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Monopolistic Competition

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alistair mckay

on 7 October 2013

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Transcript of Monopolistic Competition

Monopolistic Competition
Assumptions
Large number of Firms
Relatively free entry/exit into the market
Product Differentiation
physical differences
quality differences
location services
product image
Large number of firms
Relatively free entry/exit
Product differentiation
Examples
What similarities do Monopolistic Competition, Monopoly and Perfect Competition share?
Like Monopoly, the Monopolistic Competitive firm faces a downward sloping Demand curve.
Because the products have substitutes, the Demand curve is relatively elastic compared to Monopoly
Price & Non-Price Competition
Price Competition
Firms lower their prices
Non-price Competition
Use methods other than lowering prices
Can you think of any methods?
Non-price Advertising
Product Differentiation
Monopolistic Firms compete with each other on the basis of price and non-competition.
As a business owner which of the two ways, price/nonprice competition do you feel would benefit your business most?
Why?
What factors do you have to consider when making your decision?
Consumer Loyalty
Differentiation from substitutes.
Examples?
Monopolistic Competition
Short-Run

Profit
Loss
Normal Profit
Monopolistic Competition Long Run
Firms earning Economic Profits will attract new entrants to the industry.
Unprofitable firms will shut their plants and leave the industry.
Similar to Perfect Competition, all firms will earn Zero Economic Profit in the Long-run
Allocative Efficiency
Define Allocative Efficiency?
Where must a firm produce to be considered Allocatively Efficient?
Producers produce only that type of goods and services which are desirable in the society and high demand.
Allocative Efficiency occurs where P = MC
Is the Monopolistic Competitive firm Allocatively Efficient? Why/Why not?
Allocatively Inefficient
P > MC
Productive Efficiency
Define Productive Efficiency?
Where must a firm produce to be considered Productively Efficient?
producing goods and services with the optimal combination of inputs to produce maximum output for the minimum cost.
P = min. ATC
Is the Monopolistic Firm productively efficient? Why/why not?
Productively Inefficient
P > min. ATC
Q(1) < Q(2)
Underallocation of resources
Monopolistic Competition is neither Allocatively nor Productively Efficient
Excess Capacity
Capacity Output
Output level at which plant capacity is fully used
ATC = Minimum
Excess Capacity
amount of output lost when a firm underuses plant a
firm does not produce at minimum ATC
Excess Capacity results from the downward sloping Demand curve.
Examples
Monopolistic Competition vs. Perfect Competition
How is Monopolistic Competition similar to Perfect Competition?
they both achieve Zero Economic Profit in the Long-run.
How are they different?
Differences
Perfect Competition
Productive/Allocative Efficiency is achieved in the long-run.
NO Excess capacity
NO product variety
Monopolistic Competition
Productive/Allocative Efficiency is NOT achieved in the long-run
Excess capacity
Product Variety
Monopolistic Competition vs Monopoly
How is a Monopolistic firm similar to a Monopolistic Competitive firm?
Both DO NOT achieve Allocative/Productive Efficiency
How are they different?
Differences
Monopolistic Competition
Achieves Zero Economic Profit in the long-run
Competition puts downward pressure on price
Achieves some Economies of Scale
Monopoly
DOES NOT achieve Zero Economic profit in the long-run
Lack of competition does NOT put downward pressure on price
Potential to achieve Economies of Scale is much greater
Classwork/Homework
a. Using diagrams show how a monopolistic firm maximizes profit.
b. Using diagrams show how a monopolistic firm maximizes revenues.
c. Compare the profit maximizeing monopolistic firm with the revenue maxiimizing firm.
a. Using diagrams, show the profit maximizing position of a firm that is earning abnormal economic profit.
b. Can this firm earn abnormal profits in the long-run?
In a monopolistically competitive market
firms can behave like monopolies in the short run
including by using market power to generate profit (price/non-price competition).
In the long run
other firms enter the market and the benefits of differentiation decrease with competition
the market becomes more like a perfectly competitive one where firms cannot gain economic profit.
Why would a Monopolistic Competitive firm be considered Allocatively Inefficient?
One thought is the use of slogans and imagery to stimulate psychological impulses to buy.
Why would Monopolistic competitive firm be considered Productively Inefficient?
Why does it produce at P > min. ATC?
Thought:
advertising and other costs of artificial differentiation drive up a monopolistic competitor's price (Pe), which is above the minimum average total cost.
Monopolistic competition misallocates resources because costs, and thus prices, are higher and each firm's output is less.
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