CHAPTER+17+.+MONOPOLISTIC+COMPETITION+;)

=Chapter 17: Monopolistic Competition = = = 

=Introduction = = =  In this chapter, we learn about markets that are both monopolistic and competititve. This is called a Monopolistic Competition. This is a market structure in which firms sell products that are similar but not identical. For it to be a monopolistic competition, it must have many sellers of a good, slight product differentiation, and free entry. Thus, it is very different from an oligopoly which only has a small amount of sellers. Thus a monopolistic competition is more of a competitive system than an oligopoly. However, it is still not perfectlycompetitive because each sellers offer a slightly different product.

To understand this type of system, you need to first understand the decisions facing an individual firm, then what happens in the long run as firms enter and exit the industry. After that you need to compare the equilibrium under monopolistic competition to the equilibrium under perfect competition. then we have to consider whether the outcome in a monopolistically competitive market is desireable form the standpoint of the society as a whole.

=**The Short Run:** = = =  Each firm in a monopolistically competitive market is like a mono[oly. It faces a downward-sloping demand curve, and thus, it follows the ruloe of profit maximization. it chooses the quantity at which marginal revenue equals marginal cost and then finds the price consistend with that quantity using the demand curve.

To make a profit, price needs to exceed average total cost, as shown in chart A



if the price is blow average total cost, the best the company can do is minimize it losses. As shown in chart B



In the short run, the monopolistic competitions are exactly the same as a monopoly. = **The Long Run:** = = =  However, a company does not stay in the short run for long. Once the firm starts creating profit, they have an incentive to enter the market. This increases the number of products and reduces demand faced by each firm. Once entered, the demand curves for the firms shift to the left. And as the demands for these firms' products fall, these firms experience declining profit.

But if a firm is instead experiencing losses, firms have an incentive to exit. once exited, the firms create less products, creating higher demand. And thus, it moves the demand curve to the right, opposite to when a company enters the market. As demand for the remaining products rise, the firm experience declining losses.

The cycle of exit and entering continues until the company experiences 0 profit and losses. Once it reaches this equilibrium, other firms have no incentive to enter or exit. As shown in the chart below, characteristics of a long-run monopolistically competitive market is comprised of both of a monopoly and a competitive market. Like a monopolistic market, price exceed marginal cost and like a competitive market, price equals average total cost.



The difference between the long term monopoly and monopolistically competitive market is that a monopoly continues to earn positive profit because there are no close substitutes, while monopolistically competitive markets allow free entry, thus the profit in this market is driven to zero.

Now we have to understand the difference between a monopolistically competitive market with a perfect competition. The 2 major differences are excess capacity and markup

 = **Excess Capacity:** = = =  In the long run, monopolitically competitive markets drive down to 0 profit. However, a perfect competition produce at an efficient scale. Thus at a monopolistically competitive firm, they have a excess capacity, which means, a firm can increaes the quantity it produces and lower the average total cost of production.

=<span style="font-family: 'Comic Sans MS',cursive;"> **Markup:** = =<span style="font-family: 'Comic Sans MS',cursive;"> = <span style="font-family: 'Comic Sans MS',cursive;"> The second difference is the relationship between price and marginal cost. For a competitive firm, price equals marginal cost. For a monopolistically competitive firm, price exceeds marginal cost because the firm has some market power. Thus, it does not ensure that price always equals a marginal cost. Thus, in the long run, the monopolistically competitive firms run on the lower, increasing losses section. =<span style="font-family: 'Comic Sans MS',cursive;"> **Monopolistic Competition and the welfare of society:** = =<span style="font-family: 'Comic Sans MS',cursive;"> = <span style="font-family: 'Comic Sans MS',cursive;"> Now we must decide if a monopolistically competitive is desirable in the competitive market of society as a whole. Is it possible for the policymakers to improveon the market outcomes?

A source of inefficient is the markup of price over marginal cost. Because of markup consumers who value a good more than the marginal cost of production will not buy it. thus a monopolistically competitive market has normal deadweight loss of monopoly pricing. However, this problem is not an easy one to fix. the best was to enforce marginal cost pricing would be regulating all firms that produce differentiated products. However, since it is so common, the administrative burden would be much too great.

Along with that fact, regulating monopolistically competitive markets would include all the problems of a natural monopoly. since profit is 0, lowering down prices would create firms to make losses. But to keep firms in business, the government would need to support these firms through taxes. However, this would be too inefficient and policy makers would rather keep the inefficiency of monopolistic pricing

The main problem with monopolistically competitive markets however, is because there is too much or too little entry. This creates externalities that are both positive and negative. It could either provide a positive support to consumers or impose negative support to other firms. When this happens, there is always too much or too little amount of goods.

Thus in conclusion, we can come to the point of thinking that monopolistically competitive do not have all the desireable welfare properties, the invisible hand, that competitive market have.

<span style="font-family: 'Comic Sans MS',cursive;"> =<span style="font-family: 'Comic Sans MS',cursive;"> **Advertising:** = =<span style="font-family: 'Comic Sans MS',cursive;"> = <span style="font-family: 'Comic Sans MS',cursive;"> Advertising exists everywhere in our modern economy. Advertising is just another part of monopolistic competition. Because each firm sells a product that is similar to each other, each company has a incentive to attract customer to their product instead of the others.



But the real question is, does advertising serve a valuable purpose or does it waste resources? =<span style="font-family: 'Comic Sans MS',cursive;"> **The Critiques:** = =<span style="font-family: 'Comic Sans MS',cursive;"> = <span style="font-family: 'Comic Sans MS',cursive;"> Critics claim that advertising manipulate people's tastes. Because advertising is more psychological than informational, this is not neccessarily false. They also argue that advertisin impedes on competition. Advertisements tend to push people to buy a certain product ofter the other by convincing the buyers how different their item is from the others. When faced with such "facts" jpeople feel more inclined to buy similar products for a higher price. =<span style="font-family: 'Comic Sans MS',cursive;"> **The Defense:** = =<span style="font-family: 'Comic Sans MS',cursive;"> = <span style="font-family: 'Comic Sans MS',cursive;"> Defenders of advertising argue that advertising only provides information to the customers. They claim that it shows the new products for sale, the prices, and the locations of where it is sold. They also claim that advertisements create competition because it teaches people about all the other firms in the market and makes a person take advantage of price differences. Also, it allows new firms to enter easier because it can attract customers from other firms.

The amount of quality of information supplied in advertisement is also hotly debated. Defenders claim that the amount of money being spent on the advertising itself can be a signal to consumers about the quality of the prodcuts being offered.

Finally, advertising is closely related to the existence of brand names. In many markets there are firms with their own brand names and others with generic substitutes. Critics claim that brand names only confuse customers from thinking that the product is different from the generic products. However, others claim that brand names are a useful ways for consumers to ensure that goods are of high quality. This is because with a brand name, a firm has a higher incentive to maintain high quality for their financial stakes.

In conclusion monopolistically competitive markets are basically a hybrid of monopolies and competitive markets. Because each company provides similar yet different products, each firm advertises to attract people to a certain good than the other. Advertising provides information about the good yet manipulates consumers' tastes and promotes brand loyalty. However, the faults of the monopolistically competitive markets still stand, with little choices to be made from a policy maker to improve it. =<span style="font-family: 'Comic Sans MS',cursive;"> Key Terms/Concepts that you need to know = =<span style="font-family: 'Comic Sans MS',cursive;"> = <span style="font-family: 'Comic Sans MS',cursive;">
 * <span style="font-family: 'Comic Sans MS',cursive;"> -Monopolistic competition: **a market sturcture in which many firms sell products that are similar but not identical

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