Copyright2004 South-Western17Monopolistic CompetitionCopyright 2004 South-WesternMonopolistic Competition Imperfect competition refers to those market structures that fall between perfect competition and pure monopoly.The Four Types of Market StructureCopyright 2004 South-Western Tap water Cable TVMonopoly (Chapter 15) Novels MoviesMonopolistic Competition (Chapter 17) Tennis balls Crude oilOligopoly (Chapter 16)Number of Firms?Perfect Wheat MilkCompetition (Chapter 14)Type of Products?Identical productsDifferentiated productsOne firmFew firmsMany firmsCopyright 2004 South-WesternMonopolistic Competition Types of Imperfectly Competitive Markets Monopolistic Competition Many firms selling products that are similar but not identical. Oligopoly Only a few sellers, each offering a similar or identical product to the others.Copyright 2004 South-WesternMonopolistic Competition Markets that have some features of competition and some features of monopoly.Copyright 2004 South-WesternMonopolistic Competition Attributes of Monopolistic Competition Many sellers Product differentiation Free entry and exitCopyright 2004 South-WesternMonopolistic Competition Many Sellers There are many firms competing for the same group of customers. Product examples include books, CDs, movies, computer games, restaurants, piano lessons, cookies, furniture, etc.Copyright 2004 South-WesternMonopolistic Competition Product Differentiation Each firm produces a product that is at least slightly different from those of other firms. Rather than being a price taker, each firm faces a downward-sloping demand curve.Copyright 2004 South-WesternMonopolistic Competition Free Entry or Exit Firms can enter or exit the market without restriction. The number of firms in the market adjusts until economic profits are zero.Copyright 2004 South-WesternCOMPETITION WITH DIFFERENTIATED PRODUCTS The Monopolistically Competitive Firm in the Short Run Short-run economic profits encourage new firms to enter the market. This: Increases the number of products offered. Reduces demand faced by firms already in the market. Incumbent firms demand curves shift to the left. Demand for the incumbent firms products fall, and their profits decline.Figure 1 Monopolistic Competition in the Short RunCopyright2003 Southwestern/Thomson LearningQuantity0PriceProfit- maximizing quantityPriceDemandMRATC(a) Firm Makes ProfitAverage total cost ProfitMCCopyright 2004 South-WesternCOMPETITION WITH DIFFERENTIATED PRODUCTS The Monopolistically Competitive Firm in the Short Run Short-run economic losses encourage firms to exit the market. This: Decreases the number of products offered. Increases demand faced by the remaining firms. Shifts the remaining firms demand curves to the right. Increases the remaining firms profits.Figure 1 Monopolistic Competitors in the Short RunCopyright2003 Southwestern/Thomson LearningDemandQuantity0PricePriceLoss- minimizing quantityAverage total cost(b) Firm Makes LossesMRLossesATCMCCopyright 2004 South-WesternThe Long-Run Equilibrium Firms will enter and exit until the firms are making exactly zero economic profits.Figure 2 A Monopolistic Competitor in the Long RunCopyright2003 Southwestern/Thomson LearningQuantityPrice0Demand MRATCMCProfit-maximizing quantityP = ATCCopyright 2004 South-WesternLong-Run Equilibrium Two Characteristics As in a monopoly, price exceeds marginal cost. Profit maximization requires marginal revenue to equal marginal cost. The downward-sloping demand curve makes marginal revenue less than price. As in a competitive market, price equals average total cost. Free entry and exit drive economic profit to zero.Copyright 2004 South-WesternMonopolistic versus Perfect Competition There are two noteworthy differences between monopolistic and perfect competitionexcess capacity and markup.Copyright 2004 South-WesternMonopolistic versus Perfect Competition Excess Capacity There is no excess capacity in perfect competition in the long run. Free entry results in competitive firms producing at the point where average total cost is minimized, which is the efficient scale of the firm. There is excess capacity in monopolistic competition in the long run. In monopolistic competition, output is less than the efficient scale of perfect competition.Figure 3 Monopolistic versus Perfect CompetitionCopyright2003 Southwestern/Thomson LearningQuantity0PriceDemand(a) Monopolistically Competitive FirmQuantity0PriceP = MCP = MR (demand curve)(b) Perfectly Competitive FirmMCATCMCATCMREfficient scalePQuantity producedQuantity produced = Efficient scaleCopyright 2004 South-WesternMonopolistic versus Perfect Competition Markup Over Marginal Cost For a competitive firm, price equals marginal cost. For a monopolistically competitive firm, price exceeds marginal cost. Because pr