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Monopolistic Competition: The Competitive Model in a More Realistic Setting

This chapter explores the concept of monopolistic competition and its impact on the coffeehouse market in the United States. It explains the downward-sloping demand and marginal revenue curves of monopolistically competitive firms and discusses how firms maximize profit in the short run. It also analyzes the effects of new firms entering the market and the long-run profitability of existing firms.

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Monopolistic Competition: The Competitive Model in a More Realistic Setting

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  1. 12 CHAPTER MonopolisticCompetition: The Competitive Modelin a More RealisticSetting The coffeehouse market is competitive because it is inexpensive to open a new store. Hundreds of firms in the United States operate coffeehouses. Prepared by: Fernando Quijano

  2. 12 CHAPTER Chapter OutlineandLearning Objectives Monopolistic Competition: The Competitive Modelin a More Realistic Setting

  3. Monopolistic Competition: The Competitive Model in a More Realistic Setting Monopolistic competitionA market structure in which barriers to entry are low and many firms compete by selling similar, but not identical, products.

  4. Demand and Marginal Revenue for a Firmin a Monopolistically Competitive Market 12.1 LEARNING OBJECTIVE Explain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves. The Demand Curve for a Monopolistically Competitive Firm FIGURE 12-1 The Downward-Sloping Demand for Caffè Lattes at a Starbucks If a Starbucks increases the price of caffè lattes, it will lose some, but not all, of its customers. In this case, raising the price from $3.00 to $3.25 reduces the quantity of caffè lattes sold from 3,000 to 2,400. Therefore, unlike a perfect competitor, a Starbucks store faces a downward-sloping demand curve.

  5. Demand and Marginal Revenue for a Firmin a Monopolistically Competitive Market 12.1 LEARNING OBJECTIVE Explain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves. Marginal Revenue for a Firm with a Downward-Sloping Demand Curve Table 12-1 Demand and Marginal Revenue at a Starbucks

  6. Demand and Marginal Revenue for a Firmin a Monopolistically Competitive Market 12.1 LEARNING OBJECTIVE Explain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves. Marginal Revenue for a Firm with a Downward-Sloping Demand Curve FIGURE 12-2 How a Price Cut Affects a Firm’s Revenue If the local Starbucks reduces the price of a caffè latte from $3.50 to $3.00, the number of caffè lattes it sells per week will increase from 5 to 6. Its marginal revenue from selling the sixth caffè latte will be $0.50, which is equal to the $3.00 additional revenue from selling 1 more caffè latte (the area of the green box) minus the $2.50 loss in revenue from selling the first 5 caffè lattes for $0.50 less each (the area of the red box).

  7. Demand and Marginal Revenue for a Firmin a Monopolistically Competitive Market 12.1 LEARNING OBJECTIVE Explain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves. Marginal Revenue for a Firm with a Downward-Sloping Demand Curve FIGURE 12-3 The Demand and Marginal Revenue Curves for a Monopolistically Competitive Firm Any firm that has the ability to affect the price of the product it sells will have a marginal revenue curve that is below its demand curve. We plot the data from Table 12-1 to create the demand and marginal revenue curves. After the sixth caffè latte, marginal revenue becomes negative because the additional revenue received from selling 1 more caffè latte is smaller than the revenue lost from receiving a lower price on the caffè lattes that could have been sold at the original price.

  8. How a Monopolistically CompetitiveFirm Maximizes Profit in the Short Run 12.2 LEARNING OBJECTIVE Explain how a monopolistically competitive firm maximizes profit in the short run. FIGURE 12-4 Maximizing Profit in aMonopolistically Competitive Market

  9. 12.2 LEARNING OBJECTIVE • YOUR TURN:For more practice, do related problem 2.6 at the end of this chapter. 12-2 Solved Problem Explain how a monopolistically competitive firm maximizes profit in the short run. Does Minimizing Cost Maximize Profits? Will Apple maximize profits if it produces 800,000 iPhones per month? Average cost reaches a minimum at a quantity of 800,000, but profits are maximized at a quantity of 600,000.

  10. What Happens to Profits in the Long Run? 12.3 LEARNING OBJECTIVE Analyze the situation of a monopolistically competitive firm in the long run. How Does the Entry of New Firms Affect the Profits of Existing Firms? FIGURE 12-5 How Entry of New Firms Eliminates Profits Panel (a) shows that in the short run Starbucks can charge a price above average total cost (point A) and make a profit, shown by the green rectangle. But this profit attracts new firms to enter the market, which shifts the demand and marginal revenue curves to the curves labeled “Long run” in panel (b). At point B, Starbucks breaks even.

  11. 12.3 LEARNING OBJECTIVE What Happens to Profits in the Long Run? Analyze the situation of a monopolistically competitive firm in the long run. How Does the Entry of New Firms Affect the Profits of Existing Firms? Table 12-2 The Short Run and the Long Run for a Monopolistically Competitive Firm

  12. 12.3 LEARNING OBJECTIVE MakingtheConnection • YOUR TURN:Test your understanding by doing related problem 3.6 at the end of this chapter. Analyze the situation of a monopolistically competitive firm in the long run. • The Rise and Decline of Starbucks In a monopolistically competitive industry, maintaining profits in the long run is very difficult. Starbucks: No longer different enough?

  13. What Happens to Profits in the Long Run? 12.3 LEARNING OBJECTIVE • YOUR TURN:Test your understanding by doing related problem 3.4 at the end of this chapter. Analyze the situation of a monopolistically competitive firm in the long run. Is Zero Economic Profit Inevitable in the Long Run? A firm’s profits will be eliminated in the long run onlyif a firmstands still and fails to find new ways of differentiating its product or fails to find new ways of lowering the cost of producing its product. Don’t Let This Happen to YOU!Don’t Confuse Zero Economic Profit with Zero Accounting Profit

  14. 12.3 LEARNING OBJECTIVE • YOUR TURN:For more practice, do related problem 3.7 at the end of this chapter. Solved Problem 12-3 Analyze the situation of a monopolistically competitive firm in the long run. Can It Be Profitable to Be the High-Price Seller? Because the greater demand more than offsets the higher costs, the hhgregg store makes a larger profit.

  15. Comparing Perfect Competition and Monopolistic Competition 12.4 LEARNING OBJECTIVE Compare the efficiency of monopolistic competition and perfect competition. Monopolistic competition and perfect competition share the characteristic that in long-run equilibrium, firms earn zero economic profits. However, there are two important differences between long-run equilibrium in the two markets: • Monopolistically competitive firms charge a price greater than marginal cost. • Monopolistically competitive firms do not produce at minimum average total cost.

  16. Comparing Perfect Competition and Monopolistic Competition 12.4 LEARNING OBJECTIVE Compare the efficiency of monopolistic competition and perfect competition. Excess Capacity under Monopolistic Competition FIGURE 12-6 Comparing Long-Run Equilibrium under Perfect Competition and Monopolistic Competition A monopolistically competitive firm has excess capacity: If it increased its output, it could produce at a lower average cost.

  17. Comparing Perfect Competition and Monopolistic Competition 12.4 LEARNING OBJECTIVE Compare the efficiency of monopolistic competition and perfect competition. Is Monopolistic Competition Inefficient? Economists have debated whether monopolistically competitive markets being neither productively nor allocatively efficient results in a significant loss of well-being to society in these markets compared with perfectly competitive markets. How Consumers Benefit from Monopolistic Competition Consumers benefit from being able to purchase a product that is differentiated and more closely suited to their tastes.

  18. 12.4 LEARNING OBJECTIVE MakingtheConnection • YOUR TURN:Test your understanding by doing related problem 4.6 at the end of this chapter. Compare the efficiency of monopolistic competition and perfect competition. • Abercrombie & Fitch: Can the Product Be Too Differentiated? A firm whose strategy of product differentiation succeeds will experience increases in same-store sales. Did Abercrombie and Fitch narrow its target market too much?

  19. How Marketing Differentiates Products 12.5 LEARNING OBJECTIVE Define marketing and explain how firms use it to differentiate their products. Marketing All the activities necessary for a firm to sell a product to a consumer. Brand Management Brand management The actions of a firm intended to maintain the differentiation of a product over time.

  20. How Marketing Differentiates Products 12.5 LEARNING OBJECTIVE Define marketing and explain how firms use it to differentiate their products. Advertising If the increase in revenue that results from the advertising is greater than the increase in costs, the firm’s profits will rise. Defending a Brand Name A firm can apply for a trademark, which grants legal protection against other firms using its product’s name.

  21. 12.5 LEARNING OBJECTIVE MakingtheConnection Google Tries (and Fails) toMeasure the Effectivenessof Radio Advertising Define marketing and explain how firms use it to differentiate their products. A firm’s optimal level of advertising occurs where the marginal cost of advertising equals the marginal revenue earned from advertising. Does spending on radio advertising attract customers? • YOUR TURN:Test your understanding by doing related problem 5.7 at the end of this chapter.

  22. 12.6 LEARNING OBJECTIVE What Makes a Firm Successful? Identify the key factors that determine a firm’s success. FIGURE 12-7 What Makes a Firm Successful? The factors under a firm’s control—the ability to differentiate its product and the ability to produce it at lower cost—combine with the factors beyond its control to determine the firm’s profitability.

  23. 12.6 LEARNING OBJECTIVE MakingtheConnection Identify the key factors that determine a firm’s success. Is Being the First Firm inthe Market a Key to Success? The firms that were first to introduce a product ultimately lost out to latecomers who did a better job of providing consumers with products that were more reliable, less expensive, more convenient, or otherwise provided greater value. Although not first to market, Bic ultimately was more successful than the firm that pioneered ballpoint pens. • YOUR TURN:Test your understanding by doing related problem 6.6 at the end of this chapter.

  24. AN INSIDE LOOK Starbucks Faces McCompetition >> The effect of entry on price, quantity, and profits at Starbucks.

  25. KEY TERMS Brand management Marketing Monopolistic competition

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