LN25Miller950022 17 LN25

Chapter 25
Monopolistic
Competition
Introduction
John Locke is the author of crime-adventure e-books
selling for 99 cents at Amazons website. When he saw
that successful authors were charging $9.99 for their ebooks, he expressed a confidence that he would have
customers who feel that the other books are not
necessarily ten times better than his.
E-books are an example of a product that exhibits
product differentiation, a fundamental characteristic of
monopolistic competition. In this chapter, you will learn
why the growing importance of e-books has complicated
the process of selling both e-books and physical books.
Copyright 2014 Pearson Education, Inc. All rights reserved.
25-2
Learning Objectives
Discuss the key characteristics of a monopolistically
competitive industry
Contrast the output and pricing decisions of
monopolistically competitive firms with those of
perfectly competitive firms
25-3
Learning Objectives (cont'd)

Explain why brand names and advertising are
important features of monopolistically competitive
industries
Describe the fundamental properties of information
products and evaluate how the prices of these
products are determined under monopolistic
competition
25-4
Chapter Outline
Monopolistic Competition
Price and Output for the Monopolistic
Competitor
Comparing Perfect Competition with
Brand Names and Advertising
Information Products and Monopolistic
Competition
25-5
Did You Know That

A company called J & D Foods offers baconflavored and turkey-and-gravy-flavored soft drinks?
And you can buy bottled water in flavors of Buffalo
wings, cheeseburger, and fish and chips?
Product heterogeneity, variations in product
characteristics, and advertising did not show up in
our analysis of perfect competition.
These are features of monopolistic competition
the subject of this chapter.
25-6
In the 1920s and 1930s, economists were
aware of industries that did not fit under
perfect competition or pure monopoly
Theoretical and empirical research was
instituted to develop some sort of middle
ground
25-7
Monopolistic Competition (cont'd)

Two separately developed models of
monopolistic competition resulted
At Harvard, Edward Chamberlin published
Theory of Monopolistic Competition in 1933
That same year, Joan Robinson of
Cambridge published The Economics of
Imperfect Competition
25-8

A market situation in which a large number of
firms produce similar but not identical products
Entry into the industry is relatively easy
25-9

Characteristics of monopolistic competition
1. Significant numbers of sellers in a highly
competitive market
2. Differentiated products
3. Sales promotion and advertising
4. Easy entry of new firms in the long run
25-10

Implications of the large number of firms
1. Small market share
2. Lack of collusion
3. Independence
25-11

Product Differentiation
The distinguishing of products by brand name,
color, and other minor attributes.
25-12

Product differentiation and price
The firm has some control over the price it
charges
Unlike a perfect competitor, it faces a downward
sloping demand curve
Consider the abundance of brand names for
many products
The more successful the firm is at differentiation, the
more control it has over price
25-13
Example: Is Punxsutawny Phil Hogging Too Much

Attention?
Since 1887, Punxsutawny Phil, the groundhog
residing in the Pennsylvania town of that name,
has been used to predict the weather on February
2the official Groundhog Day.
Today, there are at least 17 groundhog lodges in
Pennsylvania and nearby states, each of which
promotes its own groundhogs weather-forecasting
talents in an effort to attract tourists to their
communities.
25-14

What do you think about advertising?
Would a perfect competitor have any incentive to
advertise?
Why would a monopolistically competitive firm
advertise?
Can advertising lead to efficiency?
25-15

Sales promotion and advertising
Can increase demand for a firm
Can differentiate a firms product
Can result in increased profits
25-16

Question
How much advertising should be undertaken?
Answer
It should be carried to the point at which the
additional revenue from one more dollar of
advertising just equals that one dollar of
additional cost
25-17
Example: A Biodegradable Chips Bag

is Crunchier Than the Chips
As part of its product differentiation, the
snack-food company Frito-Lay designed a
biodegradable bag for its Sun Chips brand.
The bag also produces a loud crunching
sound when squeezed.
Frito-Lay has incorporated the crunchiness
of this bag into its marketing, as a way of
distinguishing Sun Chips from competing
products.
25-18

Ease of entry
For any current monopolistic competitor,
potential competition is always lurking in the
background
The easierthat is, the less costlyentry is, the
more a current competitor must worry about
losing business
25-19
Price and Output for the

Monopolistic Competitor
The individual firms demand and cost
curves
Demand curve slopes downward
Profit maximized where MC intersects MR from
below
25-20

Monopolistic Competitor (cont'd)
Short-run equilibrium
In the short run, it is possible for a monopolistic
competitor to make economic profitsprofits
over and above the normal rate of return, or
beyond what is necessary to keep that firm in
the industry
Losses in the short run are clearly also possible
25-21

Monopolistic Competitor (cont'd)
The long run: zero economic profits
The rate of return will tend toward normal
Economic profits will tend toward zero
So many firms produce substitutes, any economic
profits will disappear with competition
Reduced to zero either through entry of new firms
seeking to earn a higher rate or return, or by changes
in product quality and advertising outlays by existing
firms
25-22
Figure 25-1 Short-Run and Long-Run Equilibrium

with Monopolistic Competition,
Panel (a)
25-23

Panel (b)
25-24

Panel (c)
25-25

Question
If both a monopolistic and perfect competitor
make zero economic profit in the long run, how
are they different?
Answer
Demand curve for individual perfect competitor
is perfectly elastic
25-26
Figure 25-2 Comparison of the Perfect Competitor

with the Monopolistic Competitor
25-27

In perfect competition, the long-run equilibrium
occurs where average total cost is minimized (this
does not occur in monopolistic competition)
Some have argued that this is not necessarily a
waste of resourcesas the added cost arises from
product differentiation
Chamberlin argued it is rational for consumers to
have a taste for differentiation; consumers willingly
accept the resultant increased production costs in
return for more choice and variety of output
25-28

Because differentness has value for
consumers, monopolistically competitive
firms regard their brand names as valuable
private (intellectual) property
Firms use trademarks, words, symbols, and
logos to distinguish their product brands from
goods or services sold by other firms
A successful brand image contributes to a firms
profitability
25-29

(cont'd)
Brand names and trademarks
A companys value in the marketplace depends
largely on current perceptions of future
profitability
We can see it in the market value of the worlds
most valuable product brands
Valuation depends on the market prices of
shares of stock of a company times the number
of shares traded
25-30
Table 25-1 Values of the Top Ten

Brands
25-31
Methods of Advertising
Direct Marketing
Advertising targeted at specific consumers: email, regular mail
Mass Marketing
Advertising intended to reach as many
customers as possible: radio, TV, newspaper
Interactive Marketing
Permits consumer to follow up directly by
searching for more information
25-32
International Example: A Push to Make

Electronic Billboards Interactive in Japan
In Japan, when a person glances at an
electronic advertising display, the ad often
looks back with a mechanism that can
determine the age and gender of the
person.
Based on the individuals characteristics, the
display will recommend a specific product
tailored to individual needs.
25-33
Figure 25-3 Distribution of U.S.

Advertising Expenses
25-34
Informational Versus Persuasive

Advertising
Search Good
A product with characteristics that enable an
individual to evaluate the products quality in
advance of a purchase
Experience Good
A product that an individual must consume
before the products quality can be established
Credence Good
A product with qualities that consumers lack the
expertise to assess without assistance
25-35

Examples of search goods
Clothing and music evaluated prior to purchase
Examples of experience goods

Soft-drinks, restaurants, movies
Examples of credence goods

Health care, legal advice
25-36

(cont'd)
Informational Advertising
Advertising that emphasizes transmitting
knowledge about the features of a product
Persuasive Advertising
Advertising that is intended to induce a
consumer to purchase a particular product and
discover a previously unknown taste for an item
25-37

(cont'd)
Advertising as a signaling behavior
Individual companies can explicitly engage in
signaling behavior
They do so by establishing brand names or
trademarks and promoting them
25-38
What If the government were to limit or even

ban excessive advertising?
Informational advertising is informative to buyers
of search goods.
Even a firms expenditures on persuasive
advertising communicate an intention to continue
its operations for the foreseeable future.
Any attempt to restrict the amount of advertising
would reduce the informational benefits to society.
25-39
Information Products and

Information products, such as computer
operating systems, software, and digital
music and videos, have a unique cost
structure
Product development entails high fixed
costs, but the marginal cost of producing a
copy for one more customer is low
25-40

Competition (cont'd)
Information Product
An item that is produced using informationintensive inputs at a relatively high fixed cost
but distributed for sale at a relatively low
marginal cost
25-41
Figure 25-4 Cost Curves for a Producer of an

Information Product
25-42

Short-Run Economies of Operation
A distinguishing characteristic of an information
product arising from declining short-run average
total cost as more units of the product are sold
25-43

Consider how computer game
manufacturers operate in a monopolistically
competitive market.
In monopolistic competition, marginal cost
pricing results in losses for the firm, even
though it creates efficiencies for the
economy as a whole.
25-44

Providing an information product entails incurring
relatively high fixed costs, but a relatively low perunit cost for additional units of output
The ATC for a firm that sells an information product
slopes downward, meaning the firm experiences
short-run economies of operation
In a long-run monopolistically competitive
equilibrium, price adjusts to equal ATC; the firm
earns sufficient revenues to cover total costs,
including the opportunity cost of capital
Consumers thereby pay the lowest price necessary
to induce sellers to provide the item
25-45
Figure 25-5 The Infeasibility of Marginal Cost Pricing

of an Information Product
25-46
You Are There: Have You Smelled a Ford Lately?

Linda Schmalz, a body interior materials engineer
at Ford Motor Company, is responsible for
determining the appropriate odors for accessories
within the passenger compartment of Ford
vehicles.
Schmalz has discovered that there are regional
differences in peoples perception of odors.
This has prompted her to think about offering
customized scents as a way of creating product
differentiation for Ford vehicles.
25-47
Issues & Applications: Why E-Books Are

Upending the Publishing Business
Book publishing exhibits many features of
monopolistic competition.
Given the relatively high fixed cost of authoring a
book, publishers also face downward-sloping
average total cost curves.
Variable costs are much lower for e-books, and this
alternative has caused a decrease in demand for
physical books.
The likely consequence is that some publishers of
physical books will experience economic losses and
may therefore exit the industry.
25-48
Summary Discussion of Learning

Objectives
Key characteristics of a monopolistically
competitive industry
Large number of small firms
Differentiated products
Easy entry and exit
Advertising and sales promotion
25-49

Objectives (cont'd)
Contrasting the output and pricing decisions
of monopolistically competitive firms with
those of perfectly competitive firms
Monopolistically competitive firm in short run
Produces output to point MR = MC in short run
Price set on demand curve, can be less than MC and
ATC in short run, firm earns economic profits
25-50

Objectives (cont'd)
Contrasting the output and pricing decisions
of monopolistically competitive firms with
those of perfectly competitive firms
Monopolistically competitive firm in the long run
Price = ATC in the long run as firms enter industry
Like perfectly competitive firms, earns zero economic
profits in long run
Price exceeds MC in long run
25-51

Objectives (cont'd)
Monopolistically competitive firms attempt to boost
demand for their products through product
differentiation
They engage heavily in advertising and
marketing
Providing an information product entails incurring
relatively high fixed costs but low marginal costs
In the long run equilibrium, price adjusts to
equality with average total cost
25-52

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Chapter 25

Copyright 2014 Pearson Education, Inc. All rights reserved.

Copyright 2014 Pearson Education, Inc. All rights reserved.

Learning Objectives (cont'd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

Copyright 2014 Pearson Education, Inc. All rights reserved.

Did You Know That

Copyright 2014 Pearson Education, Inc. All rights reserved.

Copyright 2014 Pearson Education, Inc. All rights reserved.

Monopolistic Competition (cont'd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

Monopolistic Competition (cont'd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

Monopolistic Competition (cont'd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

Monopolistic Competition (cont'd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

Monopolistic Competition (cont'd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

Monopolistic Competition (cont'd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

Example: Is Punxsutawny Phil Hogging Too Much

Copyright 2014 Pearson Education, Inc. All rights reserved.

Monopolistic Competition (cont'd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

Monopolistic Competition (cont'd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

Monopolistic Competition (cont'd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

Example: A Biodegradable Chips Bag

Copyright 2014 Pearson Education, Inc. All rights reserved.

Monopolistic Competition (cont'd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

Price and Output for the

Copyright 2014 Pearson Education, Inc. All rights reserved.

Price and Output for the

Copyright 2014 Pearson Education, Inc. All rights reserved.

Price and Output for the

Copyright 2014 Pearson Education, Inc. All rights reserved.

Figure 25-1 Short-Run and Long-Run Equilibrium

Copyright 2014 Pearson Education, Inc. All rights reserved.

Figure 25-1 Short-Run and Long-Run Equilibrium

Copyright 2014 Pearson Education, Inc. All rights reserved.

Figure 25-1 Short-Run and Long-Run Equilibrium

Copyright 2014 Pearson Education, Inc. All rights reserved.

Comparing Perfect Competition with

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Figure 25-2 Comparison of the Perfect Competitor

Copyright 2014 Pearson Education, Inc. All rights reserved.

Comparing Perfect Competition with

Copyright 2014 Pearson Education, Inc. All rights reserved.

Brand Names and Advertising

Copyright 2014 Pearson Education, Inc. All rights reserved.

Brand Names and Advertising

Copyright 2014 Pearson Education, Inc. All rights reserved.

Table 25-1 Values of the Top Ten

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Copyright 2014 Pearson Education, Inc. All rights reserved.

International Example: A Push to Make

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Figure 25-3 Distribution of U.S.

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Informational Versus Persuasive