MicroeconomicsECON 2302

Summer I, 2011

Marilyn Spencer, Ph.D.

Professor of Economics

Chapter 12

Announcement: 3Announcement: 3rdrd Bonus Quiz Bonus Quiz3 points possible3 points possible 

View the film, “American Gangster.” Send an email that explains his:

1. Supply chain management through vertical integration (CH 13)

2. Brand management (CH.12)

You might be able to find this film online by going to: www.projectfreetv.com.

Email your explanation (approx. 50-100 words) to

marilyn.spencer@tamucc.edu, before class, June 28.

CHAPTER 12

Monopolistic Competition: The Competitive Modelin a More RealisticSetting

The coffeehouse market is competitive because it is inexpensive to open a new store. Hundreds of firms in the United States operate

coffeehouses.

Monopolistic Competition: The Competitive Model in a More Realistic Setting

12.1 Demand and Marginal Revenue for a Firm in aMonopolistically Competitive MarketExplain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves.

12.2 How a Monopolistically Competitive FirmMaximizes Profit in the Short RunExplain how a monopolistically competitive firm maximizes profit in the short run.

12.3 What Happens to Profits in the Long Run?

Analyze the situation of a monopolistically competitive firm in the long run.

Chapter Outline and Six (6) Learning Objectives

CHAPTER 12

12.4 Comparing Perfect Competition and Monopolistic CompetitionCompare the efficiency of monopolistic competition and perfect competition.

12.5 How Marketing Differentiates ProductsDefine marketing and explain how firms use it to differentiate their products.

12.6 What Makes a Firm Successful?

Identify the key factors that determine a firm’s success.

CHAPTER 12

Chapter Outline and Learning Objectives, cont.

Monopolistic competition A market structure in which barriers to entry are low and many firms compete by selling similar, but not identical, products.

Monopolistic Competition: The Competitive Model in a More Realistic Setting

The Demand Curve for a Monopolistically Competitive Firm

FIGURE 12-1 The Downward-Sloping Demand for Caffè Lattes at a Starbucks

Explain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves.

12.1 LEARNING OBJECTIVE

Demand and Marginal Revenue for a Firmin a Monopolistically Competitive Market

If a Starbucks increases the price of caffè lattes, it will lose some, but not all, of its customers.

In this case, raising the price from $3.00 to $3.25 reduces the quantity of caffè lattes sold from 3,000 to 2,400.

Therefore, unlike a perfect competitor, a Starbucks store faces a downward-sloping demand curve.

Table 12-1

CAFFÈ LATTES SOLD PER WEEK (Q)

PRICE (P)TOTAL

REVENUE(TR = P x Q)

AVERAGEREVENUE

(AR = TR/Q)

MARGINAL REVENUE

(MR = ΔTR/ΔQ)

0

1

2

3

4

5

6

7

8

9

10

$6.00

5.50

5.00

4.50

4.00

3.50

3.00

2.50

2.00

1.50

1.00

$0.00

5.50

10.00

13.50

16.00

17.50

18.00

17.50

16.00

13.50

10.00

―

$5.50

5.00

4.50

4.00

3.50

3.00

2.50

2.00

1.50

1.00

―

$5.50

4.50

3.50

2.50

1.50

0.50

–0.50

–1.50

–2.50

–3.50

Demand and Marginal Revenue at a Starbucks

Demand and Marginal Revenue for a Firmin a Monopolistically Competitive Market:

MR for a Firm with a Downward-Sloping Demand Curve

FIGURE 12-2 How a Price Cut Affects a Firm’s Revenue

If the local Starbucks reduces the price of a caffè latte from $3.50 to $3, the number of caffè lattes it sells per week will increase from 5 to 6.

Its MR from selling the 6th caffè latte will be $0.50, which is equal to the $3 additional revenue from selling 1 more caffè latte (the area of the green box)

minus the $2.50 loss in revenue from selling the first 5 caffè lattes for $0.50 less each (the area of the red box).

Demand and Marginal Revenue for a Firmin a Monopolistically Competitive Market:

MR for a Firm with a Downward-Sloping Demand Curve

FIGURE 12-3

The D and MR Curves for a Monopolistically Competitive Firm

Any firm that has the ability to affect the price of the product it sells will have a MR curve that is below its D curve.

Data from Table 12-1 create the D and MR curves.

After the 6th caffè latte, MR becomes negative because the additional revenue received from selling 1 more caffè latte is < the revenue lost from receiving a lower price on the caffè lattes that could have been sold at the original price.

Demand and Marginal Revenue for a Firmin a Monopolistically Competitive Market:

MR for a Firm with a Downward-Sloping Demand Curve

How a Monopolistically Competitive Firm Maximizes in the Short Run

FIGURE 12-4Maximizing Profit in aMonopolistically Competitive Market

Explain how a monopolistically competitive firm maximizes profit in the short run.12.2 LEARNING OBJECTIVE

Will Apple maximize profits if it produces 800,000 iPhones per month?

Does Minimizing Cost Maximize Profits?

Solved Problem 12-2

Average cost reaches a minimum at a quantity of 800,000, but profits are maximized at a quantity of 600,000.

What Happens to Profits in the Long Run?How Does the Entry of New Firms Affect the of

Existing Firms?FIGURE 12-5 How Entry of New Firms Eliminates Profits

Panel (a) shows that in the SR, Starbucks can charge a P above ATC (point A) and make a , shown by the green rectangle. But this attracts new firms to enter the market, which shifts the D and MR curves to the curves labeled “Long run” in panel (b). At point B, Starbucks breaks even.

Analyze the situation of a monopolistically competitive firm in the long run.12.3 LEARNING OBJECTIVE

Table 12-2

The Short Run and the Long Run for a Monopolistically Competitive Firm

How Does the Entry of New Firms Affect the of Existing Firms?

What Happens to Profits in the Long Run?

The Rise and Decline of Starbucks Making

theConnection

Starbucks: No longer different enough?

In a monopolistically competitive industry, maintaining profits in the long run is very difficult.

Is Zero Economic Profit Inevitable in the Long Run?

What Happens to Profits in the Long Run?

A firm’s profits will be eliminated in the long run only if a firm stands still and fails to find new ways of differentiating its product or fails to find new ways of lowering the cost of producing its product.

Don’t Let This Happen to YOU!

Don’t Confuse Zero Economic with Zero Accounting

Can It Be Profitable to Be the High-Price Seller?Solved Problem

12-3

Because the greater demand more than offsets the higher costs, the hhgregg store makes a larger profit.

• Monopolistically competitive firms charge a price greater than marginal cost.

• Monopolistically competitive firms do not produce at minimum average total cost.

Monopolistic competition and perfect competition share the characteristic that in long-run equilibrium, firms earn zero economic profits.

However, there are two important differences between long-run equilibrium in the two markets:

Compare the efficiency of monopolistic competition and perfect competition.12.4 LEARNING OBJECTIVE

Comparing Perfect Competition and Monopolistic Competition

Excess Capacity under Monopolistic CompetitionFIGURE 12-6 Comparing Long-Run Equilibrium under Perfect

Competition and Monopolistic Competition

A monopolistically competitive firm has excess capacity: If it increased its output, it could produce at a lower average cost.

Comparing Perfect Competition and Monopolistic Competition

Economists have debated whether monopolistically competitive markets, being neither productively nor allocatively efficient, results in a significant loss of well-being to society in these markets compared with perfectly competitive markets.

How Consumers Benefit from Monopolistic Competition:

Consumers benefit from being able to purchase a product that is differentiated and more closely suited to their tastes.

Is Monopolistic Competition Inefficient?

Comparing Perfect Competition and Monopolistic Competition

Abercrombie & Fitch: Can the Product Be Too Differentiated?

Did Abercrombie and Fitch narrow its target market too much?

Makingthe

Connection

A firm whose strategy of product

differentiation succeeds will

experience increases in

same-store sales.

How Marketing Differentiates Products

Marketing All the activities necessary for a firm to sell a product to a consumer.

Brand Management The actions of a firm intended to maintain the differentiation of a product over time.

Define marketing and explain how firms use it to differentiate their products.12.5 LEARNING OBJECTIVE

If the increase in revenue that results from the advertising is greater than the increase in costs, the firm’s profits will rise.

Advertising

Defending a Brand Name

A firm can apply for a trademark, which grants legal protection against other firms using its product’s name.

How Marketing Differentiates Products

Google Tries (and Fails) toMeasure the Effectivenessof Radio Advertising

Makingthe

Connection

Does spending on radio advertising attract

customers?

A firm’s optimal level of advertising occurs where the marginal cost of

advertising equals the marginal revenue

earned from advertising.

What Makes a Firm Successful?FIGURE 12-7 What Makes a Firm Successful?

Identify the key factors that determine a firm’s success.12.6 LEARNING OBJECTIVE

The factors under a firm’s control—the ability to differentiate its product and the ability to produce it at lower cost—combine with the factors beyond its control to determine the firm’s profitability.

Although not first to market, Bic ultimately

was more successful than the firm that pioneered

ballpoint pens.

Is Being the First Firm in the Market a Key to Success?

Makingthe

Connection

The firms that were first to introduce a product ultimately lost out to latecomers who did a better job of providing consumers with products that were more reliable,

less expensive, more convenient, or otherwise provided greater value.

Starbucks Faces McCompetitionAN INSIDE LOOK

>>

The effect of entry on price, quantity, and profits at Starbucks.

Brand management

Marketing

Monopolistic competition

KEY TERMS

Assignment to prepare for Ch. 13: Pre-read Ch. 13, including:

Review Questions: 3rd ed., p. 452 1.1—1.3; p 454 2.1, 2.3—2.5; (2nd ed., p. 464, 1.1 – 1.3; p. 466, 2.1, 2.3, 2.4 & 2.5; (1st edition: 1-4, 6-8 & 10 on pp. 436-43)

Problems and Applications: 3rd ed., p. 453 1.10; p 454, 2.6, 2.7; p 455 2.10; p456, 2.17, 2.20; (2nd ed., p. 465, 1.10; p. 466, 2.6, 2.7 & 2.10; p. 467, 2.17; p. 468, 2.19; and:

The city is considering auctioning licenses that would allow one or two vendors to sell ice cream on the local beach. If the city licenses two vendors, will it receive more in total

license fees than if it sells a license to only one vendor?Will people who use the beach be better off if the city licenses

two vendors or one vendor?Suppose the city licenses two vendors but announces that

every year it will sell licenses to two new vendors. The same vendor may not hold a license more than once every five years. Would this make any difference to the prices the vendors change? (1st edition: 1, 2, 3, 4, 11, 15 & 21 on pp. 437-440).