PowerPoint Slides prepared by: Andreea CHIRITESCU Eastern Illinois UniversityMonopolistic Competition1 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Monopolistic Competition Imperfect competition Between perfect competition and monopoly Oligopoly Monopolistic competition Oligopoly Few sellers selling similar or identical products Consider the rivals behavior in decision making2 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Monopolistic Competition Monopolistic competition Many sellers Product differentiationDifferentiated products, but close substitutesNot price takers (market power- limited)Downward sloping demand curve Free entry and exitZero economic profit in the long run3 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Figure 14 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.The Four Types of Market StructureEconomists who study industrial organization divide markets into four typesmonopoly, oligopoly, monopolistic competition, and perfect competition.Short Run Equilibrium Profit maximization Produce the quantity where marginal revenue = marginal cost Price: on the demand curve If P ATC: profit If P MC)9 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Long Run Equilibrium Monopolistic vs. perfect competition Monopolistic competitionQuantity: not at minimum ATC Excess capacity (not “efficient scale”)P MC, markup over marginal cost Eager to attract additional customer Perfect competitionQuantity: at minimum ATC Efficient scaleP = MC 10 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Figure 411 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Monopolistic versus Perfect CompetitionPricePanel (a) shows the long-run equilibrium in a monopolistically competitive market, and panel (b) shows the long-run equilibrium in a perfectly competitive market. Two differences are notable. (1) The perfectly competitive firm produces at the efficient scale, where average total cost is minimized. By contrast, the monopolistically competitive firm produces at less than the efficient scale. (2) Price equals marginal cost under perfect competition, but price is above marginal cost under monopolistic competition.Quantity 0(a) Monopolistically Competitive FirmMCATCQuantity producedMC(b) Perfectly Competitive FirmMRDemand PricePriceQuantity 0Efficient scaleMarkupMC ATCQuantity produced = Efficient scaleP=MR (demand curve)P=MCExcess capacityWelfare of Society Sources of inefficiency (social welfare) Excess capacity Produce below the “efficient scale” (LR) Price over marginal costDeadweight loss of monopoly pricing Too much or too little entryProduct-variety externality Positive externality on consumersBusiness-stealing externality Negative externality on producers12 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Advertising Incentive to advertise When firms sell differentiated products and charge prices above marginal cost Advertise to attract more buyers Advertising spending Highly differentiated goods: 10-20% of revenue Homogenous products: No advertisingIndustrial products: Little advertising13 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service