Monopolistic Competition 1

Topics to be Discussed Monopolistic Competition Oligopoly Price Competition Competition Versus Collusion: The Prisoners’ Dilemma Chapter 12 2

Topics to be Discussed Implications of the Prisoners’ Dilemma for Oligopolistic Pricing Cartels Chapter 12 3

Monopolistic Competition Characteristics 1) Many firms 2) Free entry and exit 3) Differentiated product Chapter 12 4

Monopolistic Competition The amount of monopoly power depends on the degree of differentiation. Examples of this very common market structure include: Toothpaste Soap Cold remedies Chapter 12 5

Monopolistic Competition Toothpaste Crest and monopoly power Procter & Gamble is the sole producer of Crest Consumers can have a preference for Crest---taste, reputation, decay preventing efficacy The greater the preference (differentiation) the higher the price. Chapter 12 6

Monopolistic Competition Question Does Procter & Gamble have much monopoly power in the market for Crest? Chapter 12 6

Monopolistic Competition The Makings of Monopolistic Competition Two important characteristics Differentiated but highly substitutable products Free entry and exit Chapter 12 7

A Monopolistically Competitive Firm in the Short and Long Run $/Q Short Run $/Q Long Run MC AC MC AC DSR MRSR QSR PSR DLR MRLR QLR PLR Quantity Quantity 12

A Monopolistically Competitive Firm in the Short and Long Run Observations (short-run) Downward sloping demand--differentiated product Demand is relatively elastic--good substitutes MR < P Profits are maximized when MR = MC This firm is making economic profits Chapter 12 13

A Monopolistically Competitive Firm in the Short and Long Run Observations (long-run) Profits will attract new firms to the industry (no barriers to entry) The old firm’s demand will decrease to DLR Firm’s output and price will fall Industry output will rise No economic profit (P = AC) P > MC -- some monopoly power Chapter 12 14

Comparison of Monopolistically Competitive Equilibrium and Perfectly Competitive Equilibrium Perfect Competition Monopolistic Competition $/Q $/Q Deadweight loss MC AC MC AC DLR MRLR QMC P QC PC D = MR Quantity Quantity 17

Monopolistic Competition Monopolistic Competition and Economic Efficiency The monopoly power (differentiation) yields a higher price than perfect competition. If price was lowered to the point where MC = D, consumer surplus would increase by the yellow triangle. Chapter 12 18

Monopolistic Competition Monopolistic Competition and Economic Efficiency With no economic profits in the long run, the firm is still not producing at minimum AC and excess capacity exists. Chapter 12 19

Monopolistic Competition Questions 1) If the market became competitive, what would happen to output and price? 2) Should monopolistic competition be regulated? Chapter 12 20

Monopolistic Competition Questions 3) What is the degree of monopoly power? 4) What is the benefit of product diversity? Chapter 12 20

Monopolistic Competition in the Market for Colas and Coffee The markets for soft drinks and coffee illustrate the characteristics of monopolistic competition. Chapter 12 21

Elasticities of Demand for Brands of Colas and Coffee Brand Elasticity of Demand Colas: Royal Crown -2.4 Coke -5.2 to -5.7 Ground Coffee: Hills Brothers -7.1 Maxwell House -8.9 Chase and Sanborn -5.6 Chapter 12 22

Elasticities of Demand for Brands of Colas and Coffee Questions 1) Why is the demand for Royal Crown more price inelastic than for Coke? 2) Is there much monopoly power in these two markets? 3) Define the relationship between elasticity and monopoly power. Chapter 12 23