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Imperfect 3

1) Monopolistic competition describes an industry with many sellers that produce differentiated products and allows free entry in the long run. 2) In the short run, firms maximize profits where marginal cost equals marginal revenue but may earn economic profits or losses. 3) In the long run, free entry drives profits to zero as new firms enter if profits are positive or exit if losses occur, reaching equilibrium.

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Surya Panwar
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24 views

Imperfect 3

1) Monopolistic competition describes an industry with many sellers that produce differentiated products and allows free entry in the long run. 2) In the short run, firms maximize profits where marginal cost equals marginal revenue but may earn economic profits or losses. 3) In the long run, free entry drives profits to zero as new firms enter if profits are positive or exit if losses occur, reaching equilibrium.

Uploaded by

Surya Panwar
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Imperfect Competition Continued

Monopolistic Competition
• Many sellers
• Product differentiation
– each firm produces a slightly different version
of product
• each has a monopoly on differentiated product
• Free entry into industry
– drives profit to zero in long run
Short-Run Equilibrium

• Just like monopoly


• Faces downward sloping demand and MR
• Maximizes profit by producing quantity at
which MC=MR
• Enjoys economic profit if, at equilibrium,
P>AC
• Suffers loss if, at equilibrium, P<AC
Monopolistic Competition with
Short-Run Profit
$
MC

Profit AC
Pe
ACe

D, AR

0 Qe Output
MR
Monopolistic Competition with
Short-Run Loss
$
MC
AC
Loss
ACe
Pe

D, AR

0 Qe Output
MR
Long-Run Equilibrium

• Free entry makes the long run very different from


monopoly
• If firms are earning economic profits, new firms
will enter the industry taking market share from
incumbent firms
– each firm’s demand and profit falls
• This process continues until P=AC
• The opposite happens when the industry is suffering
losses
Monopolistic Competition in
Long-Run Equilibrium
In equilibrium, P>MC
$ and the firm is NOT
MC operating at the
AC minimum point of its
Zero profit AC curve. For both
reasons, monopolistic
ACe= Pe competition is not
efficient.

MCe
D, AR

0 Qe Output
MR
Characteristics of Equilibrium
• Just as in the monopoly case, price exceeds marginal
cost in the short and long run
– efficiency requires price to equal marginal cost
• Just as with perfect competition, firms may earn either
positive or negative profits in the short run but in the
long run profits are zero
• In the long run, there is excess capacity
– the firm produces less than that which would minimize costs
– not efficient
Advertising
• Because price exceeds marginal cost, these firms would
love to sell more
– the problem is that selling more requires lowering the price
• unless more consumers decide to buy at the current price
• The trick is to advertise
– advertising increases demand
• the demand curve AND marginal revenue curve shift
– also creates brand loyalty
• makes demand less elastic
– increases markup of price over marginal cost
The Debate over Advertising
• The cons
– waste of resources to make consumers think
they want something they don’t really want
– makes consumers think that there are
differences that don’t really exist
– impedes competition
• makes demand less elastic
– increases inefficient markup of price over marginal cost
• The pros
– increases competition by providing information to
consumers
• price differences
• location
• new products
– without advertising, it would be very difficult for new firms to
enter
– advertising signals quality
• even when nothing is said about quality in the ad!
The Competitive Effects of
Advertising
• Advertising impedes competition by making
demand less elastic
• Advertising promotes competition by providing
information
• The net effect appears to be pro-competitive
– professionals like doctors, optometrists, and lawyers
try to get state governments to prohibit advertising as
unprofessional
– prices substantially lower when advertising allowed
• Case Study: Advertising and eyeglasses
– in 1960s, states varied considerably on laws
concerning advertising of eyeglasses
• provided natural experiment of effect on prices
• prohibition of advertising associated with 20%
higher prices
– in 1970s, Florida repealed its ban on advertising
• prices plummeted
Advertising as a Signal of
Quality
• Advertising can be very expensive
• The willingness of firms to spend a lot on ads
with famous movie or sports stars is a signal to
consumers that they think their product is good
– firms that know their products are mediocre will not
be as willing to invest massively on a product that is
likely to be rejected by consumers
– consumers are then rationally more likely to try
products that are expensively advertised
The Effects of Brand Names
• Are the resources that go into maintaining a brand
name a waste?
– is there really any difference between Bayer and generic
aspirin?
• In many cases, society gets real benefits
– gives consumers information about quality when quality
cannot be easily determined in advance of purchase
– gives producers strong incentive to maintain quality to
protect brand name
• Consider what happens when you pull off a
highway looking for something to eat
– there’s Joe’s Diner and McDonald’s
– most will pick McDonald’s because they know exactly
what they will get there and they have no idea what they
will get at Joe’s Diner
• quality assurance is valuable to consumers
– this brand identification is valuable to firms
• McDonald’s will invest a lot to maintain it
– food poisoning at one store would be hugely costly to its reputation
Summary of Market Structures
Number of firms
Product
One Few
firm firms
Differentiated Identical

Monopolistic Perfect
Monopoly Oligopoly Competition Competition
•utilities •crude oil •cereal •wheat
•cable TV •autos •OTC drugs •beef
•Microsoft??? •golf balls •toothpaste •nails

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