UNIT 4.2: IMPERFECT COMPETITION Monopolistic Competition

Identical Products No advantage D=MR=AR=P Both efficiencies Price-Taker 1000s Perfect Competition Monopolistic Competition Oligopoly Monopoly No Similarities MR = MC Shut-Down Point Cost Curves Motivation for Profit Excess Advertising Differentiated Products Excess Capacity More Elastic Demand than Monopoly 100s Low barriers to entry No Long-Run Profit Price = ATC Price Maker (D>MR) Some Non-Price Competition Inefficient Collusion Strategic Pricing (Interdependence) Game Theory 10 or less Unique Good Price Discrimination 1 Price Maker (D>MR) High Barriers Ability to Make LR Profit Inefficient Avocados Hammocks Retail Stores Cars Appliances Local Utilities

Monopolistic Competition

1)LARGE number of large companies (but fewer than perfect competition). 2)Entry and exit is possible in the long-run. 3)Products are NOT exactly identical, BUT VERY SIMILAR, so companies use PRODUCT DIFFERENTIATION Sellers can influence the price through creating a product identity The 4 conditions of Monopolistic Competition

Monopolistic Competitive Market  Essentially, all hand soaps are the same. Yet firms can create a brand identity that separates their hand soap from their competitor’s.  This brand identity can be formed through packaging, songs, product support, and especially advertising. The key idea to understanding monopolistic competition is that firms sell products that are similar, but not exactly alike. STUDY TIP: EXAMPLE: Hand Soap  If effective, consumers will positively identify a certain brand and purchase it even if hand soap costs more.

Conditions of Monopolistic Competition The point is that firms in Monopolistic Competition use Product Differentiation & Non-price Competition to sell their products. Product Differentiation:  The real or imagined differences between competing products in the same industry.  Differentiation may be color, packaging, store location, store design, store decorations, delivery, service….. anything to make it stand out!

Product DifferentiationNon-price Competition The point is that firms in Monopolistic Competition use Product Differentiation & Non-price Competition to sell their products. Conditions of Monopolistic Competition Non-Price Competition:  Non-Price Competition involves the advertising of a product's appearance, quality, or design, rather than its price.  Advertising to help the consumer believe that this product is different and worth more money. VS Notice these commercials never mention price.

MC: Product Differentiation:  A good example are toothbrushes.  They are all the same, but at the same time different.  These differences are due in part to packaging, brand name, color, shape, etc.

Examples of Monopolistic Competition Auto, Gas, Fast Food, Airlines, etc.

WHAT HAPPENS WHEN COMPANIES IN A M.C. MARKET FAIL? They don’t close their doors, but rather merge with larger companies.

Reason: Cheaper Resources MERGERS OF MONOPOLISTIC COMPANIES  Sometimes companies fall victim to market failure. However, not all businesses close their doors and empty their factories and stores.  Many get “swallowed up” by another company. This “take-over” or acquisition of a company is known as a merger. Three types of mergers: HORIZONTAL, VERTICAL, and CONGLOMERATE. 1.) HORIZONTAL: involve firms in the SAME market, such as between two telecom companies. EXAMPLE: automaker buys an steel company Reason: Diversification 2.) VERTICAL: involve one firm buying a resource provider. 3.) CONGLOMERATE: a company buys a business in a UNRELATED industry. Reason: takeover the market Video

Graphing a Monopolistic Competitive Firm

Graphing a M.C. Firm If you can graph a monopoly, you can graph a monopolistic competitive firm. The only difference comes in the long-run. Finally, something easy to remember!!!

Monopolistic Competitive Firm in the Long-run RETURNS TO ZERO ECONOMIC PROFIT

M.C. Firms in the Long-run In the long-run, all M.C. firms will return to normal economic profit. Since the entry and exit of firms is possible AND products can be differentiated in the long-run, any short-run profits will be eliminated.

M.C. Firms in the Long-run More firms will enter the market and develop differentiated products. This will take away demand from existing firms and result in M.C. firms breaking-even in the long-run. NOTE: Unlike perfect competition, the firm is NOT at productive efficiency in the long-run. Demand shifts left as consumers are lured away.

M.C. Firms in the Long-run MC firms also operate with excess capacity. 1. Price charged by MC in long-run 2. Allocative efficient output 3. Productive efficient output (lowest point on ATC). Because monopolistically competitive firms do not operate at their minimum average total cost, they, therefore, operate with excess capacity. Distance between Long- run price and lowest ATC

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