2 Between Monopoly & Perfect Competition Imperfect competitionBetween perfect competition and monopolyOligopolyMonopolistic competitionFew sellersOffer similar or identical products
3 Between Monopoly & Perfect Competition Monopolistic competitionMany sellers (like PC)Product differentiation (no one else)Not price takersDownward sloping demand curveProduct differentiation gives them some market powerFree entry and exit (like PC)Zero economic profit in the long run (like PC)Because of free entry
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 FIGURE 15.1 Characteristics of Different Market Organizations
6 Industry Characteristics monopolistic competition A common form of industry (market) structure characterized by a large number of firms, no barriers to entry, and product differentiation.TABLE Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 2002Industry DesignationFour Largest FirmsEight Largest FirmsTwenty Largest FirmsNumber of FirmsTravel trailers and campers384558733Games, toys394863732Wood office furniture344356546Book printing335468560Curtains and draperies17251,778Fresh or frozen seafood1424529Women’s dresses1823528Miscellaneous plastic products6106,775
7 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
8 Price and Output Determination in Monopolistic Competition Product Differentiation and Demand Elasticity FIGURE Product Differentiation Reduces the Elasticity of Demand Facing a FirmThe demand curve that a monopolistic competitor faces is likely to be less elastic than the demand curve that a perfectly competitive firm faces.Demand is more elastic than the demand curve that a monopolist faces because close substitutes for the products of a monopolistic competitor are available.
9 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.
10 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
11 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
12 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.
13 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
14 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
15 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.
16 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
17 Advertising When firms Then, they have incentive to advertise Sell differentiated productsAt price above marginal costThen, they have incentive to advertiseTo attract more buyers
18 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
19 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
20 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
21 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
22 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
23 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
24 Advertising Brand names Defenders of brand names Useful: high quality Consumers – information about qualityFirms – incentive to maintain high quality
25 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