Krugman_SolMan_CH16

Krugman_SolMan_CH16 - Krugman_SolMan_CH16 11/11/04 4:48 PM...

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chapter Monopolistic Competition and Product Differentiation 1. The three conditions for monopolistic competition are (1) a large number of producers, (2) differentiated products, and (3) free entry and exit. a. There are many bands that play at weddings, parties, and so on. There are no sig- nificant barriers to entry or exit. And products are differentiated by quality (for instance, some bands have better musicians or better electronic equipment) or by style (for instance, different bands play different types of music). All three condi- tions for monopolistic competition are fulfilled. b. The industry for individual-serving juice boxes is dominated by a few very large firms (for example, Minute Maid, Welch’s, and Kool Aid), and there are signifi- cant barriers to entry, in part because of the large costs (for example, advertising) involved in gaining any market share of the national market. Products are, how- ever, differentiated—if perhaps only in the minds of consumers. Because of the small number of competitors, the industry is closer to oligopoly. c. There is a large number of dry cleaners, and each produces a product differentiat- ed by location: customers are likely to prefer to use the dry cleaner closest to their home or workplace. Finally, there are no significant barriers to entry. This is a monopolistically competitive market. d. There is a large number of soybean farmers, and there is free entry and exit in this industry. However, soybeans are not differentiated from each other—they are a standardized product. No individual soybean farmer has market power. This industry is therefore a perfectly competitive industry. 2. There are three ways in which you can differentiate your product: by style or type; by location; and by quality. If you decide to copy Starbucks both in style (for example, you copy the décor of the shop and the service) and in quality (for example, you serve coffee made from the same coffee beans, brewed in exactly the same way), you will still most likely dif- ferentiate your product by location: your coffee shop will be closer for some people than any of the other shops, and that gives you some degree of market power. But you could further differentiate your product by style (for example, you could serve coffee in porcelain cups brought to the table by waiters) or by quality (for exam- ple, you could serve only organic shade-grown coffee). All these will help you create a differentiated product that gives you more market power—that is, the power to raise prices. You would, of course, need to determine whether it allows you to raise prices sufficiently to cover the cost of paying for waiters and higher-quality coffee. 3.
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Krugman_SolMan_CH16 - Krugman_SolMan_CH16 11/11/04 4:48 PM...

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