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Principles of Economics Thirteenth Edition Chapter 15 Monopolistic Competition Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Chapter 15 Monopolistic Competition As w...

Principles of Economics Thirteenth Edition Chapter 15 Monopolistic Competition Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Chapter 15 Monopolistic Competition As with perfect competition, a monopolistically competitive industry is an industry in which entry is easy and many firms are the norm. Unlike with perfectly competitive firms, firms in a monopolistically competitive industry do not produce homogeneous goods. With some market power, a firm can charge a higher price than a competitor without losing all its customers. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 15.1 Characteristics of Different Market Organizations Products Price a Number Blank differentiated or decision Easy entry Distinguished by Examples of firms homogeneous variable Perfect Wheat farmer Many Homogeneous No Yes Market sets price Competition Textile firm One version or Still constrained by Public utility Monopoly One many versions of Yes No market demand Patented drug a product Monopolistic Yes, but Price and quality Restaurants Many Differentiated Yes Competition limited competition Hand soap Automobiles Oligopoly Few Either Yes Limited Strategic behavior Aluminum Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Industry Characteristics monopolistic competition A common form of industry (market) structure characterized by a large number of firms, no barriers to entry, and product differentiation. Characteristics of a monopolistically competitive industry: – A large number of firms – No barriers to entry – Product differentiation Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Table 15.1 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 2007 Industry Four Largest Eight Largest Twenty Largest Number of Designation Firms Firms Firms Firms Travel trailers and 40 50 63 756 campers Games, toys 34 48 62 721 Wood office 40 52 65 438 furniture Book printing 42 54 66 558 Fresh or frozen 28 41 60 481 seafood Source: U.S. Department of Commerce, Bureau of the Census, 2007 Census of Manufacturers, Concentration Ratios in Manufacturing. SubjectECO731SR12, May 2009. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Product Differentiation and Advertising product differentiation A strategy that firms use to achieve market power, accomplished by producing goods that differ from others in the market. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved How Many Varieties? In well-working markets, the level of product variety reflects the underlying heterogeneity of consumers’ tastes in that market, the gains (if any) from coordination, and cost economies due to standardization. In industries that are monopolistically competitive, differences in consumer tastes, lack of need for coordination, and modest or no scale economies from standardization give rise to a large number of firms, each with a different product. Even within this industry structure, however, these same forces play a role in driving levels of variety. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved How Do Firms Differentiate Products? (1 of 2) horizontal differentiation Products differ in ways that make them better for some people and worse for others. vertical differentiation A product difference that, from everyone’s perspective, makes a product better than rival products. behavioral economics A branch of economics that uses the insights of psychology and economics to investigate decision making. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved How Do Firms Differentiate Products? (2 of 2) Researchers in behavioral economics have found that people highly value some choice, but too much choice can reduce purchases. commitment device Actions that individuals take in one period to try to control their behavior in a future period. Some consumers try to control their own purchasing behavior by, for example, buying memberships to health clubs as an incentive to work out. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Advertising (1 of 4) One role advertising plays is to inform people about the real differences that exist among products. Advertising can also create or contribute to product differentiation, creating a brand image for a product that has little to do with its physical characteristics. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Advertising (2 of 4) The Case for Advertising Differentiated products and advertising give the market system its vitality and are the basis of its power. Product differentiation helps to ensure high quality and variety, and advertising provides consumers with valuable information on product availability, quality, and price that they need to make efficient choices in the marketplace. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Advertising (3 of 4) The Case against Product Differentiation and Advertising Critics argue that product differentiation and advertising are wasteful and inefficient. Enormous sums are spent to create meaningless and possibly nonexistent differences among products. Advertising raises the cost of products and frequently contains very little information. Often, it is merely an annoyance. Advertising can lead to unproductive warfare and may serve as a barrier to entry, thus reducing real competition. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Advertising (4 of 4) Open Questions There are strong arguments on both sides of the advertising debate, and even the empirical evidence yields conflicting conclusions. Some studies show that advertising leads to concentration and positive profits. Other studies show that advertising improves the functioning of the market. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Price and Output Determination in Monopolistic Competition Product Differentiation and Demand Elasticity When a firm can distinguish its product from all others in the minds of consumers, it can raise its price without losing all quantity demanded. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 15.2 Product Differentiation Reduces the Elasticity of Demand Facing a Firm The demand curve that a monopolistic competitor faces is likely to be less elastic than the demand curve that a perfectly competitive firm faces. Demand is more elastic than the demand curve that a monopolist faces because close substitutes for the products of a monopolistic competitor are available. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Price/Output Determination in the Short Run A profit-maximizing monopolistically competitive firm behaves much like a monopolist in the short run. Marginal revenue is not equal to price. The monopolistic competitor’s MR curve lies below its demand curve, intersecting the quantity axis midway between the origin and the point at which the demand curve intersects it. The firm chooses the output/price combination that maximizes profit. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 15.3 Monopolistic Competition in the Short Run In the short run, a monopolistically competitive firm will produce up to the point M R = M C. At q0 = 2,000 in panel (a), the firm is earning short-run profits equal to P0 ABC = $2,000. In panel (b), another monopolistically competitive firm with a similar cost structure is shown facing a weaker demand and suffering short-run losses at q1 that are equal to CABP1 = $1,000. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Price/Output Determination in the Long Run Entry and exit are easy in the long run under monopolistic competition. Profits provide an incentive for new firms to enter the industry, and firms that suffer losses can go out of business. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 15.4 Monopolistically Competitive Firm at Long-Run Equilibrium As new firms enter a monopolistically competitive industry in search of profits, the demand curves of existing profit-making firms begin to shift to the left, pushing marginal revenue with them as consumers switch to the new close substitutes. This process continues until profits are eliminated, which occurs for a firm when its demand curve is just tangent to its average total cost curve. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Economic Efficiency and Resource Allocation (1 of 2) Because entry is easy and economic profits are eliminated in the long run, monopolistic competition is efficient. However, there are two problems: 1. Once a firm achieves any degree of market power by differentiating its product, its profit-maximizing strategy is to hold down production and charge a price above marginal cost. 2. The equilibrium in a monopolistically competitive firm is necessarily to the left of the low point on its average total cost curve, which means a typical firm will not realize all the economies of scale available. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Economic Efficiency and Resource Allocation (2 of 2) Nonetheless, if product differentiation leads to the introduction of new products, improvements in old products, and greater variety, an important gain in economic welfare may at least counteract those problems. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Review Terms and Concepts behavioral economics commitment device horizontal differentiation monopolistic competition product differentiation vertical differentiation Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved