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1. Many sellers
2. Product differentiation
3. Free entry and exit
Monopolistic Competition
Characteristics of Monopolistic Competition
Chinese Food
Funeral Services
1. Many sellers: Citysearch lists 1,832 Chinese restaurants in NYC
The Market for Chinese Food in NYC
2. Product differentiation: For people who want it…
spicy blandKosher fast
3. Free entry and exit: restaurants are constantly opening and closing.
(21 reviews) (9 reviews) (1 reviews) (7 reviews) (2 reviews)
Source: CitySearchSource: CitySearch
Cost Rating→$ $ (under $20)
$$ ($21-$30)$$$ ($31-$40)
$$$$ (above $40)
Differentiated Products
Each Chinese restaurant produces meals that are slightly different from those of other Chinese restaurants.
Rather than being a price taker, each Chinese restaurant faces a downward-sloping demand curve.
The number of firms in the market adjusts until economic profits are zero.
Free Entry or Exit
Firms can enter or exit the market without restriction.
0 100 200 300 400 500 600 700 800 900 1000
Chinese Meals (number per week)
MC
D
Price ($ per meal)
0 100 200 300 400 500 600 700 800 900 1000
Chinese Meals (number per week)
MC
D
Qπ
P ATC
MR
=ATC
Over the last few years, a large number of Chinese from Fujian Province have been smuggled into New York City. Their “desperation” makes “them highly desirable as laborers” (NYTimes, 7/22/2001). Indeed, signs litter the windows of Chinese restaurants advertising jobs for “hard-working Fujianese,” including the front window of the Silk Road Palace.
0 100 200 300 400 500 600 700 800 900 1000
Chinese Meals (number per week)
MC2
D
Qπ2
P2
ATC2
MR
ATC(Qπ2)A
B
Total Revenue = A+B
Total Cost = B
Econ Profits = A
Short-run economic profits encourage new Chinese Restaurants to enter the market. This:• Increases the variety in Chinese meals.
• Reduces demand faced by restaurants already in the market.
• Incumbent restaurants’ demand curves shift to the left.
• Demand for the incumbent restaurants’ meals fall, and their profits decline.
The Long-Run Equilibrium
• Chinese restaurants will enter and exit until the firms are making exactly zero economic profits.
0 100 200 300 400 500 600 700 800 900 1000
Chinese Meals (number per week)
MC2
D3
Qπ3
P3= ATC2
MR3
ATC
The demand curve is tangent to the ATC curve.
And this tangency lies vertically above the intersection of MR and MC.
Monopolistic versus Perfect Competition
• There are two noteworthy differences between monopolistic and perfect competition:– Excess capacity– Markup over marginal cost
0 100 200 300 400 500 600 700 800 900 1000
Chinese Meals (number per week)
MC2
D3
Qπ3
P3= ATC2
MR3
ATC
The demand curve is tangent to the ATC curve.
And this tangency lies vertically above the intersection of MR and MC.
Monopolistic versus Perfect Competition
• Excess Capacity– Free entry results in competitive firms
producing at the point where average total cost is minimized, which is the efficient scale of the firm.
.– In monopolistic competition, output is less than
the efficient scale of perfect competition.
Quantity0
Price
Demand
(a) Monopolistically Competitive Firm
Quantity0
Price
P = MC P = MR(demand
curve)
(b) Perfectly Competitive Firm
MCATC
MCATC
MR
Efficientscale
P
Quantityproduced
Quantity produced =Efficient scale
Monopolistic versus Perfect Competition
Monopolistic versus Perfect Competition
• Markup over Marginal Cost– For a competitive firm, price equals marginal
cost.– For a monopolistically competitive firm, price
exceeds marginal cost.
Quantity0
Price
Demand
(a) Monopolistically Competitive Firm
Quantity0
Price
P = MC P = MR(demand
curve)
(b) Perfectly Competitive Firm
Markup
MCATC
MCATC
MR
Marginalcost
P
Quantityproduced
Quantity produced
Monopolistic versus Perfect Competition
Monopolistic Competition and the Welfare of Society
• There is the normal deadweight loss of monopoly pricing in monopolistic competition caused by the markup of price over marginal cost.
• However, it may be that people are willing to incur the cost to have the greater variety offered by monopolistically competitive markets.
