ch13 - Monopolistic Competition and Oligopoly Monopolistic...

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Chapter 13 Monopolistic Competition and Oligopoly Monopolistic Competition Monopolistic competition is a market structure in which: o A large number of firms compete. o Each firm produces a differentiated product. o Firms compete on product quality, price, and marketing. o Firms are free to enter and exit. A firm practices product differentiation if it makes a product that is slightly different from the products of competing firms. Price and Output in Monopolistic Competition A firm in monopolistic competition maximizes profit by producing the quantity at which marginal revenue equals marginal cost and charging the highest price the market will bear, just like a monopoly. In the figure, the demand curve is D . The firm’s marginal revenue curve is MR . It is derived in exactly the same way as that of a monopolist. The firm’s average total cost curve is ATC and its marginal cost curve is MC . The firm maximizes profit by producing 150 jackets and selling them at a price of $190. This outcome looks like monopoly. But unlike monopoly, in monopolistic competition, there are no barriers to entry. And just like the case of perfect competition, entry is triggered by the presence of economic profit. And exit is triggered by economic loss.
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Because in the situation shown here, the firm earns an economic profit, entry occurs. Entry decreases the demand facing this firm. The firm’s demand curve and marginal revenue curve shift leftward. As demand decreases, the firm decreases production and lowers its price. Entry continues until economic profit is eliminated. In monopolistic competition, marginal benefit exceeds marginal cost and production is less than its efficient level. In the long run, the monopolistically competitive industry produces an output at which price equals average total cost but exceeds marginal cost. This means that firms in monopolistic competition always have excess capacity in long-run equilibrium. The figure shows a firm’s excess capacity.
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Product Development and Marketing Monopolistic competition induces product innovation, which consumers also value. These gains of monopolistic competition must be set against the deadweight loss it generates. Another aspect of monopolistic competition is large selling costs. Selling costs that inform and create information that has value are not a waste. If the marginal value of information equals its marginal cost, the efficient
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ch13 - Monopolistic Competition and Oligopoly Monopolistic...

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