price exceeds marginal cost.

17. Monopolistic versus Perfect Competition
(a) Monopolistically Competitive Firm
(b) Perfectly Competitive Firm
Price
Price MC
ATC MC
ATC
Markup
Demand MR P
Quantity
produced P = MC MR
(demand
curve)
Quantity produced
Marginal
cost
Quantity
Quantity

18. Monopolistic Competition and the Welfare of Society
There is the normal deadweight loss of monopoly pricing in monopolistic competition caused by the markup of price over marginal cost.
However, it may be that people are willing to incur the cost to have the greater variety offered by monopolistically competitive markets.