1. Harcourt Brace & Company MONOPOLISTIC COMPETITION Chapter 17

2. Harcourt Brace & Company Monopolistic Competition n Markets that have some features of competition and some features of monopoly.

3. Harcourt Brace & Company Attributes of Monopolistic Competition n Many sellers n Product differentiation n Free entry and exit

4. Harcourt Brace & Company Many Sellers n There are many firms competing for the same group of customers. ä Product examples include books, CDs, movies, computer games, restaurants, piano lessons, cookies, furniture, etc.

5. Harcourt Brace & Company Product Differentiation n Each firm produces a product that is at least slightly different from those of other firms. n Rather than being a price taker, each firm faces a downward-sloping demand curve.

6. Harcourt Brace & Company Free Entry or Exit n Firms can enter or exit the market without restriction. n The number of firms in the market adjusts until economic profits are zero.

7. Harcourt Brace & Company Monopolistic Competition in the Short Run n In the short run, the monopolistically competitive firm follows a monopolist’s rule for profit maximization. ä Produce the quantity where MR = MC. ä Price should be greater than average total cost.

8. Harcourt Brace & Company Monopolistic Competition in the Short Run n Short-run economic profits encourage new firms to enter the market. This: ä Increases the number of products offered. ä Reduces demand faced by incumbent firms. ä Incumbent firms’ demand curves shift to the left.

9. Harcourt Brace & Company Monopolistic Competition in the Short Run n Short-run economic losses encourage firms to exit the market. This: ä Decreases the number of products offered. ä Increases demand faced by the remaining firms. ä Shifts the remaining firms’ demand curves to the right. ä Increases the remaining firms’ profits.

10. Harcourt Brace & Company Monopolistic versus Perfect Competition n There are two noteworthy differences between monopolistic and perfect competition—excess capacity and markup.

11. Harcourt Brace & Company Excess Capacity n There is no excess capacity in perfect competition in the long run. n Free entry results in competitive firms producing at the point where average total cost is minimized, which is the efficient scale.

12. Harcourt Brace & Company Excess Capacity n There is excess capacity in monopolistic competition in the long run. n In monopolistic competition, output is less than the efficient scale of perfect competition.

13. Harcourt Brace & Company Excess Capacity n Unlike a competitive firm, a monopolistically competitive firm could increase the quantity it produces and lower the average total cost of production.

14. Harcourt Brace & Company Markup Over Marginal Cost n For a competitive firm, price equals marginal cost. n For a monopolistically competitive firm, price exceeds marginal cost.

15. Harcourt Brace & Company Markup Over Marginal Cost n Because price exceeds marginal cost, an extra unit sold at the posted price means more profit for the monopolistically competitive firm.

16. Harcourt Brace & Company Monopolistic Competition and the Welfare of Society n Monopolistic competition does not have all the desirable properties of perfect competition.

17. Harcourt Brace & Company Monopolistic Competition and the Welfare of Society n There is the standard deadweight loss of monopolistic competition caused by the markup of price over marginal cost.

18. Harcourt Brace & Company Advertising and Brand Names n Product differentiation leads to advertising and brand names. n Some critics of advertising and brand naming contend that they exploit consumers and reduce competition.

19. Harcourt Brace & Company Advertising and Brand Names n Defenders argue that advertising provides information and increases competition by offering a greater variety of products and prices.

20. Harcourt Brace & Company Advertising and Brand Names n Firms that sell highly differentiated consumer goods typically spend between 10 and 20 percent of revenue on advertising. n Overall, about 2 % of total revenue, or over $100 billion a year, is spent on advertising.

21. Harcourt Brace & Company Conclusion n In long-run equilibrium, monopolistically competitive markets produce with some excess capacity and each firm charges a price above marginal cost.