Managerial Economics & Business Strategy Chapter 8 Managing in Competitive, Monopolistic, and Monopolistically Competitive Markets

Managing a Monopolistically Competitive Firm Like a monopoly, monopolistically competitive firms have market power that permits pricing above marginal cost. level of sales depends on the price it sets. But … The presence of other brands in the market makes the demand for your brand more elastic than if you were a monopolist. Free entry and exit impacts profitability. Therefore, monopolistically competitive firms have limited market power.

Marginal Revenue Like a Monopolist TR Unit elastic 100 Elastic Unit elastic 60 1200 Inelastic 40 20 800 10 20 30 40 50 Q 10 20 30 40 50 Q MR Elastic Inelastic

Can we use the theory? Number 9 The CEO of a major automaker overheard one of its division managers make the following statement regarding the firm’s production plans: “In order to maximize profits, it is essential that we operate at the minimum point of our ATC curve”. If you were the CEO of the automaker, would you praise or chastise the manager? Chastise the manager. Profit maximization requires producing where MR = MC.

Monopolistic Competition: Profit Maximization Maximize profits like a monopolist Produce output where MR = MC. Charge the price on the demand curve that corresponds to that quantity.

Three cases (graphically) with Monopolistic Profit Price > ATC Break-even (Zero Economic Profit, Normal Profit) Price = ATC Loss and continue to operate ATC > Price

Short-Run Monopolistic Competition MC $ ATC Profit PM ATC D Quantity of Brand X QM MR

Long Run Adjustments? If the industry is truly monopolistically competitive, there is free entry. In this case other “greedy capitalists” enter, and their new brands steal market share. This reduces the demand for your product until profits are ultimately zero.

Long-Run Monopolistic Competition Long Run Equilibrium (P = AC, so zero profits) $ AC MC P* P1 Entry D MR D1 Q1 Q* Quantity of Brand X MR1

Monopolistic Competition The Good (To Consumers) Product Variety The Bad (To Society) P > MC Excess capacity Unexploited economies of scale The Ugly (To Managers) P = ATC > minimum of average costs. Zero Profits (in the long run)!