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Monopolistic Competition. Madelyn Au & Christie Park. Agenda. Characteristics Product Differentiation Role of Advertising Firm Behaviour Short Run Long Run Allocative Efficiency Excess Capacity. Monopolistic Competition. Falls between perfect competition and monopolies
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Monopolistic Competition Madelyn Au & Christie Park
Agenda • Characteristics • Product Differentiation • Role of Advertising • Firm Behaviour • Short Run • Long Run • Allocative Efficiency • Excess Capacity
Monopolistic Competition • Falls between perfect competition and monopolies Characteristics: • Many competitors • Differentiated products • Few barriers to entry and exit • Low market power • Examples: Restaurant & Clothing Stores
Product Differentiation Non-price differences • Type, style, quality, reputation, appearance, location • Three forms of product differentiation: • Style or Type (i.e. Sedans vs. SUVs • Location (i.e. Closer vs. Cheaper but further away) • Quality (i.e. Ordinary vs. Gourmet)
Product Differentiation • Two features: • Competition among sellers • Value in diversity • Competitive advantage • Only way to acquire market power • No collusion
Role of Advertising • Information provided by a company about its product/service • 2 purposes: • Product differentiation • Market control • Increase demand, reduce demand elasticity • Is advertising worth the expense?
Role of Advertising Criticism • Manipulate people’s tastes • Impede competition • Defense • Willingness of a firm to spend advertising dollars can be a signal to consumers about the quality of the product
Role of Advertising • Brand Names • Creates a perceived difference that may or may not exist • Economically Valuable • Economically Wasteful
Firm Behaviour Short run • Acts like monopolies • Use market power to generate revenue
Firm Behaviour Short run • Acts like monopolies • Use market power to generate revenue Long run • Acts like perfect competition • No economic profit
Allocative Efficiency • Occurs when price consumers pay equals the cost of the resources used up in production • MC=MR • Neither allocatively efficient in the short run or long run • Consumers are being charged at P* when it costs A to produce the good • Total economic welfare is not maximized
Excess Capacity • Firms produce less than the output at which average total cost is minimized • Want more profit • Produce less than the minimum-cost output • Have higher costs that firms in a perfectly competitive market • Higher price or greater product diversity?
Deadweight Loss • People who would have more marginal benefit than marginal cost are not buying • People who have more marginal cost than marginal benefit are buying • Caused by markup of price over marginal cost + firm’s decision to produce less than the socially optimal quantity
Review Question 1 Monopolistically-competitive firms exercise market power because of: A. Product differentiation. B. Government franchises. C. Patent protection. D. High entry barriers.
Review Question 2 In the short run, monopolistically-competitive firms: A. May earn positive economic profit. B. May earn negative economic profit. C. May earn a normal, above normal, or below normal rate of return. D. Will continue to produce if AVC < P < ATC. E. All of the above
Review Question 3 A profit-maximizing, monopolistically-competitive firm will produce at an output level where: A. P = ATC. B. MR = MC. C. MR = ATC. D. AVC > MR. E. P = MR.
