LECTURE 10: MONOPOLISTIC COMPETITIO
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1 LECTURE 10: MONOPOLISTIC COMPETITIO Today s Topics: Brands and Adver tising 1. Between Monopoly and Perfect Competition: number of sellers? type of products? oligopolies, monopolistic competition. 2. Monopolistic Competition: competition in the short run, in the long run; compared with perfect competition, and efficiency. 3. Adver tising: pros and cons, as a signal of quality, brand names. >
2 Lecture 10 A G S M 2004 Page 2 1. BETWEEN TWO POLES Number of Sellers: One A Few Many Homog enous Homog eneous Pure Product Pure Oligopoly Competition Differentiated Monopoly Differentiated Monopolistic Product Oligopoly Competition Assume: Many Buyers I think it s wrong only one company makes the game Monopoly US humorist, Steve Wright
3 Lecture 10 A G S M 2004 Page 2 1. BETWEEN TWO POLES Number of Sellers: One A Few Many Homog enous Homog eneous Pure Product Pure Oligopoly Competition Differentiated Monopoly Differentiated Monopolistic Product Oligopoly Competition Assume: Many Buyers I think it s wrong only one company makes the game Monopoly US humorist, Steve Wright Oligopoly: a market structure in which only a few sellers offer similar or identical products. Often behave strategically. (Lecture 17.) Examples?
4 Lecture 10 A G S M 2004 Page 2 1. BETWEEN TWO POLES Number of Sellers: One A Few Many Homog enous Homog eneous Pure Product Pure Oligopoly Competition Differentiated Monopoly Differentiated Monopolistic Product Oligopoly Competition Assume: Many Buyers I think it s wrong only one company makes the game Monopoly US humorist, Steve Wright Oligopoly: a market structure in which only a few sellers offer similar or identical products. Often behave strategically. (Lecture 17.) Examples? Monopolistic Competition: a market structure in which many firms sell products that are similar but not identical.
5 Lecture 10 A G S M 2004 Page 3 DIFFERENTIATED PRODUCTS
6 Lecture 10 A G S M 2004 Page 3 DIFFERENTIATED PRODUCTS HOMOGENEOUS or
7 Lecture 10 A G S M 2004 Page 3 DIFFERENTIATED PRODUCTS HOMOGENEOUS or DIFFERENTIATED?
8 Lecture 10 A G S M 2004 Page 3 DIFFERENTIATED PRODUCTS HOMOGENEOUS or DIFFERENTIATED? Attributes: Degree of Substitutability?
9 Lecture 10 A G S M 2004 Page 3 DIFFERENTIATED PRODUCTS HOMOGENEOUS or DIFFERENTIATED? Degree of Substitutability? Attributes: Physical Attributes
10 Lecture 10 A G S M 2004 Page 3 DIFFERENTIATED PRODUCTS HOMOGENEOUS or DIFFERENTIATED? Degree of Substitutability? Attributes: Physical Attributes Ancillar y Ser vices
11 Lecture 10 A G S M 2004 Page 3 DIFFERENTIATED PRODUCTS HOMOGENEOUS or DIFFERENTIATED? Degree of Substitutability? Attributes: Physical Attributes Ancillar y Ser vices Geographical Location
12 Lecture 10 A G S M 2004 Page 3 DIFFERENTIATED PRODUCTS HOMOGENEOUS or DIFFERENTIATED? Degree of Substitutability? Attributes: Physical Attributes Ancillar y Ser vices Geographical Location Subjective Image
13 Lecture 10 A G S M 2004 Page 4 2. MONOPOLISTIC COMPETITION For a firm with market power in a market with with other firms selling close substitutes,
14 Lecture 10 A G S M 2004 Page 4 2. MONOPOLISTIC COMPETITION For a firm with market power in a market with with other firms selling close substitutes, there is competition as firms enter,
15 Lecture 10 A G S M 2004 Page 4 2. MONOPOLISTIC COMPETITION For a firm with market power in a market with with other firms selling close substitutes, there is competition as firms enter, and chang e the prices of the close substitutes,
16 Lecture 10 A G S M 2004 Page 4 2. MONOPOLISTIC COMPETITION For a firm with market power in a market with with other firms selling close substitutes, there is competition as firms enter, and chang e the prices of the close substitutes, which results in a shift to the left in the demand curve that our firm faces.
17 Lecture 10 A G S M 2004 Page 4 2. MONOPOLISTIC COMPETITION For a firm with market power in a market with with other firms selling close substitutes, there is competition as firms enter, and chang e the prices of the close substitutes, which results in a shift to the left in the demand curve that our firm faces. Monopolistic Competition
18 Lecture 10 A G S M 2004 Page 4 2. MONOPOLISTIC COMPETITION For a firm with market power in a market with with other firms selling close substitutes, there is competition as firms enter, and chang e the prices of the close substitutes, which results in a shift to the left in the demand curve that our firm faces. Monopolistic Competition Examples?
19 Lecture 10 A G S M 2004 Page 5 CONDITIONS FOR MONOP. COMP.
20 Lecture 10 A G S M 2004 Page 5 CONDITIONS FOR MONOP. COMP. 1. Many sellers competing by selling differentiated (such as branded) products.
21 Lecture 10 A G S M 2004 Page 5 CONDITIONS FOR MONOP. COMP. 1. Many sellers competing by selling differentiated (such as branded) products. 2. Because the products are differentiated (substitutes, but not perfect substitutes), each firm faces a downwards-sloping demand curve and has some market power to determine price.
22 Lecture 10 A G S M 2004 Page 5 CONDITIONS FOR MONOP. COMP. 1. Many sellers competing by selling differentiated (such as branded) products. 2. Because the products are differentiated (substitutes, but not perfect substitutes), each firm faces a downwards-sloping demand curve and has some market power to determine price. 3. Free entry or exit from the market: until zero economic profits for all.
23 Lecture 10 A G S M 2004 Page 5 CONDITIONS FOR MONOP. COMP. 1. Many sellers competing by selling differentiated (such as branded) products. 2. Because the products are differentiated (substitutes, but not perfect substitutes), each firm faces a downwards-sloping demand curve and has some market power to determine price. 3. Free entry or exit from the market: until zero economic profits for all. 4. Firms do not collude or behave strategically: they assume competitors actions fixed.
24 Lecture 10 A G S M 2004 Page 5 CONDITIONS FOR MONOP. COMP. 1. Many sellers competing by selling differentiated (such as branded) products. 2. Because the products are differentiated (substitutes, but not perfect substitutes), each firm faces a downwards-sloping demand curve and has some market power to determine price. 3. Free entry or exit from the market: until zero economic profits for all. 4. Firms do not collude or behave strategically: they assume competitors actions fixed. 5. Buyers are price takers; no bargaining.
25 Lecture 10 A G S M 2004 Page 6 IN THE SHORT RUN
26 Lecture 10 A G S M 2004 Page 6 IN THE SHORT RUN 1. Prices of substitutes affect the demand cur ve, downwards-sloping. (imperfect substitutes)
27 Lecture 10 A G S M 2004 Page 6 IN THE SHORT RUN 1. Prices of substitutes affect the demand cur ve, downwards-sloping. (imperfect substitutes) 2. Assume that each firm takes others actions constant & then sets sales (y SR * ) so that MR(y SR * ) = MC(y SR * ) (SR = Shor t Run) to maximize its profit (y SR * P SR). *
28 Lecture 10 A G S M 2004 Page 6 IN THE SHORT RUN 1. Prices of substitutes affect the demand cur ve, downwards-sloping. (imperfect substitutes) 2. Assume that each firm takes others actions constant & then sets sales (y SR * ) so that MR(y SR * ) = MC(y SR * ) (SR = Shor t Run) to maximize its profit (y SR * P SR). * 3. In general, P SR * > AC(y * ) for each firm, so that profit π is positive in the short run.
29 Lecture 10 A G S M 2004 Page 6 IN THE SHORT RUN 1. Prices of substitutes affect the demand cur ve, downwards-sloping. (imperfect substitutes) 2. Assume that each firm takes others actions constant & then sets sales (y SR * ) so that MR(y SR * ) = MC(y SR * ) (SR = Shor t Run) to maximize its profit (y SR * P SR). * 3. In general, P SR * > AC(y * ) for each firm, so that profit π is positive in the short run. attractive for new firms to produce close substitutes in the long run.
30 Lecture 10 A G S M 2004 Page 7 POSITIVE PROFITS $/unit. MC. AC output/period
31 Lecture 10 A G S M 2004 Page 7 POSITIVE PROFITS $/unit D. MC. AC. D = AR output/period
32 Lecture 10 A G S M 2004 Page 7 POSITIVE PROFITS $/unit P SR D. MC. AC. D = AR. MR y SR output/period
33 Lecture 10 A G S M 2004 Page 7 POSITIVE PROFITS $/unit P SR D D.. MC.... AC. D = AR D =AR. MR y SR output/period
34 Lecture 10 A G S M 2004 Page 7 POSITIVE PROFITS $/unit P SR P D D.. MC..... AC D = AR D =AR y y SR. MR. MR output/period With demand D, profit attracts new entrants, which contracts the demand to D.
35 Lecture 10 A G S M 2004 Page 7 POSITIVE PROFITS $/unit P SR P D D.. MC..... AC D = AR D =AR y y SR. MR. MR output/period With demand D, profit attracts new entrants, which contracts the demand to D. Profit falls, but still positive: AR (y ) = P > AC(y ).
36 Lecture 10 A G S M 2004 Page 8 LONG-RUN EQUILIBRIUM
37 Lecture 10 A G S M 2004 Page 8 LONG-RUN EQUILIBRIUM 4. In the medium-to-long run, new entrants invest, and the original firms demand curves move to the left, as their market share falls.
38 Lecture 10 A G S M 2004 Page 8 LONG-RUN EQUILIBRIUM 4. In the medium-to-long run, new entrants invest, and the original firms demand curves move to the left, as their market share falls. 5. In the long run (LR), all profits will be bidded away for the marginal firm, with AR = D P = AC π = 0 and maximum (zero) profit point on demand cur ve
39 Lecture 10 A G S M 2004 Page 8 LONG-RUN EQUILIBRIUM 4. In the medium-to-long run, new entrants invest, and the original firms demand curves move to the left, as their market share falls. 5. In the long run (LR), all profits will be bidded away for the marginal firm, with AR = D P = AC π = 0 and maximum (zero) profit point on demand cur ve the demand curve D must be tangent to the AC cur ve at the price & output chosen.
40 Lecture 10 A G S M 2004 Page 9 ZERO PROFITS $/unit MC.. AC output/period
41 Lecture 10 A G S M 2004 Page 9 ZERO PROFITS $/unit D MC.. AC. D = =AR output/period
42 Lecture 10 A G S M 2004 Page 9 ZERO PROFITS $/unit D D MC.. AC..... D = AR D = =AR output/period
43 Lecture 10 A G S M 2004 Page 9 ZERO PROFITS $/unit D D MC.. AC P MR. D = AR D = =AR y output/period
44 Lecture 10 A G S M 2004 Page 9 ZERO PROFITS $/unit D D MC.. AC P MR. D = AR D = =AR y output/period Long-run equilibrium at the margin.
45 Lecture 10 A G S M 2004 Page 9 ZERO PROFITS $/unit D D MC.. AC P MR. D = AR D = =AR y output/period Long-run equilibrium at the margin. At y, AR (y ) = P = AC(y ): zero profit.
46 Lecture 10 A G S M 2004 Page 9 ZERO PROFITS $/unit D D MC.. AC P MR. D = AR D = =AR y output/period Long-run equilibrium at the margin. At y, AR (y ) = P = AC(y ): zero profit. There will be excess capacity: firms will not operate at minimum AC, and so they could reduce AC by increasing output.
47 Lecture 10 A G S M 2004 Page 9 ZERO PROFITS $/unit D D MC.. AC P MR. D = AR D = =AR y output/period Long-run equilibrium at the margin. At y, AR (y ) = P = AC(y ): zero profit. There will be excess capacity: firms will not operate at minimum AC, and so they could reduce AC by increasing output. Why don t they?
48 Lecture 10 A G S M 2004 Page 10 VERSUS PERFECT COMPETITION
49 Lecture 10 A G S M 2004 Page 10 VERSUS PERFECT COMPETITION Higher average costs: zero profits, but firms are on the downwards-sloping part of the ATC cur ves, not at the minimum (Efficient Scale).
50 Lecture 10 A G S M 2004 Page 10 VERSUS PERFECT COMPETITION Higher average costs: zero profits, but firms are on the downwards-sloping part of the ATC cur ves, not at the minimum (Efficient Scale). Mark-up over marginal cost: price is always above MC, because the firm always has some market power, not P = MC.
51 Lecture 10 A G S M 2004 Page 10 VERSUS PERFECT COMPETITION Higher average costs: zero profits, but firms are on the downwards-sloping part of the ATC cur ves, not at the minimum (Efficient Scale). Mark-up over marginal cost: price is always above MC, because the firm always has some market power, not P = MC. Note that MC < AC, since AC is falling, not MC = AC.
52 Lecture 10 A G S M 2004 Page 10 VERSUS PERFECT COMPETITION Higher average costs: zero profits, but firms are on the downwards-sloping part of the ATC cur ves, not at the minimum (Efficient Scale). Mark-up over marginal cost: price is always above MC, because the firm always has some market power, not P = MC. Note that MC < AC, since AC is falling, not MC = AC. Always eager to make another sale: an extra unit sold at the current price means more profit, not unwilling.
53 Lecture 10 A G S M 2004 Page 11 AND EFFICIENCY Inefficient, but greater variety in the market. Inefficiencies:
54 Lecture 10 A G S M 2004 Page 11 AND EFFICIENCY Inefficient, but greater variety in the market. Inefficiencies: 1. Mark-up: P > MC the DWL of monopoly pricing: some consumers value it above MC but below the P charged.
55 Lecture 10 A G S M 2004 Page 11 AND EFFICIENCY Inefficient, but greater variety in the market. Inefficiencies: 1. Mark-up: P > MC the DWL of monopoly pricing: some consumers value it above MC but below the P charged. 2. Production y less than the Efficient Scale of production at minimum AC: excess capacity.
56 Lecture 10 A G S M 2004 Page 11 AND EFFICIENCY Inefficient, but greater variety in the market. Inefficiencies: 1. Mark-up: P > MC the DWL of monopoly pricing: some consumers value it above MC but below the P charged. 2. Production y less than the Efficient Scale of production at minimum AC: excess capacity. 3. Too much or too little entry: individual entrant considers only its profit,
57 Lecture 10 A G S M 2004 Page 11 AND EFFICIENCY Inefficient, but greater variety in the market. Inefficiencies: 1. Mark-up: P > MC the DWL of monopoly pricing: some consumers value it above MC but below the P charged. 2. Production y less than the Efficient Scale of production at minimum AC: excess capacity. 3. Too much or too little entry: individual entrant considers only its profit, but consumers gain CS with a new product,
58 Lecture 10 A G S M 2004 Page 11 AND EFFICIENCY Inefficient, but greater variety in the market. Inefficiencies: 1. Mark-up: P > MC the DWL of monopoly pricing: some consumers value it above MC but below the P charged. 2. Production y less than the Efficient Scale of production at minimum AC: excess capacity. 3. Too much or too little entry: individual entrant considers only its profit, but consumers gain CS with a new product, while incumbents lose PS with the new competitor.
59 Lecture 10 A G S M 2004 Page ADVERTISING A natural feature of monopolistic competition: each firm wants more sales.
60 Lecture 10 A G S M 2004 Page ADVERTISING A natural feature of monopolistic competition: each firm wants more sales. Print media: 50% Electronic media: 33% Rest: 17%
61 Lecture 10 A G S M 2004 Page ADVERTISING A natural feature of monopolistic competition: each firm wants more sales. Print media: 50% Electronic media: 33% Rest: 17% How does the level of adver tising vary over types of goods and services?
62 Lecture 10 A G S M 2004 Page ADVERTISING A natural feature of monopolistic competition: each firm wants more sales. Print media: 50% Electronic media: 33% Rest: 17% How does the level of adver tising vary over types of goods and services? Highest adver tising budg ets for highly differentiated consumer goods.
63 Lecture 10 A G S M 2004 Page ADVERTISING A natural feature of monopolistic competition: each firm wants more sales. Print media: 50% Electronic media: 33% Rest: 17% How does the level of adver tising vary over types of goods and services? Highest adver tising budg ets for highly differentiated consumer goods. Examples?
64 Lecture 10 A G S M 2004 Page 13 PRO & CON
65 Lecture 10 A G S M 2004 Page 13 PRO & CON Manipulation of tastes? Creating desires that otherwise wouldn t exist?
66 Lecture 10 A G S M 2004 Page 13 PRO & CON Manipulation of tastes? Creating desires that otherwise wouldn t exist? Higher prices (for two reasons)?
67 Lecture 10 A G S M 2004 Page 13 PRO & CON Manipulation of tastes? Creating desires that otherwise wouldn t exist? Higher prices (for two reasons)? Because P > MC, and
68 Lecture 10 A G S M 2004 Page 13 PRO & CON Manipulation of tastes? Creating desires that otherwise wouldn t exist? Higher prices (for two reasons)? Because P > MC, and by reducing consumers price elasticity of demand (brand loyalty).
69 Lecture 10 A G S M 2004 Page 13 PRO & CON Manipulation of tastes? Creating desires that otherwise wouldn t exist? Higher prices (for two reasons)? Because P > MC, and by reducing consumers price elasticity of demand (brand loyalty). OR
70 Lecture 10 A G S M 2004 Page 13 PRO & CON Manipulation of tastes? Creating desires that otherwise wouldn t exist? Higher prices (for two reasons)? Because P > MC, and by reducing consumers price elasticity of demand (brand loyalty). OR Conveys information (prices, locations, existence of new products) better choices?
71 Lecture 10 A G S M 2004 Page 13 PRO & CON Manipulation of tastes? Creating desires that otherwise wouldn t exist? Higher prices (for two reasons)? Because P > MC, and by reducing consumers price elasticity of demand (brand loyalty). OR Conveys information (prices, locations, existence of new products) better choices? More competition, not less (think: Internet comparison browsing).
72 Lecture 10 A G S M 2004 Page 13 PRO & CON Manipulation of tastes? Creating desires that otherwise wouldn t exist? Higher prices (for two reasons)? Because P > MC, and by reducing consumers price elasticity of demand (brand loyalty). OR Conveys information (prices, locations, existence of new products) better choices? More competition, not less (think: Internet comparison browsing). Reduces brands market power.
73 Lecture 10 A G S M 2004 Page 13 PRO & CON Manipulation of tastes? Creating desires that otherwise wouldn t exist? Higher prices (for two reasons)? Because P > MC, and by reducing consumers price elasticity of demand (brand loyalty). OR Conveys information (prices, locations, existence of new products) better choices? More competition, not less (think: Internet comparison browsing). Reduces brands market power. Facilitates entry.
74 Lecture 10 A G S M 2004 Page 13 PRO & CON Manipulation of tastes? Creating desires that otherwise wouldn t exist? Higher prices (for two reasons)? Because P > MC, and by reducing consumers price elasticity of demand (brand loyalty). OR Conveys information (prices, locations, existence of new products) better choices? More competition, not less (think: Internet comparison browsing). Reduces brands market power. Facilitates entry. Empirical results:
75 Lecture 10 A G S M 2004 Page 13 PRO & CON Manipulation of tastes? Creating desires that otherwise wouldn t exist? Higher prices (for two reasons)? Because P > MC, and by reducing consumers price elasticity of demand (brand loyalty). OR Conveys information (prices, locations, existence of new products) better choices? More competition, not less (think: Internet comparison browsing). Reduces brands market power. Facilitates entry. Empirical results: Across 50 states: price of spectacles 20% lower when adver tising allowed.
76 Lecture 10 A G S M 2004 Page 14 AS A SIGNAL OF QUALITY
77 Lecture 10 A G S M 2004 Page 14 AS A SIGNAL OF QUALITY How much information?
78 Lecture 10 A G S M 2004 Page 14 AS A SIGNAL OF QUALITY How much information? The firm s willingness to buy adver tising (especially for repeat-purchase, experience goods) is a signal of quality?
79 Lecture 10 A G S M 2004 Page 14 AS A SIGNAL OF QUALITY How much information? The firm s willingness to buy adver tising (especially for repeat-purchase, experience goods) is a signal of quality? Is what the adver t says important?
80 Lecture 10 A G S M 2004 Page 14 AS A SIGNAL OF QUALITY How much information? The firm s willingness to buy adver tising (especially for repeat-purchase, experience goods) is a signal of quality? Is what the adver t says important? Not much just that it is expensive and paid for.
81 Lecture 10 A G S M 2004 Page 15 BRAND NAMES Economics of brand names:
82 Lecture 10 A G S M 2004 Page 15 BRAND NAMES Economics of brand names: Perceived differences, not real a rip-off, from adver tising.
83 Lecture 10 A G S M 2004 Page 15 BRAND NAMES Economics of brand names: Perceived differences, not real a rip-off, from adver tising. But: Quality firms use brands to convey signals about quality; and, firms must defend their brands reputations (or brand equity) as high-quality products by maintaining quality.
84 Lecture 10 A G S M 2004 Page 15 BRAND NAMES Economics of brand names: Perceived differences, not real a rip-off, from adver tising. But: Quality firms use brands to convey signals about quality; and, firms must defend their brands reputations (or brand equity) as high-quality products by maintaining quality. Rationality: irrational preference for brand names, or
85 Lecture 10 A G S M 2004 Page 15 BRAND NAMES Economics of brand names: Perceived differences, not real a rip-off, from adver tising. But: Quality firms use brands to convey signals about quality; and, firms must defend their brands reputations (or brand equity) as high-quality products by maintaining quality. Rationality: irrational preference for brand names, or for good reason?
86 Lecture 10 A G S M 2004 Page 16 SUMMARY 1. Between monopoly and perfect competition lie most markets: oligopolies (few sellers) or monopolistic competition (many sellers). 2. Monopolistic Competition: Neither perfect competition, nor pure monopoly: many sellers and zero profit, but a price mark-up. 3. Many products variety for consumers! 4. Adver tising to increase sales. Justified or not?
87 Lecture 10 A G S M 2004 Page 17 APPENDIX Under what conditions is it true that the slope of the MR cur ve ( dmr ) is twice that of the AR (i.e dq demand) curve ( dp dq )? R = Q P(Q) MR = dr dq = P(Q) + Q dp dq = P (1 + 1). η The slope of the MR cur ve is given by: dmr dq = 2 dp dq + Q d 2 P dq 2 So it is only true in general for linear demand cur ves, for which d 2 P = d dq 2 dq ( dp dq ) = 0, because their slopes are constant (but not, of course, their elasticities). <
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