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OSU ECON 4001.01 - Basics of Monopolistic Competition

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Econ 4001.01 1st Edition Lecture 20Outline of Last Lecture II. Illustration of Monopoly vs. Price DiscriminationIII. Intertemporal Price DiscriminationIV. Two Part TariffsV. Bundling-Forcing Consumers to Buy ProductsOutline of Current Lecture VI. Basics of Monopolistic CompetitionVII. Long-Run vs. Short-run in Monopolistic CompetitionVIII. Monopolistic Competition vs. Perfect CompetitionIX. Welfare Impacts of Monopolistic CompetitionX. Advertising and Monopolistic CompetitionXI. Pros and Cons of AdvertisingXII. Strategic Behavior between FirmsCurrent Lecture- Forms of Competition among Firmso We have covered perfect competition and learned about monopolyo Now, we are going to go over monopolistic competition- Basics of Monopolistic Competitiono Many sellers in marketo Products are not identical  Product differentiation allows firms to set price Demand curves slope downward, but are highly elastico Free entry and exit Firms in market have no way to deny entry New firms will enter if market is profitableThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute. Loss-making firms will exit in the long runo Examples of markets with monopolistic competition Books and movies Clothing and shoe stores Restaurants Almost all branded products are monopolistically competitive- M.C. Equilibrium in the Short Runo We follow our usual rules for monopoly: Produce at quantity where MC=MR Set price from the demand curve from thereo If price is greater than ATC, short term profits earnedo If price is less than ATC, short term losses incurred- Adjustments in the Long Run in MC Marketso Profits bring new entrants into the market Each new firm means the demand curves for the incumbent shift to the left (substitution effect) Profit for each incumbent firm is reducedo Losses cause some firms to leave the market Total variety of products in the market are reduced Demand curves for the remaining firms shift out, and eventually all losses go away- Monopolistic Competition vs. Perfect Competitiono Monopolistic Competition Firms do not operate at minimum ATC- they could lower costs by making more Price exceeds marginal cost, so price is “too high” Quantity is less than efficient level- it is “too low”o Perfect Competition Firms operate at minimum ATC- capacity is just right Price and quantity are at efficient levels- Welfare Impacts of MCo With P>MC there is a deadweight loss to the economyo Taste for product variety creates a positive benefit to consumers that producer cannot captureo Business-stealing effect (new firms entering and taking away customers) creates cost to competitors that stealing firm does not pay for- Advertising and MCo In almost all markets described by MC, advertising is important, why?o Since all firms have excess capacity, firms earning short-run profits advertise to capture new buyers and prevent competitors from taking their customerso These MC firms will spend 10-20% of their revenues in advertising spendingo Firms also advertise to increase demand- Pros and Cons of Advertisingo Pros Provide information to consumers Increases consumers satisfaction with products that they buy Enhances market ability to allocate resources efficientlyo Cons Wastes valuable resources (ad cost is a business expense) Makes consumers value unimportant attributes Harms consumers’ desire to obtain a better price- Strategic Behavior among Firmso Advertising is our first example of firms interacting with their competitors They advertise to increase demand, reduce rival’s demand Since they have declining AC, business stealing decreases their costs and increases their profits If all firms advertise, however, the effort may be wastedo In Oligopoly, these strategic concerns become more


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