Chapter+17+Monopolistic+Competition

Chapter 17: Monopolistic Competition
 Chapter 17 explores one of the four types of firm - **MONOPOLISTIC COMPETITION**. Refer the Glossary for the **bold** terms.

Glossary
Characteristics Look at the clip below for the characteristics of monopolistic competition.  In Short Run REMEMBER: Profit = (P - ATC) x Q
 * Profit Maximization: like monopoly, the quantity is where MC = MR (point A). The price is found in the demand curve above MC = MR (point B).
 * Positive Profit (on the left): since Price (P) is //above/higher than// the Average Total Cost (ATC), the firm is earning positive profit (lightly colored box) in this graph
 * Negative Profit (on the right): since P is //below/lower than// the ATC, the firm is earning negative profit.

 In Long Run Similar to perfect competition (chapt. 14), monopolistic competition also has zero economic profit in LR. This is because... - When firms in the market are //making profits//, other firms have an incentive to enter. This //reduces// the price and profit of each firm because the supply increased due to new entries. - However, when firms are //making losses//, firms will exit. This //increases// the price and profit of each firm because the supply decreased due to exits. - After these entries and exits, market reaches to the point where firms make //zero// profits. - In order for the profit formula, (P - ATC) x Q to equal zero, P = ATC must happen. With this in mind, the LR monopolistic graph looks like... //AR = Demand, Green circle:// monopolistic competition's profit, //Yellow circle:// perfect competition's profit

Monopolistic Competition vs. Perfect Competition (in Long Run) In LR perfect competition, it's P = ATC just like the monopolistic competition. However, P intersects ATC at the efficient scale (minimum of ATC) whereas in LR monopolistic competition, P is //tangent// to ATC (green circle). Because of this difference, monopolistic competition has an excess capacity. It can produce at yellow circle like perfect competition but because of downward sloping of AR, it can't reach to the maximum point (=yellow). In LR perfect competition, it's P = MC (refer chapt. 14 if necessary). However, in LR monopolistic competition, the P exceeds the MC because unlike perfect competition, it has some market power (ability to change prices). This difference makes the monopolistic competition price to be higher than the perfect competition price. Similar to monopoly, monopolistic competition has deadweight loss due to its high price that makes it difficult for the consumers to buy the goods.
 * 1. Excess Capacity**
 * 2. Markup over Marginal Cost**

Effect of New Firm's Entry
 * 1. Product-variety Externality:** from new firm's entry to the market, consumers have more options to choose from and thus, gain some consumer surplus; //positive externality// for the consumers
 * 2. Business-stealing Externality:** because of the new firm's entry, other firms lose customers and profits; //negative externality// for the existing firms

Advertising Critique vs. Defense - see the clip below media type="custom" key="5201395"

Quiz ! 1. When does the firm gain positive profit? 2. What is the relationship between the price and ATC in the LR monopolistic competition? 3. What are the differences between LR monopolistic competition and LR perfect competition? 4. Is Business-stealing Externality positive or negative? Why? 5. How do the brand names induce the firms to maintain high quality? Answers

by Sally B.