Chapter 17 MODERN PRINCIPLES OF ECONOMICS Third Edition Monopolistic Competition and Advertising
Outline Sources of Product Differentiation The Monopolistic Competition Model The Economics of Advertising 2
Introduction Monopolistic competition combines some features of competitive markets with some features of monopoly. Monopolistic competition is a market with: Many sellers. Free entry and exit. Product differentiation. Monopolistic competitors face a downward sloping demand curve. 3
Definition Monopolistic competition: a market with a large number of firms selling similar but not identical products. Examples: Restaurants Soft drinks, beer Many other consumer products 4
Product Differentiation COSTI IOSIF/SHUTTERSTOCK Can you tell the difference? 5
Product Differentiation How about now? COSTI IOSIF/SHUTTERSTOCK 6
Product Differentiation Products can be differentiated along any dimension that people care about, such as taste, style, features, or location. Differentiated products are often highly advertised. Firms want consumers to perceive their products as different and better because that increases their market power. 7
Self-Check Under monopolistic competition, there are/is: a. Many firms. b. A few firms. c. One firm. Answer: a under monopolistic competition, there are many firms. 8
Monopolistic Competition Price P Profit Short Run In the short run, a monopolistic competitor can make profits like a monopolist. AC MC Demand Q MR Quantity 9
Monopolistic Competition Price P Long Run Firms enter market share The firm produces Q Demand curve shifts LR and left makes zero profits but P > MC. Entry continues until = AC MC AC MR Demand Q LR Quantity 10
Monopolistic Competition Price Long Run The firm produces Q LR and makes zero profits but P > MC. P AC MC MR Demand Q LR Quantity 11
Monopolistic Competition A monopolistically competitive firm can reduce output and raise the price without losing all of its customers. Product differentiation means the firm is able to charge P > MC. Is there DWL? It also means that a firm does not produce at the minimum of its AC curve (inefficiency) In the longer run, consumers are better off because of new features and products. Politics of choice or market failure? 12
Monopolistic Competition Price Monopolistic Competition Price Competition P MC P = AC Profits = 0 MC AC P = AC, Profits = 0 Minimum AC MC AC P C P = MR Demand Q MC Quantity MR Q C Quantity Comparing Monopolistic competition and Competition. 13
Self-Check Firms in which of the following markets will produce at the minimum AC: a. Monopoly. b. Monopolistic competition. c. Competition. Answer: c a competitive firm will produce at the minimum average cost. 14
Economics of Advertising Monopolies, oligopolies, and monopolistically competitive firms use advertising to differentiate their products and build brand identity. Informative advertising is about price, quality, and availability. Persuasive advertising is about changing people s minds and moving the market towards monopoly. 15
Economics of Advertising There is evidence that advertising lowers prices and improves consumer welfare. Advertising can also signal that the seller expects the product to be a success. Persuasion can give us tastes that appear silly or unjustified. Persuasion also can deepen our enjoyments and our memories. 16
Economics of Advertising In a blind taste test, subjects were given labeled and unlabeled glasses of Coke. They reported greater enjoyment from drinking the labeled Coke. Brain scans showed activity in the memory regions of the brain. INTERFOTO/ALAMY 17
Economics of Advertising Persuasive advertising can create market power by brand differentiation. Advertising helps people enjoy a lot of products. Ads make Google search, newspapers, and cable TV cheaper. 18
Takeaway A monopolistically competitive industry has many sellers, free entry, and differentiated products. Each firm retains a downward-sloped demand curve and Price remains above MC. Free entry drives price down to P = MC, where economic profits = 0. Firms do not produce at the minimum AC. 19
Takeaway Advertising can inform consumers about price, quality, and availability. Advertising can also increase perceptions of product differentiation, which allows firms to increase prices. 20