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Monopolistic Competition
Examples of monopolistic competition are everywhere: the clothes students where, the frappacinos they slurp up on their way to class or work, the books they read, the nightclubs they dance at. As a result, students find the theory of monopolistic competition more relevant than the theory of perfect competition, which best describes produces like wheat and soybeans, products that few students every consider buying. If students are reasonably comfortable with the material on perfect competition and monopoly, then this chapter should not be difficult. It is also shorter than average.
PRINCIPLES OF
MICROECONOMICS
F OURT H E DITIO N
N. G R E G O R Y M A N K I W
PowerPoint Slides by Ron Cronovich
2007 Thomson South-Western, all rights reserved
In this chapter, look for the answers to these questions: How is monopolistic competition similar to perfect
competition? How is it similar to monopoly?
Monopolistic competition:
a market structure in which many firms sell products that are similar but not identical.
Examples:
Another important dimension of product differentiation, not emphasized in the book, is location. Gasoline seems like an undifferentiated product, yet different gas stations charge different prices. How can some gas stations get away with charging 5 or even 10 cents more per gallon? The answer is product differentiation by location. Imagine youre driving home in rush-hour traffic from a grueling 10hour day at the office. The orange warning light comes on, indicating your car needs gas. After uttering a few choice expletives, you notice two gas stations at an upcoming intersection. The one on the right charges 5 cents more than the one on the left, but is easily accessible. The one on the left would require you to make a left-hand turn in heavy traffic to get into the station, and another to get out. And how much would you save? If you buy 20 gallons, youd save only $1. Alternatively, imagine you run a gas station located in a highly residential area, in which there are few other businesses including gas stations. If people want gas, they can buy it from you, or they can drive 10 minutes to a more commercial area with lots of gas stations. Your location allows you to charge a higher price. Business people have long understood that location is a critical dimension of product differentiation. Hence the saying location, location, location.
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That long-run profits are zero follows from free entry/exit. The market power of a monopolistic competitor follows from the fact that it sells a product that is at least somewhat different from products sold by other firms.
firm has market power? none, price-taker yes D curve facing firm horizontal downwardsloping
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For monopolistic competition, free entry/exit drives profits to zero in the long run. In contrast, barriers to entry prevent the monopolists profits from being driven to zero. A monopoly is the sole seller of a product with no close substitutes. In contrast, the monopolistic competitor sells a product with many close substitutes. As a result, demand for the monopolists product is less elastic than demand for the monopolistic competitors product.
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importance of strategic high interactions between firms likelihood of fierce competition low
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The graphical analysis of the monopolistically competitive firms output, price, and profits/losses is very similar to that of the monopoly firm. One subtle difference is that the demand curve (and MR curve) facing the monopolistically competitive firm is likely to be flatter than the demand curve facing the monopolist, as the monopolistic competitor faces competition from other firms selling similar products.
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ATC
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If profits are in the short run: New firms enter market, taking some demand away from existing firms, prices and profits fall. If losses are in the short run: Some firms exit the market, remaining firms enjoy higher demand and prices.
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The level of output that minimizes ATC is greater than the output that maximizes the monopolistic competitors profits. Hence, we say the monopolistic competitor operates with excess capacity. (More on this topic on the next slide.)
MONOPOLISTIC COMPETITION
The monopolistic competitor operates on the downward-sloping part of its ATC curve, produces less than the cost-minimizing output. Under perfect competition, firms produce the quantity that minimizes ATC.
Due to the markup of price over marginal cost, the market output under monopolistic competition will be smaller than the socially efficient output, as we discuss on the following slide.
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The problem facing policymakers here is similar to the problem arising from natural monopoly: With natural monopoly, ATC is always falling, so MC is below ATC. If regulators force a natural monopoly to price at marginal cost, it will incur losses.
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One of these externalities is positive, the other is negative. Its not clear which one is bigger, and it may in fact differ by industry.
the product-variety externality: surplus consumers get from the introduction of new products the business-stealing externality: losses incurred by existing firms when new firms enter market
This section of the textbook has a nice FYI box contrasting the views on advertising of John Kenneth Galbraith and Frederic Hayek, two of the great economists of the 20th century.
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The Critique of Advertising Critics of advertising believe: Society is wasting the resources it devotes to
advertising.
Firms advertise to manipulate peoples tastes. Advertising impedes competition it creates the perception that products are more differentiated than they really are, allowing higher markups.
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It provides useful information to buyers. Informed buyers can more easily find and exploit price differences. Thus, advertising promotes competition and reduces market power.
The study mentioned here was by economist Lee Benham, published in the Journal of Law and Economics in 1972. The textbook has a case study that discusses this research in more detail.
Ads may convince buyers to try a product once, but the product must be of high quality for people to become repeat buyers. The most expensive ads are not worthwhile unless they lead to repeat buyers. When consumers see expensive ads, they think the product must be good if the company is willing to spend so much on advertising.
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Brand Names
In many markets, brand name products coexist
with generic ones.
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The Critique of Brand Names Critics of brand names believe: Brand names cause consumers to perceive
differences that do not really exist.
Consumers willingness to pay more for brand names is irrational, fostered by advertising. Eliminating govt protection of trademarks would reduce influence of brand names, result in lower prices.
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The Defense of Brand Names Defenders of brand names believe: Brand names provide information about quality
to consumers.
Companies with brand names have incentive to maintain quality, to protect the reputation of their brand names.
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