12-1 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Chapter 12 Monopolistic competition

12-2 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Learning objectives Improve on the definition of monopolistic competition given in Chapter 8 and discuss the nature and prevalence of monopolistic competition Analyse and evaluate the price–output behaviour of monopolistically competitive firms Discuss the implications of monopolistic competition for economic efficiency Explain and assess the role of non-price competition; that is, competition based on product quality and advertising, in monopolistically competitive industries

12-3 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Characteristics of monopolistic competition Relatively large numbers of firms –Each firm has a small market share –Impossible for collusion among firms –Independent actions — no feeling of mutual interdependence among firms

12-4 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Characteristics of monopolistic competition Product differentiation Competition based not just on price but also non-price competition  Product quality  Services  Location  Promotion and packaging Firms have limited control over the price due to consumer loyalty and preferences

12-5 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Characteristics of monopolistic competition Ease of entry –No legal and technical barriers to entry –Low economies of scale –Low set-up costs

12-6 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Percentage of industry sales value produced by small & medium firms

12-7 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Price and output determination The firm’s demand curve Highly elastic, why? –More close substitutes than a pure monopolist –Not perfect substitutes (as is the case with perfect competition) –Elasticity depends on:  Number of rivals  Degree of product differentiation

12-8 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Short-run price and output determination How much to produce? –Produce an output level where MR = MC In the short run, firms can either make economic profit or losses –Profits: when AC > AR (D ) –Losses: when AC < AR (D )

12-9 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Short-run price and output determination (cont.) How much to produce? –MR = MC Profits or losses in the short run –Profits: when AC > AR (D ) — entry of new firms –Losses: when AC < AR (D ) — exit of existing firms

12-10 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Economic profits Short-run price and output determination: short-run profits Q D P Price and costs MR MC Q AC

12-11 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Losses Q D P Price and costs MR MC Q AC Short-run price and output determination: short-run losses

12-12 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Long run How much to produce? –MR = MC Firms tend to break even; that is, normal profit –Tangency solution: profit-maximising firm will produce an output when its demand curve is at a tangent to its ATC curve –When ATC = AR(D)

12-13 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Long-run equilibrium Why do monopolistically competitive firms tend to break even in the long run? –Profits attract new entrants and reduce the market share of existing firms –Losses encourage exits, and increase the market share of existing firms resulting in normal profits

12-14 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Long-run equilibrium (cont.) Complications –Firms may achieve a measure of product differentiation that cannot be duplicated by rivals, and such firms may realise economic profits even in the long run –Some entry is partially restricted. Because of product differentiation, greater financial barriers may exists –Some economic losses may be tolerated by firms even in the long run

12-15 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Long-run equilibrium (cont.) Q D MR MC P Price and costs Q AC

12-16 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Monopolistic competition & economic efficiency Productive inefficiency: minimum ATC is not necessarily chosen, resulting in excess capacity –Excess capacity occurs when firms produce at a higher unit cost than minimum ATC at equilibrium Allocative inefficiency: –Price does not necessarily equal MC Redeeming features –Product variety –Increased level of consumer choice

12-17 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Non-price competition Assists firms to improve their long-run equilibrium position Product differentiation and product development –At a point in time –Over time

12-18 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia The economics of advertising The case for advertising Information and efficiency –Provides information that helps consumers make rational choices Competition –Advertising promotes competition, and diminish monopoly power Communication support –Advertising supports national communication: commercial radio and television, newspapers and magazine are financed wholly or partly by advertising

12-19 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia The economics of advertising (cont.) The case against advertising Persuasion and wastage –Advertising tend be misleading, and often confuse consumers with too much information Concentration –Extensive advertising creates financial barriers to entry and promote the growth of monopoly Media bias

12-20 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Next chapter: Oligopoly