Monopolistic Competition

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1 Monopolistic Chapter 17 Copyright 2001 by Harcourt, Inc. All rights reserved. Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida The Four Types of Market Structure Number of Firms? Many firms One firm Few firms Differentiated products Type of Products? Identical products Monopoly Oligopoly Monopolistic Perfect Tap water Tennis balls Novels Wheat Cable TV Crude oil Movies Milk Types of Imperfectly Competitive Markets u Monopolistic u Many firms selling products that are similar but not identical. u Oligopoly u Only a few sellers, each offering a similar or identical product to the others. 1

2 Monopolistic Markets that have some features of competition and some features of monopoly. Attributes of Monopolistic u Many sellers u Product differentiation u Free entry and exit Monopolistic Competitors in the Short Run... (a) Firm Makes a Profit Average total cost Profit 0 Profitmaximizing quantity 2

3 A Monopolistic Competitor in the Long Run... P= 0 Profit-maximizing quantity Monopolistic versus Perfect There are two noteworthy differences between monopolistic and perfect competition excess capacity and markup. Excess Capacity u There is no excess capacity in perfect competition in the long run. u Free entry results in competitive firms producing at the point where average total cost is minimized, which is the efficient scale of the firm. 3

4 Excess Capacity u There is excess capacity in monopolistic competition in the long run. u In monopolistic competition, output is less than the efficient scale of perfect competition. Excess Capacity... (a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm P P = Excess capacity P = (demand curve) produced Efficient scale produced = Efficient scale Markup Over Marginal Cost u For a competitive firm, price equals marginal cost. u For a monopolistically competitive firm, price exceeds marginal cost. 4

5 Markup Over Marginal Cost Because price exceeds marginal cost, an extra unit sold at the posted price means more profit for the monopolistically competitive firm. Markup Over Marginal Cost... (a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm Markup P Marginal cost P = P = (demand curve) produced produced Monopolistic versus Perfect... (a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm Markup P Marginal cost P = P = (demand curve) produced Efficient scale Excess capacity produced = Efficient scale 5

6 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. Advertising u Firms that sell highly differentiated consumer goods typically spend between 10 and 20 percent of revenue on advertising. u Overall, about 2 percent of total revenue, or over $100 billion a year, is spent on advertising. Advertising u Critics of advertising argue that firms advertise in order to manipulate people s tastes. u They also argue that it impedes competition by implying that products are more different than they truly are. 6

7 Advertising u Defenders argue that advertising provides information to consumers u They also argue that advertising increases competition by offering a greater variety of products and prices. u The willingness of a firm to spend advertising dollars can be a signal to consumers about the quality of the product being offered. Brand Names u Critics argue that brand names cause consumers to perceive differences that do not really exist. Brand Names u Economists have argued that brand names may be a useful way for consumers to ensure that the goods they are buying are of high quality. u providing information about quality. u giving firms incentive to maintain high quality. 7

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