Chapter 10 Part 1 Monopolistic Competition Lecture Slides PDF

Chapter 10: Lecture Slides Monopolisti Part 1: Monopolistic Competition c Competition and Oligopoly  Learning Objectives By the end of this chapter, you should be able to: Describe the characteristics of a monopolistically competitive market. Determine the profit-maximizi...

Chapter 10: Lecture Slides Monopolisti Part 1: Monopolistic Competition c Competition and Oligopoly  Learning Objectives By the end of this chapter, you should be able to: Describe the characteristics of a monopolistically competitive market. Determine the profit-maximizing quantity and price for a monopolistically competitive firm. Describe the characteristics of an oligopoly. Explain how collusion impacts production decisions in an oligopolistic market. Identify the dominant strategy, if present, for each player, given a payoff matrix.  Learning Objectives-2 →Describe how firms with market power respond to changes in demand and costs. →Compare the market decisions made by competitive firms and firms with market power. →Describe the efficiency outcomes in markets where firms have market power. Measures of Market Concentration Measures of Market Concentration →Both competitive and monopoly market structures are rare →The most common form of market structures which we observe around us is Monopolistically competitive markets or Oligopoly markets →But how do we know the exact nature of a market/ industry →We need a concrete indicator to identify the type of market structure we are dealing with →A high concentration ratio implies that few sellers make up the industry →A low concentration ratio implies that more than a few sellers make up the industry Market Share → An individual firm’s market share is measured in terms of the percentage of the entire market’s output or market revenues/ sales →Market share in terms of output Firm A produces 10 quintals of wheat and the Total market output of wheat = 10,000 quintals Firm A’s market share = × 100 = × 100 = 0.1% →Market share in terms of sales Firm A’s total revenue = $5,000 and the Total Market Revenue = $ 100,000 Firm A’s market share = × 100 = × 100 = 5% F o u r Fi r m C o n c e n t r a t i o n R a t i o → It calculates the market share enjoyed by the top 4 firms in the market →To measure this, we need to first identify the top 4 firms and calculate their market share →Next, we need to sum up their individual market share to get the Four Firm Concentration ratio →A value of 40% or higher means the market is oligopolistic F o u r Fi r m C o n c e n t r a t i o n R a t i o Market Share Company Sales (billions of $) (%) A 60 30 B 6 C 28 14 D 26 13 E 10 F 20 G 40 20 J 10 Total 200 77 H e r fi n d a h l - H i r s c h m a n I n d e x →It is another measure of industry concentration →It is calculated by considering the summation of the square of the Market shares of each firm in the industry →The higher value of HHI indicates more concentration in the market meaning the more monopolized the market is H e r fi n d a h l - H i r s c h m a n I n d e x Sales (billions Market Market Share Company of $) Share (%) Squared A 60 30 900 B 6 3 9 C 28 14 196 D 26 13 169 E 10 5 25 F 20 10 100 G 40 20 400 J 10 15 225 Total 200 1824 Monopolistic Competition Monopolistic Competition Many producers with small market share Low barriers to entry: easy entry and exit Slightly different products but closely substitutable A firm that raises prices loses some customers to rivals Some control over price makes firms price makers Downward-sloping demand curve Firms act independently or interdependently Firms engage in non-price competition/ product differentiation Monopolistic Competition Examples →Local restaurants →Gas station →Hair stylists →Local brewery/pub →Breakfast cereals →Beer →Highway Motels Ty p e s o f P r o d u c t D i ff e r e n t i a t i o n Physical differences: Physical appearance, quality, packaging Location: Spatial differentiation, convenience Services: Accompanying services for products Product information: Product promotion and advertising Monopolistic Competition in the Short R Demand curve, D Slopes downward Firms have market power More elastic than a monopolist’s demand but less elastic than a perfect competitor’s Marginal revenue curve, MR Below the demand curve Slopes downward Monopolistic Competition in the Short R Demand curve, D Slopes downward Firms have market power More elastic than a monopolist’s demand but less elastic than a perfect competitor’s Marginal revenue curve, MR Below the demand curve Slopes downward Monopolistic Competition in the Short R Cost curves Average total cost, ATC Average variable cost, AVC Marginal cost, MC Profit maximization The profit-maximizing quantity (Q*) Where MR = MC The profit-maximizing price, P* (Highest price Consumers want to pay for Q*) Up on the demand curve S h o r t - R u n P r o fi t o r L o s s If P* > ATC Economic profit If ATC > P* > AVC Economic loss Produce in the short run to minimize losses If P* < AVC: AVC curve above D curve Economic loss Shut down in the short run to minimize losses to the Fixed cost  S h o r t - R u n P r o fi t o r L o s s The monopolistically competitive firm produces the level of output at which marginal revenue equals marginal cost (point e) and charges the price indicated by point b on the downward- sloping demand curve. In panel (a), the firm produces q units, sells them at price p, and earns a short-run economic profit equal to (p - c) multiplied by q, shown by the blue rectangle. In panel (b), the average total cost exceeds the price at the output where marginal revenue equals marginal cost. Thus, the firm suffers a short-run loss equal to (c - p) multiplied by q, shown by Z e r o E c o n o m i c P r o fi t i n t h e L o n g R u n Short run economic profit New firms enter the market Draw customers away from other incumbent firms Reduce demand facing other firms: Individual firm’s demand curve shifts downward and become flatter or more elastic Profit disappears in long run: Price = Average Cost becomes Zero economic profit Z e r o E c o n o m i c P r o fi t i n t h e L o n g R u n Short-run economic loss Some firms exit the market Their customers switch to remaining firms Increase demand facing the remaining firms: Individual firms’ demand curve shifts upward and becomes steeper or less elastic Loss is erased in the long run Zero economic profit Graph of Monopolistic Competition in the Long- run 𝑀𝐶 Cost and Revenue 𝑃 ∗ 𝐴𝑇𝐶 𝑆𝑅 = Short run Profit 𝐶 ∗𝑆𝑅 𝐷 𝑆𝑅 𝐷 𝐿𝑅 𝑀𝑅 𝑆𝑅 𝑀𝑅 𝐿𝑅 ∗ 𝑄 𝐿𝑅 𝑄∗𝑆𝑅 Quantity Monopolistic Competition in the Long-run The MC firm in the short-run faces a Demand curve DSR produces an output of QSR and charges a Price PSR For this Q= Q*SR the AC = C*SR < P*SR The firm is earning profit given by the shaded yellow rectangle The Profit encourages new firms to enter making the firm’s demand to shift downward to D LR In the long-run the Firm chooses Q= Q*LR [MRLR = MC] For this Q= Q*LR the AC = C*LR = P*LR Zero economic profit in the Long run P r o fi t i n t h e S h o r t - r u n a n d L o n g - r u n In the Short run, a firm in a Monopolistic Competition can earn positive economic profit or economic loss or normal profit. When new firms enter the market, the existing firms face increased competition, and it affects their demand elasticities In the Long run the firms earn Normal Profit Comparing Monopolistic Competition The MC firm’s demand curve is more responsive/ elastic than a Monopolist This is because they produce goods that have close substitutes unlike a monopolist whose product has no close substitute Compared to that of a perfectly competitive firm the Monopolistically competitive firm faces a downward-sloping demand curve because it produces differentiable products That also means that a Monopolistically competitive firm is not a Price taker but a Price maker/searcher C o m p a r i n g Fi r m D e m a n d s across Markets E ffi ciency in the Monopolistic Competition The monopolistically competitive firm is neither Resource allocative efficient (since it charges a price greater than marginal cost [P> MC]) Nor Productive efficient (since it does not charge a price equal to its lowest ATC and operates at excess capacity [Not lowest ATC in the Long run])  Excess Capacity Excess Capacity Theorem: A monopolistic competitor in equilibrium produces an output smaller than the one that would minimize its costs of production. Firms with excess capacity could easily serve more customers and lower average cost by increasing the quantity Marginal value of increased output > MC The greater output would increase social welfare Why Excess Capacity exist in the MC market? Argument: Monopolistic competition results in too many suppliers and artificial product differentiation Counterargument: Consumers are willing to pay a higher price for a wider selection