Monopolistic Perfect Competition

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Seventh EditionThe Big PicturePrinciples ofWojciech Gerson (1831-1901)EconomicsN. Gregory Mankiw16Now, we will look at firm’s revenueBut revenue depends on market structure1. Competitive market (chapter 14)2. Monopoly (chapter 15)MonopolisticCompetitionCHAPTERChapter 13: The cost of production3. Monopolistic Competition (this chapter)4. Oligopoly (chapter 17)Are there other types of markets?Yes, but not for nowModified by Joseph Tao-yi Wang 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Seventh Edition1Perfect CompetitionPrinciples ofWojciech Gerson (1831-1901)EconomicsN. Gregory MankiwProducts are Perfect SubstitutesResult: Price TakingP MR MCSR: Will operate if P AVC (FC is sunk)MonopolisticPerfectCompetitionCHAPTER14LR: Will operate at P ATCFirms enter if P ATC; exit if P ATCModified by Joseph Tao-yi Wang 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Seventh Edition3MonopolyPrinciples ofEconomicsWojciech Gerson (1831-1901)MR MC to maximize profit (still true!)N. Gregory MankiwBut, P MR (D - downward sloping)Welfare Cost of a Monopoly:Profits (unfair?) vs. DWL (efficiency loss!)CHAPTER15MonopolyModified by Joseph Tao-yi Wang 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Cures? Do nothing?Auction off the market! 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.51

In this chapter,look for the answers to these questionsSeventh EditionPrinciples ofWojciech Gerson (1831-1901)EconomicsN. Gregory Mankiw What market structures lie between perfectcompetition and monopoly, and what are theircharacteristics? How do monopolistically competitive firms chooseprice and quantity? Do they earn economic profit?MonopolisticCompetitionCHAPTER16 How does monopolistic competition affect society’swelfare? What are the social costs and benefits ofadvertising?Modified by Joseph Tao-yi Wang 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Characteristics & Examples of MonopolisticCompetitionINTRODUCTION:Between Monopoly and CompetitionTwo extremesPerfect competition (perfect substitutes): manyfirms, identical productsMonopoly (no close substitutes): one firmCharacteristics:Many sellersProduct differentiationLocation, location, location! (產品定位)Free entry and exitIn between these extremes: imperfect competitionOligopoly: only a few sellers offer similar oridentical products.Monopolistic competition: many firms sellsimilar but not identical products. Partial Substitutes!Examples:apartmentsbooksbottled waterclothingfast foodnight clubs8 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Comparing Perfect & Monop. CompetitionPerfectcompetitionComparing Monopoly & Monop. CompetitionMonopolisticcompetitionmanyfree entry/exitnoyeszerolong-run econ. profitspositivezerodifferentiatedfirm has market power?yesyesD curve facing firmdownwarddownwardslopingsloping(market demand)close substitutesnonemanyfree entry/exityesyeslong-run econ. profitszerothe products firms sellidenticalfirm has market power? none, price-taker yes 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom lynumber of sellersnumber of sellersD curve facing firm9 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.downwardsloping10 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.many112

A Monopolistically Competitive Firm EarningProfits in the Short RunThe firm faces adownward-slopingD curve.At each Q, MR P.To maximize profit,firm produces Qwhere MR MC.A Monopolistically Competitive FirmWith Losses in the Short RunPriceMCprofitATCPThe best this firmcan do is tominimize its losses.ATCThe firm uses theD curve to set P.For this firm,P ATCat the output whereMR MC.DPriceMClossesATCATCPDMRMRQQQuantity 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.1213 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.A Monopolistic Competitor in the Long RunMonopolistic Competition and MonopolyEntry and exitoccurs untilP ATC andprofit zero.Short run: Under monopolistic competition,firm behavior is very similar to monopoly.Long run: In monopolistic competition,entry and exit drive economic profit to zero.If profits in the short run:New firms enter market,taking some demand away from existing firms,prices and profits fall.If losses in the short run:Some firms exit the market,remaining firms enjoy higher demand and prices. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.QuantityPriceNotice that theP ATCfirm charges amarkup of pricemarkupover marginal costand does notMCproduce atminimum ATC.14Why Monopolistic Competition IsLess Efficient than Perfect CompetitionMCATCDMRQQuantity 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.15Monopolistic Competition and Welfare1. Excess capacityThe monopolistic competitor operates on thedownward-sloping part of its ATC curve,produces less than the cost-minimizing output.Under perfect competition, firms produce thequantity that minimizes ATC.Monopolistically competitive markets do nothave all the desirable welfare properties ofperfectly competitive markets.Because P MC,market quantity socially efficient quantity.Yet, not easy for policymakers to fix this problem:Firms earn zero profits, so cannot require themto reduce prices.2. Markup over marginal costUnder monopolistic competition, P MC.Under perfect competition, P MC. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.16 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.173

ACTIVE LEARNINGMonopolistic Competition and WelfareNumber of firms in the market may not be optimal,due to external effects from the entry of new firms:The product-variety externality:surplus consumers get from the introductionof new productsThe business-stealing externality:losses incurred by existing firmswhen new firms enter marketThe inefficiencies of monopolistic competition aresubtle and hard to measure. No easy way forpolicymakers to improve the market outcome. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.18Advertisingperfect competition, monopoly, and monopolisticcompetition. In each of these, would you expectto see firms spending money to advertise theirproducts? Why or why not?2. Is advertising good or bad from society’sviewpoint? Try to think of at least one “pro” and“con.” 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Critics of advertising believe:Society is wasting the resources it devotes toadvertising.In general, the more differentiated the products,the more advertising firms buy.Economists disagree about the social value ofadvertising.20The Defense of AdvertisingFirms advertise to manipulate people’s tastes.Advertising impedes competition—it creates theperception that products are more differentiatedthan they really are, allowing higher markups. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.21Advertising as a Signal of QualityDefenders of advertising believe:A firm’s willingness to spend huge amountson advertising may signal the quality of its productto consumers, regardless of the content of ads.It provides useful information to buyers.Informed buyers can more easily find andexploit price differences.Ads may convince buyers to try a product once,but the product must be of high quality for peopleto become repeat buyers.Thus, advertising promotes competition andreduces market power.Results of a prominent study: Benham (1972)Eyeglasses were more expensive in statesthat prohibited advertising by eyeglass makersthan in states that did not restrict such advertising. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.1. So far, we have studied three market structures:The Critique of AdvertisingIn monopolistically competitive industries,product differentiation and markup pricinglead naturally to the use of advertising. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.1Advertising22The most expensive ads are not worthwhileunless they lead to repeat buyers.When consumers see expensive ads,they think the product must be good if the companyis willing to spend so much on advertising. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.234

Brand NamesThe Critique of Brand NamesIn many markets, brand name products coexistwith generic ones.Firms with brand names usually spend more onadvertising, charge higher prices for the products.As with advertising, there is disagreement aboutthe economics of brand namesJ 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.24The Defense of Brand Names 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.25CONCLUSIONDefenders of brand names believe:Brand names provide information about qualityto consumers.Companies with brand names have incentiveto maintain quality, to protect the reputation oftheir brand names. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Critics of brand names believe:Brand names cause consumers to perceivedifferences that do not really exist.Consumers’ willingness to pay more for brandnames is irrational, fostered by advertising.Eliminating govt protection of trademarkswould reduce influence of brand names,result in lower prices.Differentiated products are everywhere;examples of monopolistic competition abound.The theory of monopolistic competitiondescribes many markets in the economy,yet offers little guidance to policymakers lookingto improve the market’s allocation of resources.26 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.27SummarySummary A monopolistically competitive market has Monopolistic competition does not have all of themany firms, differentiated products, and freeentry. Each firm in a monopolistically competitivemarket has excess capacity—it producesless than the quantity that minimizes ATC.Each firm charges a price above marginal cost. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.desirable welfare properties of perfectcompetition. There is a deadweight loss causedby the markup of price over marginal cost. Also,the number of firms (and thus varieties) can betoo large or too small. There is no clear way forpolicymakers to improve the market outcome. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.5

Summary Product differentiation and markup pricing leadto the use of advertising and brand names.Critics of advertising and brand names arguethat firms use them to reduce competition andtake advantage of consumer irrationality.Defenders argue that firms use them to informconsumers and to compete more vigorously onprice and product quality. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Monopolistic CompetitionMost close to realityDifferentiated Products:Location, location, location!SR: Like a monopoly (locally)LR: Zero profitsHomework: Mankiw, Ch.16,Problem 2, 5, 7, 8, 9, 10. 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.316

Monopolistic Competition Seventh Edition CHAPTER 16 Wojciech Gerson (1831-1901) Modified by Joseph Tao-yiWang In this chapter, look for the answers to these questions What market structures lie between perfect competition and monopoly, and what are their characteristics? How do monopolistically competitive firms choose price and quantity?

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