Deni Friawan

Define and identify monopolistic competition

Like competitive market, in monopolistic competition there are many firms Yet, each firms have limited monopoly power due to product differentiation

Explain how output and price are determined in a monopolistically competitive industry

Compare the outcome under monopolistic competition and under perfect competition
Explain why advertising cost are high in a monopolistically competitive industry

Products Price a Number differentiated decision Free of firms or homogeneous variable entry

Distinguished by

Examples

Perfect competition Monopoly Monopolistic competition Oligopoly

Many One
Many Few

Homogeneous A single, unique product

Differentiated Either

No Yes
Yes, but limited Yes

Yes No
Yes

Price competition Wheat farmer only Textile firm Still constrained Public utility by market demand Patented Drug
Price and quality competition Restaurants Hand soap Automobiles Aluminum

Limited Strategic behavior

Not every industry fits neatly into one of these categories; however, this is a useful framework for thinking about industry structure and behavior.

Monopolistic competition is a market with the following characteristics:

A large number of firms.

Each firm has only a small market share and limited market power Each firm is sensitive to the average market price, but no firm pays attention to the actions of the other

Collusion, or conspiring to fix prices, is impossible.

Each firm produces a differentiated product.

each firm makes a product that is slightly different from the products of competing firms. This differentiation is often accomplished through advertising

Firms compete on product quality, price, and marketing.

Because

firms produce differentiated products, each firm has a downward-sloping demand curve for its own product.

Firms
There

are free to enter and exit the industry.

are no barriers to entry in monopolistic competition, so firms cannot earn an economic profit in the long run.

 The

demand curve faced by a monopolistic competitor is likely to be less elastic than the demand curve faced by a perfectly competitive firm
more elastic than the demand curve faced by a monopoly.

But

A firm that has decided the quality of its product and its marketing program that produces the profit-maximizing quantity at which its marginal revenue equals its marginal cost (MR = MC). The price is determined from the demand curve for the firms product. In the short run, it operates much like a single-price monopoly. It makes an economic profit (as figure 1) when P > ATC. A firm might incur an economic loss in the short run when P < ATC (figure 2)

In the long run, economic profit induces entry. And entry continues as long as firms in the industry make an economic profitas long as (P > ATC). As firms enter the industry, each existing firm loses some of its market share. The demand for its product decreases and the demand curve for its product shifts leftward. The decrease in demand decreases the quantity at which MR = MC and lowers the maximum price that the firm can charge to sell this quantity. Price and quantity fall with firm entry until P = ATC and firms earn zero economic profit.

Two key differences between monopolistic competition and perfect competition are:

Excess capacity

Markup

A firm has excess capacity if it produces less than the quantity at which ATC is a minimum. A firms markup is the amount by which its price exceeds its marginal cost.

Excess Capacity

Firms in monopolistic competition operate with excess capacity in long-run equilibrium. The downward-sloping demand curve for their products drives this result.

Markup

Firms in monopolistic competition operate with positive mark up. Again, the downward-sloping demand curve for their products drives this result.

 In

contrast, firms in perfect competition have no excess capacity and no markup. perfectly elastic demand curve for their products drives this result.

The

 Because
So

in monopolistic competition P > MC, marginal benefit exceeds marginal cost.

monopolistic competition seems to be inefficient. the markup of price above marginal cost arises from product differentiation. value variety but variety is costly. competition brings the profitable and possibly efficient amount of variety to market.

But

People

Monopolistic

Profit-Maximizing Product Innovation & Efficiency

Innovation is costly, but it increases total revenue.

Firms pursue product development until the marginal revenue from innovation equals the marginal cost of innovation.
Profit is maximized when marginal revenue equals marginal cost. In monopolistic competition, price exceeds marginal revenue, so the amount of innovation is probably less than efficient.

Advertising Firms in monopolistic competition incur heavy advertising expenditures.

Figure

13.6 shows estimates of the percentage of sale price for different monopolistic competition markets.

Selling Costs and Total Costs

Selling costs, like advertising expenditures, fancy retail buildings, etc. are fixed costs.

Average fixed costs decrease as production increases, so selling costs increase average total costs at any given level of output but do not affect the marginal cost of production. Selling efforts such as advertising are successful if they increase the demand for the firms product.
Advertising costs might lower the average total cost by increasing equilibrium output and spreading their fixed costs over the larger quantity produced

The advertising expenditure shifts the average total cost curve upward. with no advertising, the firm produces 25 units of output at an average total cost of $60. With advertising, the firm produces 100 units of output at an average total cost of $40. The firm operates at a higher output and lower average total cost than it would without advertising

Selling Costs and Demand

In Figure 13.8(a), with no advertising, demand is not very elastic and the markup is large. In Figure 13.8(b), advertising makes demand more elastic, increases the quantity and lowers the price and markup. Warning: figure 13.8 (b) occurs if all firms advertize

Using Advertising to Signal Quality

Why

do Coke and Pepsi spend millions of dollars a month advertising products that everyone knows? answer is that these firms use advertising to signal the high quality of their products. signal is an action taken by an informed person or firm to send a message to uninformed persons.

One

For example: Coke VS Oke

Coke is a high quality cola and Oke is a low quality cola.

If Coke spends millions on advertising, people think Coke must be good. If it is truly good, when they try it, they will like it and keep buying it. If Oke spends millions on advertising, people think Oke must be good. If it is truly bad, when they try it, they will hate it and stop buying it.

So if Oke knows its product is bad, it will not bother to waste millions on advertising it.And if Coke knows its product is good, it will spend millions on advertising it. Consumers will read the signals and get the correct message. None of the ads need mention the product. They just need to be flashy and expensive.