Slide 1Knowledge RecapKnowledge RecapImperfect CompetitionMonopolistic CompetitionMonopolistic CompetitionMonopolistic CompetitionMonopolistic CompetitionMonopolistic CompetitionECON 203: Principles of MicroeconomicsClass 18: Monopolistic Competition1Knowledge Recap•Monopoly vs perfect competition2Characteristics of the MarketPerfect Competition MonopolyMany firms. One firm.Homogenous product (many substitutes).Unique product (no substitutes).No barriers to entry. Barriers to entry.Knowledge Recap•Monopoly vs perfect competition3Firm and Market OutcomesPerfect Competition MonopolyFirms are price-takers. Firms are price-makers.Firm can sell any Q at market P. When firm increases Q, P falls.In equilibrium MC = MR = P. In equilibrium MC = MR < P.In long-term firms make zero economic profits.In the long-term the firm can make positive economic profits.Imperfect Competition•Imperfect competition.– A market structure that lies between perfect competition and a monopoly.– Better representation of real world goods.• Types of imperfect competition.– Monopolistic competition.• Examples: books, cars, clothes.–Oligopolies. •Examples: cable TV, wireless communication, soda.4Monopolistic Competition•Monopolistic competition.–A market structure in which there are many firms selling products that are similar but not identical.5Characteristics of the MarketPerfect Competition Monopoly Monopolistic CompetitionMany firms. One firm. Many firms.Homogenous product (many substitutes).Unique product (no substitutes).Heterogeneous product (imperfect substitutes). No barriers to entry. Barriers to entry. No barriers to entry.Monopolistic Competition•Individual firms’ decisions.– Because of product differentiation, firms face downward sloping demand.– To increase Q firms must decrease P of all units MR < P– Profit maximized where MC = MR < P.– Profit (or loss) determined by TR – TC = (P – ATC)*Q6Monopolistic Competition•Market equilibrium.–With no barriers to entry, existence of profits encourages market entry.–New firm entry increases the number of available products and shifts the demand curve of each firm to the left.–Opposite effects take place in the existence of losses. –Process continues until firms in market make zero profits.–In the long-run P = ATC > MC.7Monopolistic Competition•Monopolistic competition vs perfect competition.–Excess capacity. •With monopolistic competition an increase in scale of production (Q supplied) would lead to a reduction in ATC.•Firms do not increase Q in spite of having the production capacity to do so because of negative effect on P and profit.–Markup over MC.•With monopolistic competition P > MC.•The value of an additional unit sold is above its marginal cost.8Monopolistic Competition•Welfare effects of monopolistic competition.–P > MC leads to deadweight loss. •Given high number of firms, regulation is very costly and leads to additional inefficiencies.–Costs of advertising may be seen as a waste of resources.•Defenders of advertising argue that it increases the amount of available information, thereby increasing consumers’
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