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Slide 1C H A P T E R C H E C K L I S T15.1 WHAT IS MONOPOLISTIC COMPETITION?Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 1115.2 OUTPUT AND PRICE DECISIONSSlide 13Slide 15Slide 16Slide 18Slide 19Slide 21Slide 22Slide 23Slide 25Slide 2715.3 DEVELOPMENT AND MARKETINGSlide 29Slide 30Slide 31Slide 33Slide 34Slide 36Slide 38Slide 39Slide 41Slide 43Slide 44Slide 45When you have completed your study of this chapter, you will be able toC H A P T E R C H E C K L I S TDescribe and identify monopolistic competition.1Explain how a firm in monopolistic competition determines its output and price in the short run and the long run .2Explain why advertising costs are high and wy firms use brand names in monopolistic competition.315.1 WHAT IS MONOPOLISTIC COMPETITION?Monopolistic competition is a market structure in which:•A large number of independent firms compete.•Each firm produces a differentiated product.•Firms compete on product quality, price, and marketing.•Firms are free to enter and exit.Large Number of FirmsLike perfect competition, the market has a large number of firms. Three implications are:Small market shareNo market dominanceCollusion impossible15.1 WHAT IS MONOPOLISTIC COMPETITION?Product DifferentationProduct differentiationMaking a product that is slightly different from the products of competing firms.A differentiated product has close substitutes but it does not have perfect substitutes.When the price of one firm’s product rises, the quantity demanded of that firm’s product decreases.15.1 WHAT IS MONOPOLISTIC COMPETITION?Competing on Quality, Price, and MarketingQualityDesign, reliability, service, ease of access to the product.PriceA downward sloping demand curve.MarketingAdvertising and packaging15.1 WHAT IS MONOPOLISTIC COMPETITION? Entry and ExitNo barriers to entry.A firm cannot make economic profit in the long run.15.1 WHAT IS MONOPOLISTIC COMPETITION? Identifying Monopolistic CompetitionTwo indexes:•The four-firm concentration ratio•The Herfindahl-Hirschman Index15.1 WHAT IS MONOPOLISTIC COMPETITION?The four-firm concentration ratioThe percentage of the value of sales accounted for by the four largest firms in the industry.The range of concentration ratio is from almost zero for perfect competition to 100 percent for monopoly.•A ratio that exceeds 40 percent: indication of oligopoly.•A ratio of less than 40 percent: indication of monopolistic competition.15.1 WHAT IS MONOPOLISTIC COMPETITION?The Herfindahl-Hirschman Index (HHI)The square of the percentage market share of each firm summed over the largest 50 firms in a market.Example, four firms with market shares as 50 percent, 25 percent, 15 percent, and 10 percent.HHI = 502 + 252 + 152 + 102 = 3,450A market with an HHI less than 1,000 is regarded as competitive.An HHI between 1,000 and 1,800 is moderately competitive.15.1 WHAT IS MONOPOLISTIC COMPETITION?Limitations of Concentration MeasuresThe two main limitations of concentration measures alone as determinants of market structure are their failure to take proper account of•The geographical scope of a market•Barriers to entry and firm turnover15.1 WHAT IS MONOPOLISTIC COMPETITION?15.2 OUTPUT AND PRICE DECISIONSHow, given its costs and the demand for its jeans, does Tommy Hilfiger decide the quantity of jeans to produce and the price at which to sell them?The Firm’s Profit-Maximizing DecisionThe firm in monopolistic competition makes its output and price decision just like a monopoly firm does.Figure 15.1 on the next slide illustrates this decision.1. Profit is maximized when MR = MC3. The profit-maximizing price is $75 per pair.4. The firm makes an economic profit of $6,250 a day.2. The profit-maximizing output is 125 pairs of Tommy jeans per day.ATC is $25 per pair, so15.2 OUTPUT AND PRICE DECISIONS15.2 OUTPUT AND PRICE DECISIONSProfit Maximizing Might Be Loss MinimizingSome firms in monopolistic competition have a tough time making a profit. A burst of entry into an industry can limit the demand for each firm’s own product. Figure 15.1 on the next slide illustrates a firm incurring a loss in the short run.1. Loss minimized when MC = MR3. The price is $40 per month, which is less than ATC.4. The firm incurs an economic loss.2. The loss-minimizing output is 40,000 customers.15.2 OUTPUT AND PRICE DECISIONSLong Run: Zero Economic ProfitEconomic profit induces entry and economic loss induces exit, as in perfect competition.Entry decreases the demand for the product of each firm.Exit increases the demand for the product of each firm.In the long run, economic profit is competed away and firms earn normal profit.Figure 15.3 on the next slide illustrates long-run equilibrium.15.2 OUTPUT AND PRICE DECISIONS1. The output that maximizes profit is 75 pairs of Tommy jeans a day.2. The price is $50 per pair. Average total cost is also $50 per pair.3. Economic profit is zero.15.2 OUTPUT AND PRICE DECISIONSMonopolistic Competition and Perfect CompetitionThe two key differences between monopolistic competition and perfect competition are that in monopolistic competition, there is•Excess capacity•A markup of price over marginal cost15.2 OUTPUT AND PRICE DECISIONSExcess CapacityA firm has excess capacity if the quantity it produces is less that the quantity at which average total cost is a minimum.A firm’s efficient scale is the quantity of production at which average total cost is a minimum.MarkupA firm’s markup is the amount by which price exceeds marginal cost.15.2 OUTPUT AND PRICE DECISIONS1. The efficient scale is 100 pairs of jeans a day.15.2 OUTPUT AND PRICE DECISIONS2. The quantity produced is less than the efficient scale and the firm has excess capacity.3. Price exceeds marginal cost by the amount of the markup.In perfect competition, the efficient quantity is produced and price equals marginal cost.15.2 OUTPUT AND PRICE DECISIONSIs Monopolistic Competition EfficientEfficiency requires marginal benefit to equal marginal cost.In monopolistic competition, price exceeds marginal cost, which is an indicator of inefficiency.Making the Relevant ComparisonPrice exceeds marginal cost because of product differentiation. But product variety is valued.The Bottom LineThe bottom line is ambiguous. But compared to the alternative, monopolistic competition looks efficient.15.2 OUTPUT AND PRICE DECISIONS15.3 DEVELOPMENT AND MARKETING Innovation and Product DevelopmentWherever economic profits are earned,


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UWG ECON 2106 - Monopolistic Competition

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