Monopolistic Competition closer to reality Please listen to the audio as you work through the slides. Monopolistic Competition closer to reality Please listen to the audio as you work through the slides. Look for: 1.Determination of the profit maximizing price and quantity. 2.Implications for efficiency

Learning Objectives Students should be able to thoroughly and completely explain: 1.The characteristics of monopolistic competition. 2.The characteristics of product differentiation in the monopolistic competition case. 3.The conditions under which the monopolistically competitive firm in the short run will: 1.Achieve economic profit 2.Minimize economic loss Monopolistic Competition

Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly Four Market Models Monopolistic Competition: Characteristics 1.Relatively Large Number of Sellers – competitive aspect - 25 to 70, Each with relatively Small market shares 2.Not price makers 3.No collusion – secret agreement between two or more parties for a fraudulent, illegal, or deceitful purpose 4.Easy Entry and Exit – relative to monopoly and oligopoly, typically smaller firms 5.Economies of scale are fewer, capital requirements lower

Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly Four Market Models Monopolistic Competition: Characteristics 6. (Non-price competition) Advertising and product differentiation Goal – make price less of a factor in consumer decision and make the differentiation more important 7. Independent action – they make their own independent decisions 8. Differentiated Products, substitutes are available 9. Monopolistically competitive industries more competitive than monopolistic

Product Differentiation Production of products with slightly different physical characteristics, attributes Different degrees of customer service, Different numbers of locations for convenience, Different qualities, - good, better, best

Product Attributes – physical or qualitatitive things about the product Many different configurations of the product Computers Smart phones Cars Service – grades or levels of service Many different service levels to pick from Computers Smart phones Characteristics of Differentiated Products

Location – store or service locations Convenience stores vs. supermarkets Starbucks Wal-Mart Neighborhood store vs. Supercenters vs. Sams Club Hotels and motels – high end vs low end Brand Names, Bayer, Anacin, Bufferin – are all aspirin Characteristics of Differentiated Products

Packaging It’s vodka Characteristics of Differentiated Products

Trademarks Characteristics of Differentiated Products

Celebrity associated: Jeans, Perfume, Clothing Etc. Some Control Over Price – due to differentiation Issue of consumer preference – willing to pay a higher price. Still quite limited due to potential substitutes Characteristics of Differentiated Products

Examples of monopolistically competitive industries Grocery stores Gas stations, barber shops Dry cleaners Clothing stores Restaurants Medical care providers Legal services Real estate sales

Price & output determination in monopolistic competition Assumptions: 1. Each firm produces a specific differentiated product 2. Engages in advertising The monopolistically competitive demand curve is not perfectly elastic Reasons: 1.Fewer rivals than perfectly competitive structure 2.Products are differentiated, so they are not perfect substitutes relative to pure competition. 3.The price elasticity of demand faced by the monopolistic competitor depends on the number of rivals and the degree of product differentiation. 4.The more rivals and less differentiation case means closer to the Perfect Competition model than the monopoly model.

D MR P1P1 ATC Price and Costs Q1Q1 Short-Run Economic Profits Expect New Competitors Price & output determination in monopolistic competition Quantity A1A1 MC

D MR P1P1 ATC Price and Costs Q1Q1 Expect New Competitors Quantity A1A1 New competition drives down the price level – leading to economic losses in the short run. MC Short-Run Economic Profits Price & output determination in monopolistic competition

D MR MC P2P2 ATC Price and Costs Q2Q2 Short-Run Economic Losses Quantity A2A2 Price & output determination in monopolistic competition

Short-Run Economic Losses D MR MC P2P2 ATC Price and Costs Q2Q2 Quantity A2A2 With economic losses, firms will exit the market – stability occurs when economic profits are zero. Price & output determination in monopolistic competition

D MR MC P 3 = A 3 ATC Price and Costs Q3Q3 Quantity Long-Run Equilibrium Normal Profit Only Price & output determination in monopolistic competition

Monopolistic Competition and Efficiency Not Productively Efficient in the long run P > Minimum ATC Not Allocatively Efficient in the long run Price > MC under allocation of resources to the product Excess Capacity – plant and equipment that are under utilized because firms are producing less than the minimum ATC level of output. Pure competition: P = MC = Minimum ATC

D MR MC P 3 = A 3 ATC Price and Costs Q3Q3 Quantity Long-Run Equilibrium Price is Not = Minimum ATC Price  MC Monopolistic Competition and Efficiency Q4Q4 Excess capacity

Monopolistic Competition and Efficiency Product Variety and efficiency Firms attempt to achieve economic profit by: Product differentiation and advertising Benefits of Product Variety: 1.Satisfy varied consumer tastes and expands choice 1.Autos 2.Phones 3.Clothes, shoes 2.Tradeoff between consumer choice and productive efficiency. 1.Stronger product differentiation – greater excess capacity - greater productive inefficiency

Monopolistic Competition and Efficiency Product Variety and efficiency Firms attempt to achieve economic profit by: Product differentiation and advertising Non - Benefits of Product Variety: 1.Nonprice Competition – adds complexity to the monopolistically competitive firm. How do you measure advertising effectiveness? 2.Trial & Error Search for Maximum Profits Monopolistically competitive firm juggles price, product, and advertising to maximize profits.

Questions For the Monopolistic Competition Market Structure 1.List and explain the characteristics of monopolistic competition. 2.List and explain the characteristics of product differentiation. 3.Explain the conditions under which the monopolistically competitive firm in the short run will: 1.Achieve economic profit 2.Minimize economic loss

monopolistic competition product differentiation nonprice competition excess capacity oligopoly homogeneous oligopoly differentiated oligopoly strategic behavior mutual interdependence concentration ratio interindustry competition import competition Herfindahl index game-theory model collusion kinked-demand curve price war cartel tacit understandings price leadership