Monopolistic Competition Chapter 17 Copyright © 2001 by Harcourt, Inc. All rights reserved. Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Four Types of Market Structure MonopolyOligopolyMonopolistic Competition Perfect Competition Tap water Cable TV Tennis balls Crude oil Novels Movies Wheat Milk Number of Firms? Type of Products? Many firms One firm Few firms Differentiated products Identical products

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Types of Imperfectly Competitive Markets u Monopolistic Competition u Many firms selling products that are similar but not identical. u Oligopoly u Only a few sellers, each offering a similar or identical product to the others.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Attributes of Monopolistic Competition u Many sellers u Product differentiation u Free entry and exit

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Product Differentiation u Each firm produces a product that is at least slightly different from those of other firms. u Rather than being a price taker, each firm faces a downward-sloping demand curve.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Free Entry or Exit u Firms can enter or exit the market without restriction. u The number of firms in the market adjusts until economic profits are zero.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Monopolistic Competitors in the Short Run... (a) Firm Makes a Profit Quantity 0 Price Demand MR ATC Profit MC Profit- maximizing quantity Price Average total cost

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Monopolistic Competitors in the Short Run... Quantity 0 Price Demand MR Losses (b) Firm Makes Losses MC ATC Average total cost Loss- minimizing quantity Price

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Monopolistic Competition in the Short Run Short-run economic profits encourage new firms to enter the market. This: uIncreases the number of products offered. uReduces demand faced by the incumbent firms already in the market.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Monopolistic Competition in the Short Run Short-run economic losses encourage firms to exit the market. This: uDecreases the number of products offered. uIncreases demand faced by the remaining firms.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Long-Run Equilibrium Firms will enter and exit until the firms are making exactly zero economic profits.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Monopolistic Competitor in the Long Run... Quantity Price 0 Demand MR ATC MC Profit-maximizing quantity P=ATC

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Two Characteristics of Long- Run Equilibrium ¶As in a monopoly, price exceeds marginal cost. u Profit maximization requires marginal revenue to equal marginal cost. u The downward-sloping demand curve makes marginal revenue less than price.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Two Characteristics of Long- Run Equilibrium ·As in a competitive market, price equals average total cost. u Free entry and exit drive economic profit to zero.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Advertising u Firms that sell highly differentiated consumer goods typically spend between 10 and 20 percent of revenue on advertising. u Overall, about 2 percent of total revenue, or over $100 billion a year, is spent on advertising.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Advertising u Critics of advertising argue that firms advertise in order to manipulate people’s tastes. u They also argue that it impedes competition by implying that products are more different than they truly are.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Advertising u Defenders argue that advertising provides information to consumers u They also argue that advertising increases competition by offering a greater variety of products and prices. u The willingness of a firm to spend advertising dollars can be a signal to consumers about the quality of the product being offered.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Brand Names Critics argue that brand names cause consumers to perceive differences that do not really exist.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Brand Names Brand names may be a useful way for consumers to ensure that the goods they are buying are of high quality. u providing information about quality. u giving firms incentive to maintain high quality.

Monopolistic Competition Chapter 17 Summary