Monopolistic Competition Copyright ACDC Leadership 2015

Characteristics of Monopolistic Competition: Perfect Competition Monopolistic Competition Monopolistic Competition Pure Monopoly Pure Monopoly Oligopoly Oligopoly Characteristics of Monopolistic Competition: Relatively Large Number of Sellers Differentiated Products Some control over price Easy Entry and Exit (Low Barriers) A lot of non-price competition (Advertising) Copyright ACDC Leadership 2015

Examples: Fast Food Restaurants Furniture companies Jewelry stores Hair Salons Clothing Manufacturers Copyright ACDC Leadership 2015

“Monopoly” + ”Competition” Monopolistic Qualities Control over price of own good due to differentiated product D greater than MR Plenty of Advertising Not efficient Perfect Competition Qualities Large number of smaller firms Relatively easy entry and exit Zero Economic Profit in Long-Run since firms can enter/exit Copyright ACDC Leadership 2015

Differentiated Products 5 Copyright ACDC Leadership 2015

Differentiated Products Goods are NOT identical. Firms seek to capture a piece of the market by making unique goods. Since these products have substitutes, firms use NON-PRICE Competition. Copyright ACDC Leadership 2015

Examples of NON-PRICE Competition Brand Names and Packaging Example? Product Attributes Service Location Advertising Two Goals 1. Increase Demand 2. Make demand more INELASTIC

Monopolistic Competition Firm’s demand curve How does it compare to previous models? Down-sloping and highly elastic (Why?) Elasticity depends on number of rivals and degree of product differentiation Short run profit or loss How is profit maximized? Produce where MR=MC Long run profit/loss? Normal profit Easy entry and exit Inefficient 11-8

Drawing Monopolistic Competition Copyright ACDC Leadership 2015

In the short-run, it is the same graph as a monopoly making profit Monopolistic Competition is made up of prices makers so MR is less than Demand In the short-run, it is the same graph as a monopoly making profit P MC ATC P1 In the long-run, new firms will enter, driving down the DEMAND for firms already in the market. D MR Q Q1 10 Copyright ACDC Leadership 2015

Why does DEMAND shift? When short-run profits are made… New firms enter. New firms mean more close substitutes and less market shares for each existing firm. Demand for each firm falls. When short-run losses are made… Firms exit. Result is less substitutes and more market shares for remaining firms. Demand for each firm rises. Copyright ACDC Leadership 2015

Firms enter so demand falls until there is no economic profit MC ATC P1 D MR Q Q1 12 Copyright ACDC Leadership 2015

Firms enter so demand falls until there is no economic profit Price and quantity falls and TR=TC P MC ATC PLR D MR Q QLR 13

Quantity where MR =MC up to Price = ATC LONG-RUN EQUILIBRIUM Quantity where MR =MC up to Price = ATC P MC ATC PLR D MR Q QLR 14

What happens when there is a loss? In the short-run, the graph is the same as a monopoly making a loss ATC P MC P1 In the long-run, firms will leave, driving up the DEMAND for firms already in the market. D MR Q Q1 15 Copyright ACDC Leadership 2015

Firms leave so demand increases until there is no economic profit ATC P MC P1 D MR Q Q1 16 Copyright ACDC Leadership 2015

Firms leave so demand increases until there is no economic profit Price and quantity increase and TR=TC ATC P MC PLR D MR QLR Q 17 Copyright ACDC Leadership 2015

Complications A normal profit is the result in the theoretical model, but in the real world, variables can create variation from the model. Stronger product differentiation may produce more monopolistic power and long-term economic profits Air Jordan, anyone? Barriers to entry may differ from industry to industry Ex: Large scale shoe manufacturer vs. local cobbler

Extensions What three options can a monopolistically competitive firm undertake to gain/sustain an economic profit? 1. Reduce costs 2. Increase demand (and costs?) for their product through differentiation 3. Increase demand (and costs) through advertising

Are Monopolistically Competitive Firms Efficient? Copyright ACDC Leadership 2015

Long- Run Equilibrium Not Allocatively Efficient because P  MC Not Productively Efficient because not producing at Minimum ATC P ATC MC PLR D MR Q QLR QProd Efficient 21 Copyright ACDC Leadership 2015 QSocially Optimal

This firm also has EXCESS CAPACITY Long- Run Equilibrium This firm also has EXCESS CAPACITY P ATC MC PLR D MR Q QLR QProd Efficient 22 Copyright ACDC Leadership 2015

Excess Capacity Given current resources, the firm can produce at the lowest costs (minimum ATC) but they decide not to. The gap between the minimum ATC output and the profit maximizing output. Not the amount underproduced Copyright ACDC Leadership 2015

Long- Run Equilibrium The firm can produce at a lower cost but it holds back production to maximize profit P ATC MC PLR D Excess Capacity MR Q QLR QProd Efficient 24 Copyright ACDC Leadership 2015

Monopolistic Competition is inefficient, but other benefits accrue to society… Product Variety More Choices! #AMERICA! Innovation Better Stuff! Copyright ACDC Leadership 2015

Practice Question   Assume there is a monopolistically competitive firm in long-run equilibrium. If this firm were to realize productive efficiency, it would: A) have more economic profit. B) have a loss. C) also achieve allocative efficiency. D) be under producing. E) be in long-run equilibrium. Answer is B. Draw a monopolistic competitive graph in the long run. * Copyright ACDC Leadership 2015

2008 Audit Exam 9.C