Principles of EconomicsEC 201California State Polytechnic University, PomonaDr. BresnockFall, 2002(1) Choose Q so thatMax (TR – TC) or Max Total Economic ProfitsMax (TR – TC) or Max Total Economic ProfitsPrinciples of EconomicsEC 201California State Polytechnic University, PomonaDr. BresnockFall, 2002Lecture 15 Monopolistic Competition: Price and Output DeterminationCharacteristics:(1) Relatively Large # of Firms -- i.e. 25 – 70.(2) Product Differentiation -- with respect to product attributes, service,location, packaging, brand names. Typically consumer goods markets.(3) Limited Price Control -- no collusion among firms over price.Independent pricing action.(4) Relatively Easy Entry and Exit -- of firms into and out of the industryin response to the presence of economic profits and losses.(5) Non-Price Competition -- i.e. advertising, promotions, brand names,free samples.Price and Output DeterminationThe monopolistically competitive firm’s D-Curve will be more elastic than themonopolist’s, but less elastic than the purely competitive firm’s. Thus, themonopolistically competitive firm’s D-Curve will be downward sloping, that is,to sell more units the monopolistically competitive firm will do so at lowerprices.Short Run Equilibrium Once again, the total and marginal approaches for afirm to profit maximize or loss minimize apply.Total Approach(1) Choose Q so thatMax (TR – TC) or Max Total Economic Profits(2) At the chosen Q, select that P.Marginal Approach(1) Choose Q so thatMR = MC (Guarantees that Total Economic Profits will be Maximized)MC > 0(2) At the chosen Q, select that P.EC 201 Lecture 15 Fall, 2002 A. BresnockLong Run EquilibriumTotal Approach(1) Choose Q so that Max (TR – TC) or Max Total Economic Profits(2) At the chosen Q, select that P.Marginal Approach(1) Choose Q so thatMR = MC (Guarantees that Total Economic Profits will be Maximized)MC > 0(2) At the chosen Q, select that P. At this price, the monopolisticallycompetitive firm will find that P = ATC, or P = AC. Note that themonopolistically competitive firm will not break even at minimum ATC, orAC, as was the case for the purely competitive firm.Graph 1 Mostly Likely Outcomes for the Monopolistically CompetitiveFirm (Short Run)2EC 201 Lecture 15 Fall, 2002 A. BresnockGraph 2 Most Likely Outcome for the Monopolistically CompetitiveFirm (Long Run)Wastes of Monopolistic CompetitionIn the long run:(1) P > MC -- the monopolistically competitive firm does not achieveallocative efficiency(2) P > min. ATC -- the monopolistically competitive firm does not achievethe most productive efficiency. There are lots of underutilizedfirms in the industry. The existing firms are notoperating at optimal capacity.Graph 3 Wastes of Monopolistic Competition – Long Run3EC 201 Lecture 15 Fall, 2002 A. Bresnock4EC 201 Lecture 15 Fall, 2002 A. BresnockNon-Price Competition -- The monopolistically competitive firm may usethe following ways to improve its long-run position:(1) Product Differentiation -- at a point in time the firm can increase thevariety of products that it offers in an attempt to provide more choices tothe consumer. The problem here is that as the variety increases, it maylead to even more excess capacity and hence greater productiveinefficiency across firms.(2) Product Development -- over time the firm can introduce newproducts. The problems with this are that the product differentiationmay be superficial, or may be a “planned obsolescence” move by thefirm.(3) Advertising -- helps the firm to adapt consumer demand to itsproduct. There are several pros and cons associated with the use ofadvertising. They are:Pros:a) provides information to assist consumers in making rationalchoices,b) supports national and international communication,c) stimulates product development,d) allows successful firms to expand production and realizeeconomies of scale,e) promotes competition, or diminishes monopoly power, andf) promotes full employment by encouraging consumer spending, or“creating wants or demands”.Cons:a) persuades rather than informs,b) is relatively unproductive and thus adds little to society’s well-being,c) may entail significant external costs, andd) may be self-canceling, that is, it may not increase production butrather lead to rival firms matching the ad campaigns. See below.5EC 201 Lecture 15 Fall, 2002 A.