Monopolistic Competition
The Four Types of Market Structure
Monopolistic Competition
Monopolistic Competition is one type of imperfect competition.
◦ Many firms selling products that are similar but not identical.
◦ Markets that have some features of competition and some features of
monopoly.
Characteristics Of Monopolistic
Competition
Many sellers (Competition)
◦ There are many firms competing for the same group of customers e.g.
books, CDs, restaurants.
Product differentiation (Monopoly)
◦ 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 (Competition)
◦ Firms can enter or exit the market without restriction.
What are the benefits of having similar
but not identical products?
-to producers?
-to consumers?
Monopolistic Competition and the
Welfare of Society
Externalities of entry include:
◦ The product-variety externality:
◦ 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.
Identify whether the firms will advertise
of not? And give some examples
o Selling highly differentiated consumer goods?
o Selling industrial products?
o Selling homogeneous products?
Questions
For each of the following pairs of firms, explain
which firm would be more likely to engage in
advertising:
a. a family-owned farm or a family-owned
restaurant
b. a manufacturer of forklifts or a manufacturer of
cars
c. a company that invented a very comfortable
razor or a company that invented a less
comfortable razor
Is advertising good or bad?
Is advertising good or bad?
Critics Defenders
• Firms advertise in order • Provides information to
to manipulate people’s consumers
tastes.
• Increases competition
• It impedes competition by offering a greater
by implying that products variety of products and
are more different than prices
they really are.
Do you support huge investments by the
firms on Branding?
Branding and Brand Names
Advertising As A Signal Of Quality
Critics argue that brand names cause consumers to perceive
differences that do not really exist.
However, brand names may be a useful way for consumers
to ensure that the goods they are buying are of high quality
by:
◦ Providing information about quality.
◦ Giving firms incentive to maintain high quality.
Monopolistically Competitive Firm in the Short
Run : Case of profit
Short-run economic profits encourage new firms to
enter the market. This:
◦ Increases the number of products offered.
◦ Reduces demand faced by firms already in the market.
◦ Incumbent firms’ demand curves shift to the left.
◦ Demand for the incumbent firms’ products fall, and their profits
decline.
Monopolistically Competitive Firm in the Short
Run: Case of profit
Price
MC
ATC
Price
Average
total cost
Profit Demand
MR
0 Profit- Quantity
maximizing
quantity
Monopolistically Competitive Firm in
the Short Run: Case of Loss
Short-run economic losses encourage firms to exit
the market. This:
◦ Decreases the number of products offered.
◦ Increases demand faced by the remaining firms.
◦ Shifts the remaining firms’ demand curves to the right.
◦ Increases the remaining firms’ profits.
Monopolistically Competitive Firm in the Short
Run: Case of loss
Price
MC
ATC
Losses
Average
total cost
Price
MR Demand
0 Loss- Quantity
minimizing
quantity
The Long-Run Equilibrium
Price
MC
ATC
Firms will enter and exit
P = ATC
until the firms are making
exactly zero economic
profits.
Demand
MR
0
Profit-maximizing Quantity
quantity
Long-Run Equilibrium
◦ Monopoly feature: price exceeds marginal cost.
◦ Profit maximization requires marginal revenue to equal marginal
cost.
◦ The downward-sloping demand curve makes marginal revenue less
than price.
◦ Competitive market feature: price equals average total
cost.
◦ Free entry and exit drive economic profit to zero.
Monopolistic versus Perfect Competition
There are two noteworthy differences between
monopolistic and perfect competition—
① Excess capacity
② Mark-up.
Monopolistic versus Perfect Competition
① Excess Capacity
◦ There is no excess capacity in perfect competition in the long
run.
◦ Free entry results in competitive firms producing at the point where
average total cost is minimized, which is the efficient scale of the firm.
◦ There is excess capacity in monopolistic competition in the
long run.
◦ In monopolistic competition, output is less than the efficient scale of
perfect competition.
Monopolistic versus Perfect Competition:
Excess capacity
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Price Price
MC MC
ATC ATC
P
P = MC P = MR
(demand
curve)
MR Demand
0 Quantity Efficient Quantity 0 Quantity produced = Quantity
produced scale Efficient scale
Monopolistic versus Perfect Competition
② Mark-up Over Marginal Cost
◦ For a competitive firm, price equals marginal cost.
◦ For a monopolistically competitive firm, price exceeds marginal
cost.
◦ Because price exceeds marginal cost, an extra unit sold at the
posted price means more profit for the monopolistically
competitive firm.
Monopolistic versus Perfect Competition:
Mark-up
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Price Price
MC MC
ATC ATC
mark-up
P
P = MC P = MR
(demand
Marginal curve)
cost
MR Demand
0 Quantity Quantity 0 Quantity produced Quantity
produced
Question
Colgate is one firm of many in the market for toothpaste,
which is in long-run equilibrium.
a. Draw a diagram showing Colgate’s demand curve,
marginal-revenue curve, average-total cost curve, and
marginal-cost curve. Label Colgate’s profit-maximizing
output and price.
b. What is Colgate’s profit? Explain.
c. On your diagram, show the consumer surplus derived
from the purchase of Colgate toothpaste. Also show the
deadweight loss relative to the efficient level of output.
d. If the government forced Colgate to produce the efficient
level of output, what would happen to the firm? What would
happen to Colgate’s customers?
a. The profit maximizing level of output is QM and the price is PM
b. Colgate's profit is zero, because at quantity QM, price equals average total
cost.
c. The consumer surplus from the purchase of Colgate toothpaste is areas A + B.
The efficient level of output occurs where the demand curve intersects the
marginal-cost curve, at QC. The deadweight loss is area C, the area above
marginal cost and below demand, from QM to QC.
d. If the government forced Colgate to produce the efficient level of output, the
firm would lose money because average total cost would exceed price, so the
firm would shut down. If that happened, Colgate's customers would earn no
consumer surplus.
