Chapter 16 Monopolistic Competition Between Monopoly and Perfect Competition Many industries fall somewhere between the cases of perfect competition and monopoly imperfect competition o Firms face competition but the competition is not so rigorous as to make o Firms have market power but it is not so great that the firm can be an the firm a price taker exact monopoly Oligopoly products a market structure in which only a few sellers offer similar or identical o Concentration ratio the percentage of total output in the market supplied by the four largest firms Cereal firms aircraft manufacturing firms electric lamp bulb firms and cigarettes firms are all oligopolies a market structure in which many firms sell products Monopolistic Competition that are similar but not identical o Many sellers high competition for same customer base o Product differentiation slight variation in product regular downward sloping demand curve o Free entry and exit number of firms adjust until economic profit is zero Competition with Differentiated Products The Monopolistically Competitive Firm in the Short Run Downward sloping demand curve Follows monopolist s rule for profit maximization it chooses to produce the quantity at which marginal revenue equals marginal cost and then uses its demand curve to find the price at which it can sell that quantity Profit maximization quantity is found at intersection of the MR and MC cost curves o When ATC is above price loss o When ATC is below price profit The Long Run Equilibrium Profit encourages entry in the market and entry shifts the demand curves faced by the new firms to the left As the demand for the firms products falls since more firms are now in the market more options to choose from the firms experience declining profit When firms are making a negative profit they have an incentive to leave the market As firms exit customers have fewer products to choose from and demand expands by those firms that stay in the market Demand curve shifts to the right o Entry and exit continue until the firms in the market reach zero economic profit At equilibrium firms have no incentive to enter or exit the market Maximum profit is zero only if the price and ATC aren t intersecting but touching Price ATC Same quantity as MR equals MC Difference between monopoly and monopolistically competitive market monopoly makes positive economic profit in the long run but monopolistically competitive markets reach zero in the long run Monopolistic Versus Perfect Competition Differences between monopolistic and perfect competition excess capacity and the markup Excess Capacity Firms produce on the downward sloping portion of their ATC curve in a monopolistic competition Competitive firms produce at minimum of ATC o Efficient Scale the point at which the quantity minimizes ATC In the long run monopolistically competitive firms produce below the efficient scale and perfectly competitive firms produce above it They produce below equilibrium therefore have excess capacity since in theory they could produce more than they do o Excess Capacity monopolistically competitive firms can increase the quantity they produce and lower the average total cost of production However firms choose not to do this because they would have to cut prices so they operate with excess capacity Markup over Marginal Cost Price exceeds marginal cost because the firm always has some market power in a monopolistically competitive market Since marginal cost is below average total cost and price equals average total cost price must be above marginal cost o An extra unit sold means more profit Example firms will send out Christmas cards to the buyers in order to gain a bigger customer base Monopolistic Competition and the Welfare of Society Inefficient aspects of monopolistic competition o Some consumers who value a good at more than the marginal cost of production but less than the price won t buy the good Regulating firms that produce different products can be difficult therefore most of the time policymakers decide it s better to live with the inefficiency of monopolistic pricing o There can be too many or not enough firms in the market because there is free entry 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 anew competitor entry of a new firm imposes negative externalities on existing firms Monopolistically competitive markets do not have all the desirable welfare properties of perfectly competitive markets The invisible hand doesn t ensure that total surplus is maximized but there is no easy way to fix inefficiency Advertising Firms that sell consumer goods spend 10 20 on advertising firms that sell industrial products spend less and firms that sell homogeneous products wheat spend nothing at all The Debate Over Advertising The critique of advertising Critics of advertising argue that firms advertise to manipulate people s tastes Advertising can be psychological rather than informative It also increases the perception of product differentiation and brand loyalty which makes consumers less concerned with the price differences of similar goods Each firm charges a larger markup over marginal cost Defenders of advertising argue that firms use advertising to provide information to customers This information allows customers to make better choices about what to buy which allows markets to efficiently allocate resources Advertising can also inform people about prices which can lead them to make smarter decisions when purchasing goods Policymakers have come to accept advertising as a way to provide information to customers and make markets more competitive Advertising as a Signal of Quality The willingness of a firm to spend a large amount of money on advertising can be a signal to customers about the quality of the product being offered o If a firm is selling a low quality product they will ultimately lose money if they advertise and eventually they ll stop advertising their product Firms that benefit from advertising will benefit from money spent in publicizing their product Brand Names Critics argue brand names cause consumers to perceive differences that don t really exist In reality the products are usually indistinguishable Defenders argue brand names are a useful way for consumers to
View Full Document
Unlocking...