Monopolistic Competition

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Characteristics

• Firms face low entry barriers• Differentiated Products

-they face a downward sloping demand curve-no Long Run Profits-Non-price Competition

• Price Taker• Many Small Firms

Product Differentiation• Price-searchers produce

differentiated products – products that differ in design, dependability, location, ease of purchase, etc.• Rival firms produce similar products

(good substitutes) and therefore each firm confronts a highly elastic demand curve.

McHits or McMisses?Hulaburger - 1962

Filet o Fish - 1963Strawberry shortcake - 1966Big Mac - 1968Hot Apple Pie - 1968Egg McMuffin - 1975Drive Thru - 1975Chicken McNuggets -

1983Extra Value Meal - 1991McLean Deluxe - 1991Arch Deluxe - 199655-cent Special - 1997Big Xtra - 1999

McRib, Sundaes and others ??

Big MacBig N TastyBig N Tasty w/ CheeseQuarter Pounder w/ CheeseDouble Quarter Pounder w/ CheeseCrispy ChickenChicken McGrillFilet-O-FishDouble CheeseburgerCheeseburgerHamburgerChicken McNuggets (4)Chicken McNuggets (6)Chicken McNuggets (9)McSalad Shaker Chef SaladMcSalad Shaker Garden SaladMcSalad Shaker Grilled Chicken Caeser Salad

Fish Supreme Chicken Parmesan Sandwich 2/3 lb. Monster Thickburger® 1/3 lb. Low Carb Thickburger®

Little Thick Cheeseburger 1/4 lb. Little Thickburger®

1/3 lb. Cheeseburger Chili Cheese Thickburger®

1/3 lb. Original Thickburger® 1/3 lb. Mushroom 'N' Swiss Thickburger®

1/3 lb. Bacon Cheese Thickburger®

Big Chicken Fillet Sandwich Charbroiled Chicken Club Sandwich Charbroiled BBQ Chicken Sandwich

Big Hot Ham 'N' Cheese™ Regular Hamburger

Regular Cheeseburger Double Cheeseburger

5-Piece Chicken Breast Strips 7-Piece Chicken Breast Strips

Big Shef

Double Jr. Cheeseburger Deluxe

1/4 lb.* Single

1/2 lb.* Double with Cheese

3/4 lb.* Triple with Cheese

Baconator®

Jr. Hamburger

Jr. Bacon Cheeseburger

Jr. Cheeseburger Deluxe

Jr. Cheeseburger

Double Stack

Deluxe Double Stack

Triple Stack

Homestyle Chicken Go Wrap

Grilled Chicken Go Wrap

Spicy Chicken Go Wrap

Crispy Chicken Deluxe

Chicken Club

Ultimate Chicken Grill

Spicy Chicken Sandwich

Homestyle Chicken Fillet

10-piece Chicken Nuggets

Premium Fish Fillet Sandwich

Crispy Chicken Sandwich

Double Jr. Cheeseburger Deluxe

1/4 lb.* Single 1/2 lb.* Double with Cheese

3/4 lb.* Triple with Cheese

Baconator® Jr. Hamburger Jr. Bacon Cheeseburger

Jr. Cheeseburger Deluxe

Jr. Cheeseburger Double Stack Deluxe Double Stack

Triple Stack Homestyle Chicken Go Wrap

Grilled Chicken Go Wrap

Spicy Chicken Go Wrap

Crispy Chicken Deluxe

Chicken Club Ultimate Chicken Grill

Spicy Chicken Sandwich

Homestyle Chicken Fillet

10-piece Chicken Nuggets

Premium Fish Fillet Sandwich

Crispy Chicken Sandwich

Price and Output• A profit-maximizing price searcher

will expand output as long as marginal revenue exceeds marginal cost.• Price will be lowered and output

expanded until MR = MC

• The price charged by a price searcher will be greater than its marginal cost.

d

Price

Quantity/time

P2

P1

MRq1 q2

Increase inTotal Revenue

Reduction inTotal Revenue

Marginal Revenue of a Price Searcher

• Initial price P1 & output q1. Total revenue (TR) = P1 * q1.1. As price falls from P1 to P2, output increases from q1 to q2,

two conflicting influences on TR.1. TR will rise because of an increase in the number of units sold (q2 - q1) * P2.

2. TR will decline [(P1 - P2) * q1] as q1 units once sold at the higher price (P1) are now sold at the lower price (P2). • Depending on the size of the shaded regions, total revenue may increase or decrease.

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Output

Total

Cost

Marginal Cost

Price

(AR)Quantity

Marginal Revenue

50

80

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110

140

180

230

290

360

440

530

0

1

2

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0

110

200

270

320

350

360

350

320

270

200

30

10

20

30

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50

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Total Revenue

110

90

70

50

30

10

-10

-30

-50

-70___

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80

45

37

35

36

38

41

45

49

53

ATC

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_________

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Marginal Cost

Price

(AR)Quantity

Marginal Revenue

0

1

2

3

4

5

6

7

8

9

10

120

110

100

90

80

70

60

50

40

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90

70

50

30

10

-10

-30

-50

-70

80

45

37

35

36

38

41

45

49

53

ATC

Cost

Output

60

50

40

30

20

10

1 2 3 4 5 60 7 8 9 10

70

80

90

100

110

120

Cost

Output

60

50

40

30

20

10

1 2 3 4 5 60 7 8 9 10

70

80

90

100

110

120

Price

Quantity

108

30 45

500

24

MC

ATC

MR D = AR

1. Firm’s profit maximizing output?2. What price will they charge?3. Firm’s revenue? Total Cost? Total Profit?4. How will things change in time?

d

MR

MC

ATC

Price and Output: Short Run Profit

Quantity/timeq

C

EconomicProfits

• A monopolistic competitor maximizes profits by producing where MR = MC, at output level q and charges a price P along the demand curve for that output level.• At q the average total cost is C.

• Because the price is greater than the average total cost per unit (P > C) the firm is making economic profits equal to the area ( [ P - C ] * q )

• What impact will economic profits have if this is a typical firm?

Price

P

Profits and Losses in the Long Run• Economic profits attract competition.

• New firms will expand supply and lower price.

• Individual demand curves will shift inward until the economic profits are eliminated.

• Economic losses cause firms to leave the market.• Demand for the remaining firms’ output

will rise until the losses have been eliminated, ending the incentive to exit.

• Firms can make either profits or losses in the short run, but only zero economic profit in the long run.

• Because entry and exit are free, competition will eventually drive prices down to the level of ATC.

Quantity/timeq

P

d

MR

MC

ATC

Price and Output: Long Run

• When profits (losses) are present, the demand curve will shift inward (outward) until the zero profit equilibrium is restored.• The price searcher establishes its output level where MC = MR.• At q the average total cost is equal to the market price. Zero economic profit is present. No incentive for firms to either enter or exit the market is present.

C = P

Price

Entry or Exit?

Supply

Profits

Case 1: Prices rise

Price

Quantity

$6

$5

$4

$3

$2

$1

10 20 30 40 50 600

Demand

SR Profits

1. Increased Demand, Price goes up2. Firms enter, Demand

faced by each firm decreases

3. Price goes down4. No LR Profits

ATCMC

Entry or Exit?

Supply

Profits

Case 2: Prices fall

Price

Quantity

$6

$5

$4

$3

$2

$1

10 20 30 40 50 600

Demand SR

Losses

1. Demand falls, Price goes down

ATC

2. Firms leave, Demand faced by each firm increases

3. Price goes up4. No LR Losses

MC

Price

Quantity/Time

Pure Comp Mono comp

Price

Quantity/Time

d

MC

ATC

d

MR

MC

ATC

P2

q2

P1

q1

• LR equilibrium for both.• P = ATC and there are no economic profits.• In monopolistic competition, firms face a

downward-sloping demand curve, its profit-maximizing price exceeds MC.

• In Monopolistic Competition, output is too small to minimize ATC in long-run equilibrium.

Comparing Price Taker Markets

Price

Quantity/Time

Pure Comp Mono comp

Price

Quantity/Time

d

Price MC

ATC

d

MC

ATC

P2

P1

Price

MR

q2q1

• Even though the two markets have the same cost structure, the price in the monopolistic competitor’s market is higher than that in the price-taker’s market ( P2 > P1 ).

• Some consider this price discrepancy a sign of inefficiency; others perceive it as a premium society pays for variety and convenience (product differentiation).

Comparing Price Taker Markets

Allocative Efficiency• Allocative efficiency is achieved when

the most desired goods are produced at the lowest possible cost.

• The Minimum point on the ATC curve:• ATC > marginal cost at the minimum

point• No allocative efficiency in Monopolistic

Competition.

Price Discrimination• Sellers may gain from price

discrimination by charging:• higher prices to groups of customers

with more inelastic demand • lower prices to groups of customers

with more elastic demand

• Price discrimination generally leads to more output and additional gains from trade.

The Economics of Price Discrimination

• If the airline charges all customers the same price, profits will be maximized where MC = MR. Here the airline charges everyone $400 and sells 100 seats.

Price

Quantity/timeSingle price

$400

$200

$300

$100

$500

$600

$700

MC

D100

MR

Net operating revenue($300*100) = $30,000

• Consider a hypothetical market for airline travel where the Marginal Cost per traveler is $100.

• This generates Net Operating Revenue of $30,000 or (total revenues) $40,000 – (operating costs) $10,000.

Price

Quantity/timeSingle price

$400

$200

$300

$100

$500

$600

$700

MC

D100

MR

Net operating revenue($300*100) = $30,000

The Economics of Price Discrimination• By charging higher prices to consumers with less elastic demand and lower prices to those with more elastic demand it will increase net operating revenue.

• If the airline charges $600 to business travelers (who have a highly inelastic demand) and $300 to other travelers (who have a more elastic demand), it can increase its Net Operating Revenue to $42,000.

Price

Quantity/timePrice Discrim.

$400

$200

$300

$100

$500

$600

$700

MC

D

Net operating revenuefrom business travelers($500*60) = $30,000

Net operating revenuefrom all others

($200*60) = $12,000

60 120

Right after you graduate, you get a job in production management and you are responsible for the entire company on weekends.Here are the costs of production for the company:

Quantity Average Total Cost 500 $200 501 $201

Your current level of production is 500 units and all 500 have been ordered by regular customers.

One weekend, the phone rings. It is a customer who wants to buy one unit of your product. This means increasing production to 501 units. The customer offers to buy it for $450.Should you accept the offer?What is the net change in the firm’s profit?

Quantity Average Total Cost 500 $200 501 $201

$100,701 - $100,000 = $701

Marginal Cost = $701

Marginal Revenue = ??

Marginal Cost = ??

Marginal Revenue = $450

Profit or Loss

L o s s

Total Cost (Q x ATC)$100,000$100,701

You’re Fired!!!

In a competitive price-searcher market, the firms willa. be able to choose their price, and the entry barriers into the market will be low.b. be able to choose their price, and the entry barriers into the market will be high.c. have to accept the market price for their product, and the entry barriers into the market will be low.d. have to accept the market price for their product, and the entry barriers into the market will be high.A profit-maximizing price searcher will expand output to the point wherea. total revenue equals total cost. b. marginal revenue equals marginal cost.c. price equals average total cost. d. price equals marginal cost.In the long run, neither competitive price takers nor competitive price searchers will be able to earn economic profits becausea. entry barriers into these markets are high, raising the costs of each firm.b. the government will dictate moderate prices for these firms.c. competition will force prices down to the level of per-unit production costs.d. marginal revenue is always less than marginal cost when barriers to entry are low.If a market is in long-run equilibrium, which of the following conditions will be present in a competitive price-taker market but absent from a competitive price-searcher market?a. P = ATC b. MR = MCc. P = MC d. MR < P

As long as a market is contestable, then even if it has only a few sellers, thea. threat of new firms will prevent the prices from rising above the competitive level.b. producers will be able to charge prices that are high enough to produce long-run economic profits.c. producers will not face new competition because the barriers to entry are high.d. market will never be expected to come close to the competitive result.

If firms in a competitive price-searcher market are currently earning economic losses, then in the long run,a. new firms will enter the market, and the current firms will experience a decrease in demand for their products until zero economic profit is again restored.b. new firms will enter the market, and the current firms will experience an increase in demand for their products until zero economic profit is again restored.c. some existing firms will exit the market, and the remaining firms will experience an increase in demand for their products until zero economic profit is again restored.d. some existing firms will exit the market, and the remaining firms will experience a decrease in demand for their products until zero economic profit is again restored.Compared to the outcome when the firms are price takers, competitive price-searcher markets will result ina. a wider variety of products and higher prices.b. less product variety and higher prices.c. a wider variety of products and lower prices.d. less product variety and lower prices.

What price should this competitive price-searcher firm charge in order to maximize profits?a. $5 b. $7 c. $8 d.

$10What is the maximum economic profit this firm depicted in Figure 2 will be able to earn?a. $0 b. $20 c. $30 d.

$100If the cost and demand conditions of this competitive price-searcher firm, what will happen in the future?a. Firms will go out of business, and the market price will rise.b. The current market price will tend to persist into the future.c. New firms will enter the market, and demand facing this firm will decline.d. The firms in this industry probably will collude in order to increase their profitability.

d. $10

b. $20

The average variable cost (AVC) and average total cost (ATC) for a firm are indicated in Figure 3. If the marginal cost curve were constructed, at what output would it cross the AVC curve?

a. 2 b 3c. 4 d. 5

At what output would a properly constructed marginal cost curve cross the ATC curve?a. 3 b 4 c. 5 d. 6

Calculate the total cost of producing four units.a. $10 b. $15 c $60 d. $75

Calculate the total variable cost of producing three units.a. $10 b. $15 c. $30 d. $45

Which output level would be most closely associated with the point where diminishing marginal returns have begun?a 4 b. 5c. 6 d. 8

Which output minimizes per-unit cost?a. 4 b. 6 c. 7 d 8

Which of the following is true?a. Firms in this industry begin to experience diminishing returns to their variable factors at output q1.b. Between q1 and q2, firms in this industry experience economies of scale.c Firms producing output rates less than q1 or more than q2 will find it difficult to survive.d. The largest firms in this industry have the lowest per-unit cost.

The graph illustrates a firma.capable of earning economic profit.b.that is only able to break even when it maximizes profit.c taking economic losses.d. that should shut down immediately.

When price rises from P2 to P3, the firm finds thata. marginal cost exceeds marginal revenue at a production level of Q2.b. if it produces at output level Q3 it will earn a positive profit.c expanding output to Q4 would leave the firm with losses.d. it could increase profits by lowering output from Q3 to Q2.When price falls from P3 to P1, the firm finds that

a.fixed cost is higher at a production level of Q1 than it is at Q3.b. it should produce Q1 units of output.c. it should produce Q3 units of output.d it should shut down immediately.