© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/eO’Sullivan/Sheffrin Prepared by: Fernando Quijano and Yvonn Quijano CHAPTERCHAPTER 11 Entry and Monopolistic Competition

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Entry and Monopolistic Competition An entrepreneur is a person who has an idea for a business and coordinates the production and sale of goods and services.An entrepreneur is a person who has an idea for a business and coordinates the production and sale of goods and services. Entrepreneurs take risks, committing time and money to a business without any assurance that it will be profitable.Entrepreneurs take risks, committing time and money to a business without any assurance that it will be profitable.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Output and Entry Decisions Marginal PRINCIPLE Increase the level of an activity if its marginal benefit exceeds its marginal cost; reduce the level of an activity if its marginal cost exceeds its marginal benefit. If possible, pick the level at which the activity’s marginal benefit equals its marginal cost.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Short-Run Equilibrium in Monopolistic Competition: A Single Toothbrush Producer The single toothbrush producer (a monopolist) picks point n (where marginal revenue equals marginal cost).The single toothbrush producer (a monopolist) picks point n (where marginal revenue equals marginal cost). 300 toothbrushes are supplied per minute at a price of $2.00 (point m) and an average cost of $0.90 (point c).300 toothbrushes are supplied per minute at a price of $2.00 (point m) and an average cost of $0.90 (point c). The profit per brush is $1.10.The profit per brush is $1.10.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Entry Decreases Price and Increases Average Cost The entry of a second toothbrush producer shifts the demand curve for the original firm to the left: A smaller quantity is sold at each price.The entry of a second toothbrush producer shifts the demand curve for the original firm to the left: A smaller quantity is sold at each price.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Entry Decreases Price and Increases Average Cost The marginal principle is satisfied at point x.The marginal principle is satisfied at point x. The firm produces a smaller quantity (200 instead of 300 toothbrushes) at a higher average cost ($1.00 instead of $0.90) and sells at a lower price ($1.85 instead of $2.00).The firm produces a smaller quantity (200 instead of 300 toothbrushes) at a higher average cost ($1.00 instead of $0.90) and sells at a lower price ($1.85 instead of $2.00).

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin The Effects of Market Entry There are three reasons why profit decreases for the individual firm after entry of a second firm:There are three reasons why profit decreases for the individual firm after entry of a second firm: Higher average cost of production Higher average cost of production Lower quantity sold Lower quantity sold Lower price Lower price

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Monopolistic Competition Monopolistic competition is a market served by dozens of firms selling slightly different products.Monopolistic competition is a market served by dozens of firms selling slightly different products. Product differentiation is a strategy of distinguishing one product from other similar products.Product differentiation is a strategy of distinguishing one product from other similar products.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Monopolistic Competition Physical characteristicsPhysical characteristics Firms may differentiate their product in several ways: LocationLocation ServicesServices Aura or imageAura or image

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Long-Run Equilibrium with Monopolistic Competition: Toothbrushes In a monopolistically competitive market, new firms will continue to enter until economic profit is zero.In a monopolistically competitive market, new firms will continue to enter until economic profit is zero. The typical firm picks the quantity at which its marginal revenue equals its marginal cost (point g ).The typical firm picks the quantity at which its marginal revenue equals its marginal cost (point g ). Economic profit is zero because the price equals the average cost (shown by point h ).Economic profit is zero because the price equals the average cost (shown by point h ).

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Trade-Offs with Monopolistic Competition Monopoly Monopolistic Competition

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Long-Run Equilibrium with Monopolistic Competition: Music Stores Music stores and other retailers differentiate their products by selling them at different locations.Music stores and other retailers differentiate their products by selling them at different locations. The typical firm chooses the quantity of CDs at which its marginal revenue equals its marginal cost (point g ).The typical firm chooses the quantity of CDs at which its marginal revenue equals its marginal cost (point g ). Economic profit is zero because the price equals the average cost (shown by point h ).Economic profit is zero because the price equals the average cost (shown by point h ).