Monopolistic CompetitionCh. 17

Characteristics

• Many firms selling similar (not identical) products

• Not price taker, face downward demand curve• Free entry & exit of firms – long run economic profit will be zero

Compare to Perfect Comp.

• Similar in that there are many sellers, but instead of identical products, they can differentiate their products

Short Run

• Follows monopolist’s rule for profit max:MR = MC then use Demand curve to find price

• Can have a profit or loss based on ATC curve

Long Run

• Firms will enter (if profit) or exit (if loss) until economic profit is zero

• ATC curve will touch Demand curve (tangent) at same quantity as MR = MC

• P > MC and P = ATC in long run

Major differences PC vs. MC

1. Excess Capacity: Profit Max output is less than quantity that minimizes ATC

- Firms could increase quantity produced and still lower ATC, but it won’t because it would have to cut its price and would lose profit

Major differences PC vs. MC

2. Markup: In PC, P = MC but in Mon. Comp., P > MC and this means in Mon. Comp., a firm

always wants to see one more customer

Welfare of Society

• Has normal deadweight loss of a monopoly caused by “markup”

• Regulation is almost impossible• Entry of firms produces 2 externalities:

positive (product variety) and negative (business stealing)

Advertising

• When do we see ads? Differentiated consumer goods

• Criticism: ads are manipulative and they impede competition which makes buyers less concerned with price allowing more markup

• Defense: ads provide info, allows customers to make better choices & it fosters competition

Advertising as a Signal of Quality

• Content is not as important as showing that your firm is willing to spend $ on ads, which is a signal of quality

• Cheap advertising doesn’t work

Brand Names

• Cause consumers to perceive differences that often do not exist

• Consumers usually act irrationally by paying more for brand name when quality is same for a generic brand

• Defense of brand names: It is way to indicate quality to consumers and give an incentive to maintain quality (reputation)