Introduction: Between Monopoly and Competitiontwo extremesperfect competition: many firms, identical productsmonopoly: one firmnike and addida are monopolistically competitive (similar but not identical)in between these extremes: imperfect competitionoligopoly: only a few sellers offer similar or identical productsvideo game consoles, national wireless companiesNOT just cell phone marketmonopolistic competition: many firms sell similar but not identical productsburger king and McDonaldsCharacteristics and Examples of Monopolistic Competitioncharacteristics:many sellersproduct differentiationfree entry and exitsprite and coke are competitive towards each other even though they come from the same firmexamples:apartmentsbooksbottled water and soft drinksshoes and clothing brandsfast foodpersonal care products (shampoo, toothpaste, deodorant, over the counter cold medicine)prescription medicine is monopolisticComparing perfect and monopolistic CompetitionPerfect CompetitionMonopolistic Competitionnumber of sellersmanymanyfree entry/exityesyeslong-run econ. profitszerozerothe products firms sellidenticaldifferentiatedfirm has market power?none, price-takeryesD curve facing firmhorizontaldownward-slopingComparing Monopoly and Monopolistic CompetitionMonopolyMonopolistic Competitionnumber of sellersonemanyfree entry/exitnoyeslong-run econ. profitspositivezerofirm has market power?yesyesD curve facing firmdownward-sloping (market demand)downward-slopingclose substitutesnonemanyA monopolistically competitive firm earning profits in the short runlook at graph in notesthe firm faces a downward-sloping elastic D curve bc of the many close substitutes availableat each Q, MR < Pto maximize profit, firm produces Q where MR = MCthe firm uses the D curve to set Pwhen the ATC curve is above the demand curve it is a LOSSMonopolistic Competition and Monopolyshort run: under monopolistic competition, firm behavior is very similar to monopolylong run: in monopolistic competition, entry and exit drive economic profit to zerolearned about entry and exit in chapter 15if profits in the short run; new firms enter market, taking some demand away from existing firms (the demand curve shifts to the left), prices and profits falldiet coke reduces the demand for regular cokeif losses in the short run: some firms enjoy higher demand (the demand curve shifts to the right) and higher priceseffects the demand not the supply!A Monopolistic Competitor in the Long Runlook at graph in notesthe ATC curve in the long run is tangent to the demand curve, therefore econ profit = 0entry and exit occurs until P = ATC ( ATC curve is tangent to the demand curve at the profit maximizing quantity) and profit = zeronotice that the firm charges a markup of price over marginal cost and does not produce at minimum ATCWhy Monopolistic Competition is less efficient than Perfect Competition1. excess capacitythe monopolistic competition operates on the downward-sloping part of its ATC curve, produces less than the cost-minimizing outputunder perfect competition, firms produce the quantity that minimizes ATC2. Markup over marginal costunder monopolistic competition, P > MCunder perfect competition, P = MCMonopolistic Competition and WelfareMonopolistically competitive markets do not have all the desirable welfare properties of perfectly competitive marketsbecause P > MC, the market quantity is below the socially efficient quantityyet, not easy for policymakers to fix this problem: Firms earn zero profit, so cannot require them to reduce pricesAdvertisingin monopolistically competitive industries, product differentiation and mark up pricing lead naturally to the use of advertisingin general, the more differentiated the products, the more advertising firms buyeconomists disagree about the social values of advertisingThe Critique of Advertisingultimately the market determines successCritics of advertising believe:society is wasting the resources it devotes to advertisingfirms advertise to manipulate people's tastes.Advertising impedes competition- it creates the perception that products are more differentiated than they really are, allowing higher markups.The Defense of Advertisingdefenders of advertising believe:it provides useful information to buyersinformed buyers can more easily find and exploit price differencesthus, advertising promotes competition and reduces market powerBrand Namesin many markets, brand name products coexist with generic onesfirms with brand names usually spend more on advertising, charge higher pricethe Critique of Brand Namescritics of brand names believe:brand names cause consumers to perceive differences that do not really existconsumers' willingness to pay more for brand names is irrational, fostered by advertisingeliminating government protection of trademarks would reduce influence of brand names, result in lower pricesThe Defense of Brand Namesdefenders of brand names believe:brand names provide information about quality to consumerscompanies with brand names have incentive to maintain quality, to protect the reputation of their brand namesConclusiondifferentiated products are everywhere; examples of monopolistic competition aboundthe university of Alabama is a monopolistic competitorthe theory of monopolistic competition describes many markets in the economy, yet offers little guidance to policymakers looking to improve the market's allocation of resourcesThursday April 12thOligopolyOligopoly: a market structure in which only a few sellers offer similar or identical productsstrategic behavior in oligopoly: A firm's decisions about P or Q can affect other firms and cause them to react. The firm will consider these reactions when making decisionsGame theory: the study of how people behave in strategic situationsExample: Cell Phone Duopoly in Small townsmall town has 140 residentsthe "good": cell phone service with unlimited anytime minutes and free phonesmall town's demand scheduletwo firms: T-Mobile, Verizon (duopoly: an oligopoly with two firms)each firm's costs: FC = $0, MC = $10, and ATC = $10Price (P)Quantity (Q)RevenueCostProfit$0140$0$1,400-1,40051306501,300-650101201,2001,2000151101,6501,100550201002,0001,0001,00025902,2509001,35030802,4008001,60035702,4507001,75040602,4006001,80045502,2505001,750at P = $10, competitive outcome: P = MC = $10; Q = 120; Profit = $0at P = $40, monopoly outcome: P = $40; Q = 60; Profit = $1,800they should form a monopoly! (the two firms for a monopoly but merging or