Monopolistic CompetitionChapter 17Copyright 2001 by Harcourt, Inc.All rights reserved. Requests for permission to make copies of any part of the work should be mailed to:Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida 32887-6777.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Four Types of Market StructureMonopolyOligopolyMonopolistic CompetitionPerfect Competition Tap water Cable TV Tennis balls Crude oil Novels Movies Wheat MilkNumber of Firms?Type of Products?Many firms One firmFew firmsDifferentiated productsIdentical productsHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Types of Imperfectly Competitive MarketsuMonopolistic CompetitionuMany firms selling products that are similar but not identical.uOligopolyuOnly a few sellers, each offering a similar or identical product to the others.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Monopolistic CompetitionMarkets that have some features of competition and some features of monopoly.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Attributes of Monopolistic CompetitionuMany sellersuProduct differentiationuFree entry and exitHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Many SellersThere are many firms competing for the same group of customers.uProduct examples include books, CDs, movies, computer games, restaurants, piano lessons, cookies, furniture, etc.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Product DifferentiationuEach firm produces a product that is at least slightly different from those of other firms.uRather than being a price taker, each firm faces a downward-sloping demand curve.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Free Entry or ExituFirms can enter or exit the market without restriction.uThe number of firms in the market adjusts until economic profits are zero.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Monopolistic Competitors in the Short Run.(a) Firm Makes a ProfitQuantity0PriceDemandMRATCProfitMCProfit- maximizing quantityPrice Average total costHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Monopolistic Competitors in the Short Run.Quantity0PriceDemandMRLosses(b) Firm Makes Losses MCATCAverage total costLoss- minimizing quantityPriceHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Monopolistic Competition in the Short RunShort-run economic profits encourage new firms to enter the market. This:uIncreases the number of products offered.uReduces demand faced by firms already in the market.uIncumbent firms demand curves shift to the left.uDemand for the incumbent firms products fall, and their profits decline.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Monopolistic Competition in the Short RunShort-run economic losses encourage firms to exit the market. This: uDecreases the number of products offered.uIncreases demand faced by the remaining firms.uShifts the remaining firms demand curves to the right.uIncreases the remaining firms profits.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Long-Run EquilibriumFirms will enter and exit until the firms are making exactly zero economic profits.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.A Monopolistic Competitor in the Long Run.QuantityPrice0DemandMRATCMCProfit-maximizing quantityP=ATCHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Two Characteristics of Long- Run EquilibriumAs in a monopoly, price exceeds marginal cost.uProfit maximization requires marginal revenue to equal marginal cost.uThe downward-sloping demand curve makes marginal revenue less than price.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Two Characteristics of Long- Run EquilibriumAs in a competitive market, price equals average total cost.uFree entry and exit drive economic profit to zero.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Monopolistic versus Perfect CompetitionThere are two noteworthy differences between monopolistic and perfect competitionexcess capacity and markup.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Excess CapacityuThere is no excess capacity in perfect competition in the long run.uFree entry results in competitive firms producing at the point where average total cost is minimized, which is the efficient scale of the firm.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Excess CapacityuThere is excess capacity in monopolistic competition in the long run.uIn monopolistic competition, output is less than the efficient scale of perfect competition.Harcourt, Inc. items and derived items copyright