07-Product_Differentiation_and_Monopolistic_Competition

07-Product_Differentiation_and_Monopolistic_Competition -...

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Product Differentiation and Monopolistic Competition Econ 425, Summer I 2008
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2 Intro b There are many markets in which products are differentiated (consumers view products as imperfect substitutes). - Cereals: approx. 200 different kinds; 4 major multibrand firms (Kellogg, General Mills, Post, and Quaker Oats) have 80% market share. - Credit cards: 4,000 card issuers; 10 largest firms have 20% market share. b Horizontal and vertical product differentiation: e.g. SUV, CX-7 or RAV4? - Vertical: consumers agree which product or brand is better. e.g. CX-7, Grand Touring better than Sport.
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3 Intro (2) b We are going to examine monopolistic competition models with free entry and differentiated products. - firms make zero economic profits in the LR; - firms have market power (face a downward-sloping demand). b Two models: - Representative consumer model: all goods are equally good substitutes to each other (Chamberlin, 1933). - Spatial or location model: consumers prefer products that are close in characteristic or geographic space (Hotelling, 1929; Salop, 1979).
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4 Intro (3) b Why do firms differentiate their products? Why does product differentiation increase firms’ market power? b Is there any optimal variety-price combination? e.g. Do you prefer a choice of three different-flavored sodas at 50 cents each or only one flavor at 25 cents? b What number of firms maximizes welfare if: - all brands are perfect substitutes? - consumers view brands as imperfect substitutes? - consumers only value some of the brands in the market?
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5 The representative consumer model without PD b Assumptions: - Firms choose output (MR r = MC); - Free entry ( n endogenously determined). b Let’s revisit our example of spring water producers: - Inverse market demand: p = 1 – 0.001Q, - Costs: C(q) = 0.28q + F, where F are fixed costs. Entry condition firms enter until p = AC (profit = 0). b Suppose F = $6.4. What is the equilibrium number of firms?
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6 The representative consumer model without PD (2) Mathematically Two-step procedure: 1. Cournot equilibrium with n firms: , . 2. Select n in which firms make zero profit: p = 0.28 + 6.4/ q . ) 1
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07-Product_Differentiation_and_Monopolistic_Competition -...

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