1. Monopolistic Competition
Chapter 17
Monopolistic Competition

2. Characteristics of Monopolistic Competition
Many sellers
Product differentiation
Free entry
Examples: books, CD’s, restaurants, movies, etc.

3. In the Short Run…
Because the product is differentiated, it faces a downward D curve and MR curve
Profit-Maximization is same as monopoly: go to MR=MC for Q of output, then to D curve to find P
Firms will make profits or losses just like a monopoly in short run

4. Figure 1 Monopolistic Competition in the Short Run
(a) Firm Makes Profit
Price MC
ATC
Demand MR
Profit-
maximizing
quantity
Price
Average
total cost
Profit
Quantity

5. Figure 1 Monopolistic Competitors in the Short Run
(b) Firm Makes Losses
Price MC
ATC
Losses
Loss-
minimizing
quantity
Average
total cost
Demand
Price MR
Quantity

6. In the Long Run… Profits = entry; shifts D curve to left
Losses = exit; shifts D curve to right
This process continues until firms are making exactly 0 economic profit
D curve and ATC curve become TANGENT
P > MC
P > MR
P = ATC

7. Figure 2 A Monopolistic Competitor in the Long Run
Price MC
ATC
Demand
The demand curve is tangent to the ATC curve. MR
Profit-maximizing
quantity P =
ATC
And this tangency lies vertically above the intersection of MR and MC.
Quantity

8. Monopolistic vs. Perfect Competition
Excess Capacity – firms produce on the downward-sloping portion of ATC, not at efficient scale. Therefore, they could produce more and decrease costs.
Markup – P > MC because firm always has some market power, so an extra unit sold = higher profit

9. Monopolistic Competition and the Welfare of Society
Inefficiency comes from P > MC, so a mon. comp. market has same DWL as monopoly pricing
There is no way to regulate firms
# of firms in market is not “ideal” because of too much or too little entry

10. Externalities with entry/exit
Product-variety externality – consumers get some consumer surplus from the intro of a new product, entry of a new firm is a positive externality to consumers
Business-stealing externality – other firms lose customers and profits from entry, it is a negative externality on existing firms

11. Advertising Varies with products
Firms selling highly differentiated goods spend about 10%-20% of revenue on advertising (soft drinks, razor blades, cereal, dog food…)
Firms selling industrial goods spend very little on advertising (satellites, etc.)
Firms selling homogeneous products spend nothing (wheat, peanuts, oil)

12. Critique of Advertising
manipulative of people’s tastes
Psychological vs. informational
Impedes competition – convinces people products are more different than they really are

13. Defense of Advertising
Information allows customers to make better decisions
Fosters competition by allowing customers to take advantages of price differences
Decreases market power
Can signal to the consumer that the quality of product is high

14. Make sure to… Read case study about eyeglasses
Read section on brand names and the pros and cons of them