Slide 1After studying this chapter, you will be able to:Slide 3What Is Monopolistic Competition?Monopolistic CompetitionWhat Is Monopolistic Competition?Slide 7What Is Monopolistic Competition?Monopolistic CompetitionPrice and Output in Monopolistic CompetitionPrice and Output in Monopolistic CompetitionPrice and Output in Monopolistic CompetitionPrice and Output in Monopolistic CompetitionPrice and Output in Monopolistic CompetitionPrice and Output in Monopolistic CompetitionPrice and Output in Monopolistic CompetitionPrice and Output in Monopolistic CompetitionPrice and Output in Monopolistic CompetitionPrice and Output in Monopolistic CompetitionPrice and Output in Monopolistic CompetitionPrice and Output in Monopolistic CompetitionProduct Development and MarketingProduct Development and MarketingProduct Development and MarketingProduct Development and MarketingProduct Development and MarketingProduct Development and MarketingProduct Development and MarketingProduct Development and MarketingProduct Development and MarketingProduct Development and MarketingProduct Development and MarketingProduct Development and MarketingProduct Development and Marketing14MONOPOLISTIC COMPETITION© 2014 Pearson Addison-WesleyAfter studying this chapter, you will be able to:¨Define and identify monopolistic competition¨Explain how a firm in monopolistic competition determines its price and output in the short run andthe long run¨Explain why advertising costs are high and why firms in a monopolistic competition use brand names© 2014 Pearson Addison-WesleyThe online shoe store shoebuy.com lists athletic shoes made by 56 different producers in 40 categories.Athletic shoe producers compete, but each has a monopoly on its own special kind of shoe.With so many different types of athletic shoes, the market isn’t perfectly competitive. The model of monopolistic competition helps us to understand the competition that we see every day in the markets for athletic shoes and most other goods and services we buy.© 2014 Pearson Addison-WesleyWhat Is Monopolistic Competition?Monopolistic competition is a market structure in which A large number of firms compete. Each firm produces a differentiated product. Firms compete on product quality, price, and marketing. Firms are free to enter and exit the industry.© 2014 Pearson Addison-WesleyMonopolistic CompetitionLarge Number of FirmsThe presence of a large number of firms in the market implies: Each firm has only a small market share and therefore has limited market power to influence the price of its product.  Each firm is sensitive to the average market price, but no firm pays attention to the actions of others. So no one firm’s actions directly affect the actions of others. Collusion, or conspiring to fix prices, is impossible.© 2014 Pearson Addison-WesleyWhat Is Monopolistic Competition?Product DifferentiationA firm in monopolistic competition practices product differentiation if the firm makes a product that is slightly different from the products of competing firms.© 2014 Pearson Addison-WesleyProduct differentiation—the heart of the space between monopoly and competition “Ice cream on the beach” monopolistic competition fills the space between monopoly and perfect competition.A__________________________________________BAn ice-cream vendor decides to set up shop on the beach—the only one. Where will she locate?© 2014 Pearson Addison-WesleyWhat Is Monopolistic Competition?Competing on Quality, Price, and MarketingProduct differentiation enables firms to compete in three areas: quality, price, and marketing. Quality includes design, reliability, and service. Because firms produce differentiated products, the demand for each firm’s product is downward sloping. But there is a tradeoff between price and quality. Because products are differentiated, a firm must market its product. Marketing takes the two main forms: advertising and packaging.© 2014 Pearson Addison-WesleyMonopolistic CompetitionEntry and ExitThere are no barriers to entry in monopolistic competition, so firms cannot make an economic profit in the long run.Examples of Monopolistic CompetitionProducers of audio and video equipment, clothing, jewelry, computers, and sporting goods operate in monopolistic competition.© 2014 Pearson Addison-WesleyPrice and Output in Monopolistic CompetitionThe Firm’s Short-Run Output and Price DecisionA firm that has decided the quality of its product and its marketing program produces the profit-maximizing quantity (the quantity at which MR = MC).Price is determined from the demand for the firm’s product and is the highest price that the firm can charge for the profit-maximizing quantity.Figure 14.1 shows a firm’s economic profit in the short run.© 2014 Pearson Addison-WesleyPrice and Output in Monopolistic CompetitionThe firm in monopolistic competition operates likea single-price monopoly. The firm produces the quantity at which MR equals MC and sells that quantity for the highest possible price.It makes an economic profit (as in this example) when P > ATC.© 2014 Pearson Addison-WesleyPrice and Output in Monopolistic CompetitionProfit Maximizing Might Be Loss MinimizingA firm might incur an economic loss in the short run.Here is an example.At the profit-maximizing quantity, P < ATC and the firm incurs an economic loss.© 2014 Pearson Addison-WesleyPrice and Output in Monopolistic CompetitionLong Run: Zero Economic ProfitIn the long run, economic profit induces entry.And entry continues as long as firms in the industry earn an economic profit—as long as (P > ATC).In the long run, a firm in monopolistic competition maximizes its profit by producing the quantity at which its marginal revenue equals its marginal cost, MR = MC.© 2014 Pearson Addison-WesleyPrice and Output in Monopolistic CompetitionAs firms enter the industry, each existing firm loses some of its market share. The demand for its product decreases and the demand curve for its product shifts leftward.The decrease in demand decreases the quantity at which MR = MC and lowers the maximum price that the firm can charge to sell this quantity.Price and quantity fall with firm entry until P = ATC and firms earn zero economic profit.© 2014 Pearson Addison-WesleyPrice and Output in Monopolistic CompetitionFigure 14.3 shows a firm in monopolistic competition in long-run equilibrium.© 2014 Pearson Addison-WesleyPrice and Output in Monopolistic