1. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 1 of 25 Monopolistic Competition: The Competitive Model in a More Realistic Setting Monopolistic competition A market structure in which barriers to entry are low and many firms compete by selling similar, but not identical, products.

2. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 2 of 25 Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market The Demand Curve for a Monopolistically Competitive Firm The Downward-Sloping Demand for Caffè Lattes at a Starbucks

3. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 3 of 25 Marginal Revenue for a Firm with a Downward-Sloping Demand Curve Demand and Marginal Revenue at a Starbucks CAFFÈ LATTES SOLD PER WEEK (Q) PRICE (P) TOTAL REVENUE (TR = P x Q) AVERAGE REVENUE (AR = TR/Q) MARGINAL REVENUE (MR = ΔTR/ΔQ) 0 1 2 3 4 5 6 7 8 9 10 $6.00 5.50 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 $0.00 5.50 10.00 13.50 16.00 17.50 18.00 17.50 16.00 13.50 10.00 ― $5.50 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 ― $5.50 4.50 3.50 2.50 1.50 0.50 –0.50 –1.50 –2.50 –3.50 Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market

4. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 4 of 25 Marginal Revenue for a Firm with a Downward-Sloping Demand Curve The Demand and Marginal Revenue Curves for a Monopolistically Competitive Firm Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market

5. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 5 of 255 of 35 © 2013 Pearson Education, Inc. Publishing as Prentice Hall Maximizing Profit in a Monopolistically Competitive Market To maximize profit, a Starbucks coffeehouse wants to sell caffè lattes up to the point where the marginal revenue from selling the last caffè latte is just equal to the marginal cost. As the table shows, this happens with the fifth caffè latte—point A in panel (a)—which adds $1.50 to the firm’s costs and $1.50 to its revenues. The firm then uses the demand curve to find the price that will lead consumers to buy this quantity of caffè lattes (point B). In panel (b), the green box represents the firm’s profits. The box has a height equal to $1.00, which is the $3.50 price minus the average total cost of $2.50, and it has a base equal to the quantity of 5 caffè lattes. So, this Starbucks’s profit equals $1 × 5 = $5.00.

6. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 6 of 25 What Happens to Profits in the Long Run? How Does the Entry of New Firms Affect the Profits of Existing Firms? How Entry of New Firms Eliminates Profits

7. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 7 of 25 The Rise and Fall of Apple’s Macintosh Computer Making the Connection Macintosh lost its differentiation, but still has a loyal— if relatively small—following.

8. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 8 of 25 Solved Problem The Short Run and the Long Run for the Macintosh

9. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 9 of 25 A firm’s profits will be eliminated in the long run only if a firm stands still and fails to find new ways of differentiating its product or fails to find new ways of lowering the cost of producing its product. What Happens to Profits in the Long Run? Is Zero Economic Profit Inevitable in the Long Run?

10. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 10 of 2510 of 35 © 2013 Pearson Education, Inc. Publishing as Prentice Hall By 2011, sales and profits at Starbucks were increasing due in part to expansion in overseas markets, such as China, where competition was not as strong as in the United States. The Rise and Decline and Rise of Starbucks Making the Connection From the mid-1990s through the mid-2000s, Starbucks strategy worked very well, and Starbucks’s opened nearly 17,000 stores worldwide. But Starbucks profitability attracted competitors. In 2009, Starbucks was struggling nationwide as it faced slowing sales and increased competition. By 2011, Starbucks had managed a remarkable turnaround, with its sales and profits increasing. Some of the success came from an expansion in overseas markets, but there were other factors. The firm gave customers more freedom to customize drinks, started a loyalty program and a mobile payment system, and provided stores with better machines. In a monopolistically competitive industry, maintaining profits in the long run is very difficult. Only by constantly innovating has Starbucks been able to return to profitability after several years of struggling with intense competition from other firms.

11. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 11 of 25 Comparing Perfect Competition and Monopolistic Competition Monopolistically competitive firms charge a price greater than marginal cost. Monopolistically competitive firms do not produce at minimum average total cost. Monopolistic competition and perfect competition share the characteristic that in long-run equilibrium, firms earn zero economic profits. However, there are two important differences between long- run equilibrium in the two markets:

12. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 12 of 25 Excess Capacity under Monopolistic Competition Comparing Long-Run Equilibrium under Perfect Competition and Monopolistic Competition Comparing Perfect Competition and Monopolistic Competition

13. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 13 of 25 Economists have debated whether monopolistically competitive markets being neither productively nor allocatively efficient results in a significant loss of well-being to society in these markets compared with perfectly competitive markets. How Consumers Benefit from Monopolistic Competition Consumers benefit from being able to purchase a product that is differentiated and more closely suited to their tastes. Is Monopolistic Competition Inefficient? Comparing Perfect Competition and Monopolistic Competition

14. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 14 of 2514 of 35 © 2013 Pearson Education, Inc. Publishing as Prentice Hall By 2011, Netflix had more than 25 million subscribers and profits of more than $150 million. Netflix: Differentiated Enough to Survive? Making the Connection When Reed Hastings decided to start Netflix in 1997, the company was an immediate success. By 2011, Netflix had more than 25 million subscribers and profits of more than $150 million. But Netflix has many competitors. In the DVD rental business, Netflix had advantages that prevented Wal- Mart and Blockbuster and other firms from entering. But Netflix may not have similar advantages in the business of streaming movies. Many other firms with large selections of movie and television programs have been entering the market. In late 2011, Netflix announced that it expected to suffer losses for a period during 2012 before returning to profitability. It remains to be seen whether Netflix can regain its profitability in the face of intense competition.

15. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 15 of 25 How Marketing Differentiates Products Marketing All the activities necessary for a firm to sell a product to a consumer. Brand management The actions of a firm intended to maintain the differentiation of a product over time. Advertising If the increase in revenue that results from the advertising is greater than the increase in costs, the firm’s profits will rise. Defending a Brand Name A firm can apply for a trademark, which grants legal protection against other firms using its product’s name.

16. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 16 of 25 What Makes a Firm Successful? A firm’s ability to differentiate its product and to produce it at a lower average cost than competing firms creates value for its customers. Some factors that affect a firm’s profitability are not directly under the firm’s control. Certain factors will affect all the firms in a market.

17. Chapter 12: Monopolistic Competition: The Competitive Modelin a More Realistic Setting © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 17 of 2517 of 35 © 2013 Pearson Education, Inc. Publishing as Prentice Hall Although not first to market, Bic ultimately was more successful than the firm that pioneered ballpoint pens. Is Being the First Firm in the Market a Key to Success? Making the Connection Some business analysts argue that the first firm to enter a market can have important first-mover advantages. By being the first to sell a particular good, a firm may find its name closely associated with the good in the public’s mind. Surprisingly, though, recent research has shown that the first firm to enter a market often does not have a long-lived advantage over later entrants. The Reynolds International Pen Company was replaced by Bic; Apple’s iPod was not the first digital music player; and Hewlett- Packard, which currently dominates the laser printer market was preceded by its inventor, Xerox. The same can be said for disposable diapers, and web browsers. In all these cases, the firms that were first to introduce a product ultimately lost out to latecomers who did a better job of providing consumers with products that were more reliable, less expensive, more convenient, or otherwise provided greater value. Your Turn: Test your understanding by doing related problem 6.6 at the end of this chapter. MyEconLab