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Chap. 11. Monopolistic Competition

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40 views26 pages

Chap. 11. Monopolistic Competition

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victoriavenven0
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© © All Rights Reserved
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PASIG CATHOLIC COLLEGE

Basic Microeconomics
Chap. 11. Monopolistic
Competition

Professor: Dr. Ronaldo A. Poblete


Monopolistic Competition
We come now to our last broad type of market
structure: monopolistic competition. Like perfect
competition, a monopolistically competitive industry is
an industry in which entry is easy and many firms are
the norm. In contrast to the perfectly competitive firm,
however, firms in this industry type do not produce
homogeneous goods. Rather, each firm produces a
slightly different version of a product. These product
differences give rise to some market power. In the
monopolistically competitive industry, a firm can
charge a higher price than a competitor and not lose
all of its customers. We will spend some time in this
chapter looking at pricing in these industries.
Monopolistic Competition

Figure 15.1 summarizes the four types:


perfect competition, monopoly, oligopoly, and
monopolistic competition. The behavior of
firms in an industry, the key decisions facing
firms, and the key policy issues government
faces in dealing with those firms differ
depending on the market structure we are in.
Although not every industry fits neatly into one
of these categories, they do provide a useful
and convenient framework for thinking about
industry structure and behavior.
Market Imperfections and the Role
of Government
Industry Characteristics
A monopolistically
competitive industry has the
following characteristics:
1. A large number of firms
2. No barriers to entry
3. Product differentiation
Product Differentiation and
Advertising
Monopolistically competitive firms
achieve whatever degree of
market power they command
through product differentiation.
But what determines how much
differentiation we see in a
market and what form it takes?
Monopolistic Competition
A common form of
industry (market) structure in
the United States,
characterized by a large
number of firms, no barriers
to entry, and product
differentiation.
Product Differentiation
A strategy that firms use to
achieve market power.
Accomplished by producing
products that have distinct
positive identities in
consumers’ minds.
How Many Varieties?
How Do Firms Differentiate
Products?
We have learned that
differentiation occurs in response to
demands by consumers for products
that meet their individual needs and
tastes, constrained by the forces of
costs of coordination and scale
economies. We can go one step
further and characterize the kinds of
differentiation we see in markets.
Horizontal Differentiation

Products differ in ways that


make them better for some
people and worse for others
Behavioral Economics
A branch of
economics that uses the
insights of psychology
and economics to
investigate decision
making.
Commitment Device
Actions that
individuals take in one
period to try to control
their behavior in a future
period.
An Economist Makes Tea
An Economist Makes Tea
The critics clearly noticed that Green
Dragon is not at the peak of the taste
curve. That is, a little more sugar would
improve the taste of the tea. Why did
Nalebuff stop short of that point? This is
product differentiation at its best.
Goldman and Nalebuff are out to
produce a new product that will attract
demand.
Vertical Differentiation
A product difference
that, from everyone’s
perspective, makes a
product better than rival
products.
Advertising
Advertising fits into the differentiation
story in two different ways.
One role advertising plays is to inform
people about the real differences that exist
among products.
Advertising can also create or contribute
to product differentiation, creating a brand
image for a product that has little to do with its
physical characteristics. We can all think of
examples of each type.
The Case for Advertising and The Case Against
Product Differentiation and Advertising
For product differentiation to be
successful, consumers must know
about product quality and availability.
Product differentiation and advertising
waste society’s scarce resources,
argue critics. They say enormous
sums of money are spent to create
minute, meaningless differences
among products.
Price and Output Determination in
Monopolistic Competition
Recall that monopolistically
competitive industries are made up of a
large number of firms, each small relative
to the size of the total market. Thus, no one
firm can affect market price by virtue of its
size alone. Firms do differentiate their
products, however, in ways we have been
discussing.
By doing so, they gain some control
over price.
Product Differentiation and
Demand Elasticity
Perfectly competitive firms face
a perfectly elastic demand for their
product: All firms in a perfectly
competitive industry produce exactly
the same product. If firm A tried to
raise prices, buyers would go
elsewhere and firm A would sell
nothing.
Price/Output Determination in
the Short Run
A profit - maximizing,
monopolistically competitive
firm behaves much like a
monopolist in the short run.
Price/Output Determination in
the Long Run
Under monopolistic competition, entry and
exit are easy in the long run. Firms can enter an
industry when there are profits to be made, and
firms suffering losses can go out of business.
However, entry into an industry of this sort
is somewhat different from entry into perfect
competition because products are differentiated
in monopolistic competition. A firm that enters a
monopolistically competitive industry is producing
a close substitute for the good in question, but
not the same good.

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