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Describe and identify monopolistic competition. Explain how a firm in monopolistic competition determines its output and price in the short run and the long run . Explain why advertising costs are high and wy firms use brand names in monopolistic competition.
Product Differentation
Product differentiation
Making 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 firms product rises, the quantity demanded of that firms product decreases.
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.
A burst of entry into an industry can limit the demand for each firms own product.
Figure 15.1 on the next slide illustrates a firm incurring a loss in the short run.
1. 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.
2. 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.
The firm must balance the cost and benefit at the margin.
Because price exceeds marginal cost, product improvement is not pushed to its efficient level.
Advertising
Firms in monopolistic competition spend a large amount on advertising and packaging their products.
Marketing Expenditures
A large proportion of the prices that we pay cover the cost of selling a good. Figure 15.5 on the next slide shows some estimates of marketing expenditures for some familiar markets.
4. If advertising enables sales to increase from 25 pairs of jeans a day to 100 pairs a day, it lowers the average total cost from $60 a pair to $40 a pair.
Figure 15.7 shows the possible effect of advertising. With no advertising, demand is low but the markup is large.
With advertising, average total cost increases and the ATC curve becomes ATC1. Demand decreases and becomes more elastic. Profit maximizing output increases, the price falls, and the markup shrinks.
Brand Names
Brand names are also used to provide information about the quality of a product.