3. Monopolistic Competition Monopoly –one firm –faces downward sloping demand curve Competition –many firms –face flat demand curve –free entry and exit over time Key Rationale: Product Differentiation

4. The Best Thing About Monopolistic Competition: NO NEW DIAGRAMS ! Yahoo! Hooray!

5. Watch how a graph of a typical monopolistically competitive firm is sketched: It looks just like a monopoly

6. The trick behind the treat of the monopolistic competition diagram shift the demand curve and thus the marginal revenue curve of the typical firm as other firms enter and exit the industry if there are economic profits: –demand shifts in as other firms enter if there are economic losses (negative profits) –demand shifts out as other firms exit

7. Here there are either profits or losses

8. Here economic profits are zero: no incentive to exit or enter

9. Now let’s watch what happens as we move the D and MR curves

10. In Long Run Equilibrium: Excess Average Total Costs

11. Long run equilibrium of a monopolistically competitive industry economic profits are driven to zero, but –(1) average total cost (ATC) not at a minimum –(2) price is greater than marginal cost (P>MC) –(3) there is deadweight loss can view the above three disadvantages as the “cost of variety”

12. Summary and Review: Predictions from Three Models

13. Oligopoly Few firms (duopoly = two) Strategic considerations come into play –game theory to concentrate on strategic considerations we focus on a case where one good is produced –but in reality oligopoly can have product differentiation too (Coke and Pepsi)

14. Four Types of Models/Industries

15. The Prisoners’ Dilemma Game: What set of strategies is an equilibrium for Pete and Ann?

16. A Duopoly as a Prisoners’ Dilemma Game

17. The prisoners’ dilemma analogy suggests a tendency toward competition Non cooperative outcome –prisoners confess –firms charge low price Cooperative outcome –prisoners remain silent –firms charge high price

18. End of Lecture