1. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 1

2. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 2 Monopolistic Competition 11 CHAPTER

3. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 3 DEFINITION OF MONOPOLISTIC COMPETITION Definition It is a market structure in which there are large numbers of small sellers selling differentiated products. These Product are close substitute and firms have easy entry and exit from the market.

4. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 4 Characteristics Large number of buyers and sellers: Each firm produces different or unique products, so they have some control over the prices and follows an independent price-output policy. Differentiated products: Product differentiation could be through packaging, design, labelling, advertising and brand name. CHARACTERISTICS OF MONOPOLISTIC COMPETITION

5. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 5 Free of entry and exit into the market: Not as easy as perfect competition because of the existence of product differentiation. Role of non-price competition is significant: Various methods used to attract the customers to buy a particular brand. Selling cost: Different types of expenditure on advertisement would incur additional cost. CHARACTERISTICS OF MONOPOLISTIC COMPETITION (CON’T)

6. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 6 TOTAL REVENUE – TOTAL COST APPROACH Using Table: Profit maximization is determined by scanning through the profit at each level, and the level which gives the highest profit is the profit maximizing output. (1) Quantity (Q) (2) Price (P) (3) Total Revenue (TR) (4) Total Cost (TC) 5) Profit (TR-TC) 0 1 2 3 4 5 6 7 8 9 10 340 330 320 310 300 290 280 270 260 240 0 340 660 960 1240 1500 1740 1960 2160 2340 2400 200 400 560 700 800 900 1040 1200 1400 1800 2400 -200 -60 100 260 440 600 700 760 540 0

7. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 7 TR, TC Quantity TC TR Highest vertical difference TOTAL REVENUE – TOTAL COST APPROACH (CON’T) Using Graph: TR curve is increasing and after the profit maximizing output, the curve starts to decline. Maximum profit is where the vertical difference between TR and TC is the highest.

8. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 8 MARGINAL REVENUE – MARGINAL COST APPROACH Using Table: The profit maximizing output level is obtained following the MR = MC rule. Quantity (Q) Price (P) Marginal Revenue (MR) Marginal Cost (MC) 0 1 2 3 4 5 6 7 8 9 10 340 330 320 310 300 290 280 270 260 240 340 320 300 280 260 240 220 200 180 60 200 160 140 100 140 160 200 400 600

9. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 9 MR, MC Quantity MC MR P* Q* AR=P MARGINAL REVENUE – MARGINAL COST APPROACH (CON’T) Using Graph: MR curve under imperfect market is downward sloping as the output increases. The profit maximization level occurs, MR = MC, where the MC curve intersect with the MR curve.

10. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 10 The demand function for a monopolistic competitive firm is given as P= 2000 – 1.5Q and MC is constant at RM800 per unit. Calculate profit maximizing price and quantity. PROFIT MAXIMIZATION USING THE EQUATION METHOD

11. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 11 PROFIT MAXIMIZATION USING THE EQUATION METHOD (CON’T) Solution For profit maximization to take place, we use the MR = MC rule. Firstly, we need to derive the demand curve. GivenP=2000 − 1.5Q MR = 2000 − 3Q MR = MC 2000 − 3Q= 800 3Q = 1200 Q= 400

12. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 12 PROFIT MAXIMIZATION USING THE EQUATION METHOD (CON’T) Substitute Q =400 into P = 2000 − 1.5Q P= 2000 − 600 P=1400

13. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 13 Monopolistic competitive firm economic profit ATC Price (RM) Quantity DD = AR Q* P* A MR AC PROFIT MAXIMIZATION IN THE SHORT RUN Economic profit or supernormal profit is the profit earned by a monopolist when TR>TC. MC The profit maximization level occurs where MR curve and MC curve intersect at point A. At output Q, the firm earns economic profit or supernormal profit equal to the area Shaded. PROFIT To find the price, we use the same vertical line with output up to the demand curve. The profit maximizing price and output are P* and Q*.

14. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 14 Monopolistic competitive firm at breakeven The profit maximization level occurs where MR curve and MC curve intersect at point A. ATC Price (RM) Quantity DD = AR MC Q* A MR AC/P* The profit maximizing price and output are P* and Q*. At output, Q monopolist is at the breakeven or earns normal profit. PROFIT MAXIMIZATION IN THE SHORT RUN (CON’T) Economic profit or supernormal profit is the profit earned by a monopolist when TR>TC.

15. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 15 The profit maximization level occurs where MR curve and MC curve intersect at point A. Monopoly competitive firm suffers economic losses ATCPrice (RM) AC Quantity DD = AR MC Q* P* A MR The profit maximizing price and output are P* and Q*. Economic losses or subnormal profit is the loss incurred by a monopolist when TR<TC. PROFIT MAXIMIZATION IN THE SHORT RUN (CON’T) At output, Q monopolist suffers economic losses or subnormal profit equal to the area shaded. LOSSES

16. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 11– 16 Monopoly competitive firm earns normal profit in long run A monopolistic competitive firm earns normal profit in the long run due free entry and exit. LRATC PROFIT MAXIMIZATION IN THE LONG RUN Price (RM) Quantity DD = LRAR LRMC Q* P* A LRMR