Chapter+17-+Monopolistic+Competition



Monopolistic Competition: A market structure in which many firms sell products that are similar but not identical.
 * Words to keep in mind: **

1. Many sellers: Many firms exist to compete for the same group of customers. 2. Product differentiation: The firms in a monopolistic competition produces similar products but not identical. Therefore, the firms are not price takers, but downward-sloping demand curve. 3. Free Entry: Firms can enter/exit the market with no restrictions. (Number of firms adjust until economic profit equals zero)
 * Monopolistic Competition Characteristics **

- Monopolistically competitive market is like a monopoly. - Since offered product is different for all firms, it faces a downward-sloping demand curve. - Monopolistically competitive firms follows a monopolist's rule for profit maximization. - Marginal revenue = Marginal cost
 * Competition with differentiated Products **

This is the graph when a firm makes profit:

The Long-Run Equilibrium ** When firms are making profit: - Entry of firms increases the number of products the consumers can choose, thus reduces the quantity demanded for each firm. - Profit encourages entry, shifting the demand curve to the left.
 * 

When firms are making losses: - When they are making losses, they have an incentive to exit the market. - Firms exit, then customers has fewer range of products to choose from. - exit shifts the demand curves of the remaining firms to the right.

- Entry and exit continues until the firms in the market are making exactly zero economic profit.

This is a graph of a monopolistic competitor in the long run: Monopolistic vs. Perfect Competition ** Excess capacity ** - Firms produce a downward sloping portion of its average total cost curve. - Monopolistic competition contrasts with perfect competition. - It could increase the quantity produced and lower average total cost of production. Markup over Marginal Cost ** - Relationship between price and marginal cost. - Competitive firm, price equals marginal cost. - Monopolistic competitive firm, price exceeds marginal cost since firm always has market power. - Perfect Competition = price equals marginal cost, thus profit is zero. - Monopolistically competitive firm = price exceeds marginal cost, makes more profit. Monopolistic Competition and the Welfare of Society ** - Monopolistic Competition is inefficient - Price over marginal cost - Has normal deadweight loss of monopoly pricing - Number of firms in the market may not be ideal - Product-variety externality: Consumers earn consumer surplus from the new product, entry of new firms gives a positive externality on consumers. - Business-stealing externality: Since firms lose customers and profits due to competition, entry of a new firm creates a negative externality on existing firms.
 * 

- When firms sell different products and price is above marginal cost, firm has an incentive to advertise so more buyers would be attracted. - Spending on adveritising compromises about 2 percent of total firm revenue.
 * Advertisements **

- Assessing the social value of advertisement is difficult.
 * Debate over advertising **

- Firms advertise to control people's tastes. - It is psychological than informational. - Impedes competition since it convinces the producers that one product is better than the other. - Finally, makes the consumers less concerned with price differences within the different firms.
 * Critique over Advertisement**

- Firms use advertisement to inform the consumers. - Fosters competition since it allows consumers to be informed about the firms (take advantage of the price). - Each firm gets less power. 
 * Defense of Advertisement**
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Advertising as a Signal of Quality ** - The willingness of the firm to spend a large amount of money on advertising. - Ex. Post & Kellogg. - Hiring stars to come out in advertisements may seem to convey information, however, it is simply an act of showing he existence and expenses.

- There are firms that sell with widely recognized brand names, and other by generic substitutes. - Ex) Bayer aspiring & generic aspirin - Critics argue: - Causes consumers to perceive differences that does not really exist. - Consumer's willingness to pay more for the brand named good is irrational foster caused by advertising. Defense's argue: - Provide consumers with information about the quality (quality can not be judged easily). - Gives incentives to maintain high quality (have financial stake to maintain high reputation of their brand names).
 * Brand Names **
 * Critics say that brand names are resulted from an irrational consumer response to advertisements.
 * Defenders say that consumers have a good reason to pay more for a certain product with names because people have more confidence in the product.

A monopolistic competitive firm is different from perfect competition because there are only few firms in a monopolistic competitive firm. On the contrary, the perfect competition has a lot of producers. A monopolistic competitive firm needs to have advertisements to make improvements.

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