Principles of Microeconomics: Chapter 16In reality, firms fall between perfectly competitive (offering identical products) and monopoly (one firm for an entire market) = imperfect competitionOligopoly: a market in which only a few sellers offer similar or identical products (e.g., breakfast cereal)Monopolistic competition: a market in which many firms sell products that are similar but not identical. Each firm has a monopoly over the product it makes, but many other firms make similar products that compete for the same customers. Monopolistic: • Many sellers: there are many firms competing for the same group of customers• Product differentiation: each firm produces a product that is at least slightly different from those of other firms. Rather than being a price taker, each firm faces a downward sloping demand curve.• Free entry and exit: firms can enter or exit the market without restriction.The Monopolistically Competitive Firm in the Short RunThe firm chooses to produce the quantity at which marginal revenueequals marginal cost (because it has a downward-sloping demand curve), much like a monopoly. Long Run EquilibriumWhen firms are making profits, new firms have an incentive to enter. This entry increases the number of products from which to choose and lowers demand faced by existing firms. When firms are making losses, firms have an incentive to exit. This exit decreases the number of products from which to choose from and raises demand faced by remaining firms. ^process continues until firms are making zero economic profit. The demand curve must be tangent to the ATC curve once economic profit is zero. •As in a monopoly market, price exceeds marginal cost. • As in a competitive market, price equals ATC. Monopolistic vs. Perfect CompetitionExcess capacity: the quantity of output at point of tangency b/w demand and ATC is less than the quantity that minimizes ATC (efficient scale).A firm could increase quantity produced to lower ATC, but would have to cut prices. It is more profitable to operate with excess capacity.For a monopolistically competitive firm, price will exceed marginal cost because the firm will always have a bit of market power. ^Zero-profit condition ensures that price must equal ATC, not marginal cost. In the long run, monopolistically competitive firms operate on the declining portion of ATC curve, so marginal cost is below ATC. Price is allowed to exceed marginal cost. Monopolistic Competition and the Welfare of SocietyOne source of inefficiency is the markup of prices over marginal cost. Because of this, some consumers who value the good at more than the marginal cost but less than the price will be deterred from buyingit. This will bring a normal DWL seen in monopoly pricing.^very difficult to regulateAnother problem: too many or too little firms in the market. Whenever a new firm considers entering the market with a new product, it will have two externalities:• The product-variety externality: Because consumers get some consumer surplus from the introduction of a new product, entry of a new firm conveys a positive externality on consumers.• The business-stealing externality: Because other firms lose customers and profits from the entry of a new competitor, entry of a new firm imposes a negative externality on existing firms.Monopolistic competition is not as efficient as perfect competition, butits subtleties are too many for policymakers to consider correcting. AdvertisingWhen firms sell differentiated products and charge above marginal cost, each firm has an incentive to advertise and attract more buyers. Average of 2% of all economic revenue is spent on advertising. Critics argue that firms advertise to manipulate people's tastes, impedes competition by differentiating products too much. Defenders argue that firms advertise to provide information, enhancing the consumer's knowledge and the market's ability to allocate resources efficiently, allows new firms a way to attract customers. As a signal of quality: the willingness of a firm to spend a large amount of money on advertising can be a signal of the quality of the product offered. Brand names: Most often, the firm with the brand name will spend more on ads and charge more for its product; critics argue that brand names cause consumers to believe there is a large differentiation between products, fostering irrationality. But, brand names may help consumers ensure what they buy is good quality, because firms have a financial stake in making sure their product
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