Chapter 17 - 17 Chapter17 MONOPOLISTIC COMPETITION...

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Monopolistic Competition SOLUTIONS TO TEXT PROBLEMS: Quick Quizzes 1. The three key attributes of monopolistic competition are:  (1) there are many sellers; (2) each firm  produces a slightly different product; and (3) firms can enter or exit the market freely. Figure 1 shows the long-run equilibrium in a monopolistically competitive market.  This  equilibrium differs from that in a perfectly competitive market because price exceeds marginal  cost and the firm doesn’t produce at the minimum point of average total cost. Figure 1 2. Advertising may make markets less competitive because it manipulates people’s tastes rather  than being informative.  Advertising gives consumers the perception that there is a greater  difference between two products than really exists.  That makes the demand curve for a product  77 MONOPOLISTIC  COMPETITION 17
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78   Chapter  17/Monopolistic Competition more inelastic, so the firms then charge greater markups over marginal cost.  However, some  advertising could make markets more competitive, since advertising is just one more method of  competition between products and since it sometimes provides useful information to consumers,  allowing them to more easily take advantage of price differences.  In addition, expensive  advertising can be a signal of quality.  Advertising also allows entry, since advertising can be  used to inform consumers about a new product. Brand names may be beneficial because they provide information to consumers about the quality  of goods.  They also give firms an incentive to maintain high quality, since their reputations are  important.  But brand names may be criticized because they may simply differentiate products  that are not really different, as in the case of drugs that are identical but the brand-name drug  sells at a much higher price than the generic drug. Questions for Review 1. The three attributes of monopolistic competition are:  (1) there are many sellers; (2) each seller  produces a slightly different product; and (3) firms can enter or exit the market without restriction.  Monopolistic competition is like monopoly because firms face a downward-sloping demand curve,  so price exceeds marginal cost.  Monopolistic competition is like perfect competition because, in  the long run, price equals average total cost, as free entry and exit drive economic profit to zero.
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