1. © 2007 Thomson South-Western

2. Monopolistic Competition
Characteristics:
Many sellers
Product differentiation
Free entry and exit
In the long run, profits are
driven to zero
Firms have some control
over price

3. What does the costs graph for one of these firms look like?

5. Short-Run vs. Long Run
Like competitive firms, the market adjusts in the short run until zero profits are earned in the long run

6. The Monopolistically Competitive Firm in the Short Run
Two things can happen
A firm could experience economic loss
A firm could experience economic profit

7. What if a firm is earning profit?

8. Figure 1 Monopolistic Competition in the Short Run
(a) Firm Makes Profit
Price MC
ATC
Demand MR
Profit-
maximizing
quantity
Price
Average
total cost
Profit
Quantity

9. Short Run Profits Encourage new firms to enter the market. This:
Increases the number of products offered.
Reduces demand faced by firms already in the market.
Demand curves shift to the left.
Profits decline.

10. Figure 2 A Monopolistic Competitor in the Long Run
Price MC
Demand
ATC
When profit is earned, firms will enter the market until profit is driven to zero MR
Profit-maximizing
quantity P =
ATC
And this tangency lies vertically above the intersection of MR and MC.
Quantity

11. What if a firm has short run losses?
Firms long run response will be to exit the market
Decreases the number of products offered.
Increases demand faced by the remaining firms until profit is driven to zero

12. Figure 1 Monopolistic Competitors in the Short Run
(b) Firm Makes Losses
Price MC
ATC
Losses
Loss-
minimizing
quantity
Average
total cost
Demand
Price MR
Quantity

13. In the long run, firms will continue to enter and/or exit the market until a firm’s economic profit is driven to zero…

14. The Long-Run Equilibrium
Two Characteristics
As in a monopoly, price exceeds marginal cost.
Causes deadweight loss
As in a competitive market, price equals average total cost.
Free entry and exit drive economic profit to zero.

15. Monopolistic versus Perfect Competition
There is a noteworthy difference between monopolistic and perfect competition:
Excess capacity
The actual capacity (production) by a firm is less than what is optimum for the firm
Optimum production (efficient scale) is where MC = ATC

16. Figure 3 Monopolistic versus Perfect Competition
(a) Monopolistically Competitive Firm
(b) Perfectly Competitive Firm
Price
Price MC
ATC MC
ATC
Demand MR P
Quantity
produced
Efficient
scale P = MC MR
(demand
curve)
Quantity produced =
Efficient scale
Excess capacity
Quantity
Quantity

17. Monopolistic versus Perfect Competition
Excess Capacity
There is no excess capacity in perfect competition in the long run.
There is excess capacity in monopolistic competition in the long run.
In monopolistic competition, output is less than the efficient scale.

18. Monopolistic Competition and the Welfare of Society
There is the normal deadweight loss of monopoly pricing in monopolistic competition caused by the markup of price over marginal cost.

19. Deadweight Loss Price MC ATC Demand MR P = ATC Quantity Monopoly
Market efficient quantity
Quantity

20. ADVERTISING
When firms sell differentiated products and charge prices above marginal cost, each firm has an incentive to advertise in order to attract more buyers to its particular product.
The firm is trying to shift their demand curve to the right to make more short-run profits.