2 Between Monopoly & Perfect Competition Imperfect competitionBetween perfect competition and monopolyOligopolyMonopolistic competitionFew sellersOffer similar or identical products
3 Between Monopoly & Perfect Competition Monopolistic competitionMany sellersProduct differentiationNot price takersDownward sloping demand curveFree entry and exitZero economic profit in the long run
4 The four types of market structure 1The four types of market structureEconomists who study industrial organization divide markets into four types:monopoly, oligopoly, monopolistic competition, and perfect competition.
5 Competition with Differentiated Products Monopolistically competitive firm in short runProfit maximizationQuantity: marginal revenue = marginal costPrice: on the demand curveIf P > ATC: profitIf P < ATC: loss
6 Monopolistic competitors in the short run 2Monopolistic competitors in the short run(a) Firm makes profit(b) Firm makes lossesPricePriceMCATCMCDemandMRATCATCPriceMRDemandLossesLoss-minimizingquantityProfitProfit-maximizingquantityPriceATCQuantityQuantityMonopolistic competitors, like monopolists, maximize profit by producing the quantity at which marginal revenue equals marginal cost. The firm in panel (a) makes a profit because, at this quantity, price is above average total cost. The firm in panel (b) makes losses because, at this quantity, price is less than average total cost.
7 Competition with Differentiated Products The long run equilibriumIf firms are making profit in short runNew firms - incentive to enter the marketIncrease number of productsReduces demand faced by each firmDemand curve shifts leftEach firm’s profit – declines until: zero economic profit
8 Competition with Differentiated Products The long run equilibriumIf firms are making losses in short runFirms - incentive to exit the marketDecrease number of productsIncreases demand faced by each firmDemand curve shifts rightEach firm’s loss – declines until: zero economic profit
9 A monopolistic competitor in the long run 3A monopolistic competitor in the long runPriceATCMCDemandMRPrice = ATCProfit- maximizingquantityQuantityIn a monopolistically competitive market, if firms are making profit, new firms enter, and the demand curves for the incumbent firms shift to the left. Similarly, if firms are making losses, old firms exit, and the demand curves of the remaining firms shift to the right. Because of these shifts in demand, a monopolistically competitive firm eventually finds itself in the long-run equilibrium shown here. In this long-run equilibrium, price equals average total cost, and the firm earns zero profit.
10 Competition with Differentiated Products The long run equilibriumZero economic profitDemand curveTangent to average total cost curveAt quantity where marginal revenue = marginal costPrice = average total costPrice exceeds marginal cost
11 Competition with Differentiated Products Monopolistic versus perfect competition, long run equilibriumMonopolistic competitionQuantity: not at minimum ATCExcess capacityP > MC, markup over marginal costPerfect competitionQuantity: at minimum ATCEfficient scaleP = MC
12 Monopolistic versus perfect competition 4Monopolistic versus perfect competition(a) Monopolistically Competitive Firm(b) Perfectly Competitive FirmPricePriceMCDemandMCMRATCATCPriceMarkupQuantityproducedP=MR(demand curve)P=MCEfficientscaleQuantity produced= Efficient scaleMCQuantityQuantityExcess capacityPanel (a) shows the long-run equilibrium in a monopolistically competitive market, and panel (b) shows the long-run equilibrium in a perfectly competitive market. Two differences are notable. (1) The perfectly competitive firm produces at the efficient scale, where average total cost is minimized. By contrast, the monopolistically competitive firm produces at less than the efficient scale. (2) Price equals marginal cost under perfect competition, but price is above marginal cost under monopolistic competition.
13 Competition with Differentiated Products Monopolistic competition & society’s welfareSources of inefficiencyMarkup of price over marginal costDeadweight lossToo much or too little entryProduct-variety externalityPositive externality on consumersBusiness-stealing externalityNegative externality on producers
14 Advertising When firms Then, they have incentive to advertise Sell differentiated productsAt price above marginal costThen, they have incentive to advertiseTo attract more buyers
15 Advertising Debate over advertising The critique of advertising Firms advertise to manipulate people’s tastesPsychological rather than informationalCreates a desire that otherwise might not existImpedes competitionIncrease perception of product differentiationFoster brand loyaltyMakes buyers less concerned with price differences among similar goods
16 Advertising Debate over advertising The defense of advertising Provide information to customersCustomers - make better choicesEnhances the ability of markets to allocate resources efficientlyFosters competitionCustomers - take advantage of price differencesAllows new firms to enter more easily
17 Advertising and the price of eyeglasses What effect does advertising have on the price of a good?Consumers – view products as being more different than they otherwise wouldMarkets less competitiveFirms’ demand curves less elasticHigher pricesConsumers – easier to find firms with the best pricesMarkets – more competitiveFirms’ demand curves more elasticLower prices
18 Advertising and the price of eyeglasses 1963, Test: advertising by optometristsStates that prohibited advertisingAverage price paid for a pair of eyeglasses = $33States that did not restrict advertisingAverage price = $26AdvertisingReduced average pricesFosters competition
19 Advertising Advertising as a signal of quality Advertising – little apparent informationReal information offered – a signalWillingness to spend large amount of money= signal about quality of the productContent of advertising = irrelevant
20 Advertising Brand names Firm – brand name Critics of brand names Spend more on advertisingCharge higher pricesThan generic substitutesCritics of brand namesProducts – not differentiatedIrrationality: consumers are willing to pay more for brand names
21 Advertising Brand names Defenders of brand names Useful: high quality Consumers – information about qualityFirms – incentive to maintain high quality
22 Monopolistic competition: between perfect competition& monopoly 1Monopolistic competition: between perfect competition& monopolyMarket structurePerfectcompetitionMonopolisticMonopolyFeatures that all three market structures shareGoal of firmsRule for maximizingCan earn economic profits in the short run?Features that monopolistic competition shares with monopolyPrice taker?PriceProduces welfare-maximizing level of output?Features that monopolistic competition shares with competitionNumber of firmsEntry in long run?Can earn economic profits in long run?Maximize profitsMR = MCYesP = MCManyNoP > MCOne