ECO001 Exercise 10

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Diploma in Management Studies

Microeconomics ECO001

Lecture 10 Monopolistic Competition

Topics to be discussed:

Features of Monopolistic Competition

Short Run Euilibrium in Monopolistic Competition

Lon! run Euilibrium in Monopolistic Competition

Comparison "et#een Monopolistic Competition and

$erfect Competition

Effect of %d&ertisin! and 'nno&ation

Ref: $ar(in) Chapter 1*

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Learning Outcomes

%fter this lecture) students should be able to: ,efine and identif- monopolistic competition

E.plain ho# output and price are determined

in a monopolisticall- competiti&e industr- Compare bet#een monopolistic competition

and perfect competition

E.plain #h- ad&ertisin! costs are hi!h in amonopolisticall- competiti&e industr-

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Monopolistic competitionis a mar(et#ith the follo#in! characteristics:

% lar!e number of firms

Each firm produces a differentiated product Firms compete on product ualit-) price) and

mar(etin!

Firms are free to enter and e.it the industr-

E.ample: Retail industr-

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Lar!e umber of FirmsThe presence of a lar!e number of firms in themar(et implies:

Each firm has onl- a small mar(et share andtherefore has limited mar(et po#er to influencethe price of its product

Each firm is sensiti&e to the a&era!e mar(etprice) but no firm pa-s attention to the actions ofthe other) and no one firm2s actions directl- affectthe actions of other firms

Collusion) or conspirin! to fi. prices) isimpossible

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Product Differentiation

$roduct ,ifferentiation

Firms in monopolistic competition practice

product differentiation) #hich means that

each firm ma(es a product that is sli!htl-different from the products of competin!

firms

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Competition with Product Differentiation

Competin! on 5ualit-) $rice) and Mar(etin! $roduct differentiation enables firms to compete

in three areas: ualit-) price) and mar(etin!

5ualit- includes desi!n) reliabilit-) and ser&ice

"ecause firms produce differentiated products)each firm has a do#n#ard6slopin! demandcur&e for its o#n product

"ut there is a tradeoff bet#een price and ualit-

,ifferentiated products must be mar(eted usin!ad&ertisin! and pac(a!in!

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Price and Output Decision

The firm produces theuantit- at #hich

mar!inal re&enue

euals mar!inal cost

and sells that uantit-

for the hi!hest

possible price

't ma(es an economicprofit 9as in this

e.ample; #hen P>

ATC

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Loss Minimi"ing

% firm mi!ht incur aneconomic loss in the

short run

P

?ATC

't #ill operate in the

short run if $ > %@C

't #ill shut do#n in the

short run if $ ? %@C

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Long Run Euili!rium

Lon! Run: Aero Economic $rofit 'n the lon! run) economic profit induces

entr-

%nd entr- continues as lon! as firms in theindustr- ma(e an economic profitBas lon!

as 9P >ATC;

'n the lon! run) a firm in monopolistic

competition ma.imi8es its profit b- producin!the uantit- at #hich its mar!inal re&enue

euals its mar!inal cost) MR MC

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Long Run Euili!rium

%s firms enter the industr-) each e.istin! firmloses some of its mar(et share The demand

for its product decreases and the demand

cur&e for its product shifts left#ard

The decrease in demand decreases theuantit- at #hich MR MCand lo#ers the

ma.imum price that the firm can char!e to

sell this uantit-

$rice and uantit- fall #ith firm entr- until P

ATCand firms earn 8ero economic profit

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Long Run Euili!rium

The fi!ure sho#s a

firm in monopolistic

competition in lon!6

run euilibrium 'f firms incur an

economic loss) firms

e.it to achie&e the

lon!6run euilibrium

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Monopolistic Competition and

Perfect Competition

T#o (e- differences bet#een monopolisticcompetition and perfect competition are: E.cess capacit-

Mar(up% firm has e.cess capacit- if it produces less

than the uantit- at #hichATCis a minimum

% firm2s mar(up is the amount b- #hich itsprice e.ceeds its mar!inal cost

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E#cess Capacit$

Firms in monopolisticcompetition operate

#ith e.cess capacit-

in lon!6run

euilibrium

The do#n#ard6

slopin! demand cur&e

for their productsdri&es this result

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Perfect Competition

'n contrast) firms in

perfect competition

ha&e no e.cess

capacit- and nomar(up

The perfectl- elastic

demand cur&e fortheir products dri&es

this result

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ECO001 Exercise 10