Characteristics of Monopolistic Competition

  • Large number of competing firms

    • Vendors in a big food court at the mall

    • Gas stations along a major highway

  • Differentiated Products

    • Similar but not identical products

    • Various types of chocolate candy: Twix, Snickers, M\&Ms…

  • Free entry and exit in the long run

    • If there are opportunities for profit, firms can enter

    • Similarly, if there is loss companies will exist

    • Unlike perfect competition, there's pricing power

    • Unlike monopoly, there's competition

    • Unlike oligopoly, there are many firms

Graph

  • Profitable firm in monopolistic competition

    • Graph similar to a monopoly earning economic profit

    • Demand curve is slightly more elastic in monopolistic competition than in monopoly

    Price Price Average total cost Profit (a) Firm Makes Profit Profit- maximizing quantity MC ATC Demand Quantity

  • Unprofitable firm in monopolistic competition

    • Graph similar to a monopoly incurring economic loss

    • Demand curve is slightly more elastic in monopolistic competition than in monopoly

    Price Average total cost Price Losses Loss- minimizing quantity (b) Firm Makes Losses MC ATC Demand Quantity

Long-Run Zero-Profit Equilibrium

  • If profitable, firm entry will occur and individual firm demand will shift left

    (a) Effects of Entry Price, marginal revenue Entry shifts the existing firm's demand curve and its marginal revenue curve leftward. MR2 MRI DI Quantity

  • If unprofitable, firm exit will occur and individual firm demand will shift right

    (b) Effects of Exit Price, marginal revenue Exit shifts the existing firm's demand curve and its marginal revenue curve hghtward. MRI MR2 DI Quantity

  • In long-run, demand curve will be tangent to its ATC at its profit-maximizing point

    Price, cost, marginal revenue MC Point of tangency ATC z Quantity

Comparing Perfect & Monopolistic Competition

  • Both make zero economic profit

  • Perfect competition operates at both minimum ATC and where P = MC.

  • Both productively and allocatively efficient

  • Monopolistic competition operates to the left of minimum-cost output and has excess capacity

    C:\\CE5A5F25\\EA5686BB-78FF-4844-9ADF-D3586C9ED368\_files\\image153.png

    (a) Long-Run Equilibrium in Perfect Competition Price, cost, marginal revenue ppc= MCpc — MR = Ppc MC ATC Quantity Qpc Minimum-cost output

    Price, cost, marginal revenue -ATC MC MG,c (b) Long-Run Equilibrium in Monopolistic Competition MC ATC QMC Quantity Minimum-cost output

Product Differentiation & Advertising

  • How firms differentiate their products

    • Differentiation by style or type

    • Differentiation by location

    • Differentiation by quality

  • Ford vs. General Motors

    • Henry Ford famously quipped that customers could the Model T in "any color, so long as it's black"

    • Alfred Sloan challenged this perfectly competitive view of automobiles

    • Even though more expensive, consumers preferred the range of styles and GM became the dominant car brand during the 20th century

Monopolistic Competition Example

  • Assume a city eliminates the license fee (fixed cost) for all firms in a monopolistically competitive industry.

    • How is output affected?

      • Not affected

      • Because marginal cost stays the same.

    • How is economic profit affected?

      • FC↓, TC↓, ATC↓

      • can make economic profit

      • Firms enter, demand increases, and drives out profit

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