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Unformatted text preview: 1/13/2021 Monopolistic Competition | Boundless Economics Boundless Economics Monopolistic Competition Monopolistic Competition … 1/26 1/13/2021 Monopolistic Competition | Boundless Economics De ning Monopolistic Competition Monopolistic competition is a type of imperfect competition such that many producers sell products that are di erentiated from one another. LEARNING OBJECTIVES Evaluate the characteristics and outcomes of markets with imperfect competition KEY TAKEAWAYS Key Points Monopolistic competition is di erent from a monopoly. A monopoly exists when a person or entity is the exclusive supplier of a good or service in a market. Markets that have monopolistic competition are ine cient for two reasons. First, at its optimum output the rm charges a price that exceeds marginal costs. The second source of ine ciency is the fact that these rms operate with excess capacity. Monopolistic competitive markets have highly di erentiated products; have many rms providing the good or service; rms can freely enter and exits in the long-run; rms can make decisions independently; there … 2/26 1/13/2021 Monopolistic Competition | Boundless Economics is some degree of market power; and buyers and sellers have imperfect information. Key Terms monopoly: A market where one company is the sole supplier. Monopolistic competition: A type of imperfect competition such that one or two producers sell products that are di erentiated from one another as goods but not perfect substitutes (such as from branding, quality, or location). Monopolistic Competition Monopolistic competition is a type of imperfect competition such that many producers sell products that are di erentiated from one another as goods but not perfect substitutes (such as from branding, quality, or location). In monopolistic competition, a rm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other rms. Unlike in perfect competition, rms that are monopolistically competitive maintain spare capacity. Models of monopolistic competition are often used to model industries. Textbook examples of industries with market structures similar to monopolistic competition include restaurants, cereal, clothing, shoes, and service industries in large cities. … 3/26 1/13/2021 Monopolistic Competition | Boundless Economics Clothing: The clothing industry is monopolistically competitive because rms have di erentiated products and market power. Monopolistic competition is di erent from a monopoly. A monopoly exists when a person or entity is the exclusive supplier of a good or service in a market. The demand is inelastic and the market is ine cient. Monopolistic competitive markets: have products that are highly di erentiated, meaning that there is a perception that the goods are di erent for reasons other than price; have many rms providing the good or service; rms can freely enter and exits in the long-run; rms can make decisions independently; there is some degree of market power, meaning producers have some control over price; and buyers and sellers have imperfect information. … 4/26 1/13/2021 Monopolistic Competition | Boundless Economics Sources of Market Ine ciency Markets that have monopolistic competition are ine cient for two reasons. The rst source of ine ciency is due to the fact that at its optimum output, the rm charges a price that exceeds marginal costs. The monopolistic competitive rm maximizes pro ts where marginal revenue equals marginal cost. A monopolistic competitive rm’s demand curve is downward sloping, which means it will charge a price that exceeds marginal costs. The market power possessed by a monopolistic competitive rm means that at its pro t maximizing level of production there will be a net loss of consumer and producer surplus. The second source of ine ciency is the fact that these rms operate with excess capacity. The rm’s pro t maximizing output is less than the output associated with minimum average cost. All rms, regardless of the type of market it operates in, will produce to a point where demand or price equals average cost. In a perfectly competitive market, this occurs where the perfectly elastic demand curve equals minimum average cost. In a monopolistic competitive market, the demand curve is downward sloping. In the long run, this leads to excess capacity. Product Di erentiation Product di erentiation is the process of distinguishing a product or service from others to make it more attractive to a target market. LEARNING OBJECTIVES De ne product di erentiation KEY TAKEAWAYS Key Points … 5/26 1/13/2021 Monopolistic Competition | Boundless Economics Di erentiation occurs because buyers perceive a di erence between products. Causes of di erentiation include functional aspects of the product or service, how it is distributed and marketed, and who buys it. Di erentiation a ects performance primarily by reducing direct competition. As the product becomes more di erent, categorization becomes more di cult, and the product draws fewer comparisons with its competition. There are three types of product di erentiation: simple, horizontal, and vertical. Key Terms product di erentiation: Perceived di erences between the product of one rm and that of its rivals so that some customers value it more. One of the de ning traits of a monopolistically competitive market is that there is a signi cant amount of non- price competition. This means that product di erentiation is key for any monopolistically competitive rm. Product di erentiation is the process of distinguishing a product or service from others to make it more attractive to a target market. Although research in a niche market may result in changing a product in order to improve di erentiation, the changes themselves are not di erentiation. Marketing or product di erentiation is the process of describing the di erences between products or services, or the resulting list of di erences; di erentiation is not the process of creating the di erences between the Kool-Aid: Kool-Aid is an individual … 6/26 1/13/2021 Monopolistic Competition | Boundless Economics products. Product di erentiation is done in order to demonstrate brand that competes with Kraft’s other brand (Tang). the unique aspects of a rm’s product and to create a sense of value. In economics, successful product di erentiation is inconsistent with the conditions of perfect competition, which require products of competing rms to be perfect substitutes. Consumers do not need to know everything about the product for di erentiation to work. So long as the consumers perceive that there is a di erence in the products, they do not need to know how or why one product might be of higher quality than another. For example, a generic brand of cereal might be exactly the same as a brand name in terms of quality. However, consumers might be willing to pay more for the brand name despite the fact that they cannot identify why the more expensive cereal is of higher “quality.” There are three types of product di erentiation: Simple: the products are di erentiated based on a variety of characteristics; Horizontal: the products are di erentiated based on a single characteristic, but consumers are not clear on which product is of higher quality; and Vertical: the products are di erentiated based on a single characteristic and consumers are clear on which product is of higher quality. Di erentiation occurs because buyers perceive a di erence. Drivers of di erentiation include functional aspects of the product or service, how it is distributed and marketed, and who buys it. The major sources of product di erentiation are as follows: Di erences in quality, which are usually accompanied by di erences in price; … 7/26 1/13/2021 Monopolistic Competition | Boundless Economics Di erences in functional features or design; Ignorance of buyers regarding the essential characteristics and qualities of goods they are purchasing; Sales promotion activities of sellers, particularly advertising; and Di erences in availability (e.g. timing and location). The objective of di erentiation is to develop a position that potential customers see as unique. Di erentiation a ects performance primarily by reducing direct competition. As the product becomes more di erent, categorization becomes more di cult, and the product draws fewer comparisons with its competition. A successful product di erentiation strategy will move the product from competing on price to competing on non-price factors. Demand Curve The demand curve in a monopolistic competitive market slopes downward, which has several important implications for rms in this market. LEARNING OBJECTIVES Explain how the shape of the demand curve a ects the rms that exist in a market with monopolistic competition KEY TAKEAWAYS Key Points The downward slope of a monopolistically competitive demand curve signi es that the rms in this industry have market power. … 8/26 1/13/2021 Monopolistic Competition | Boundless Economics Market power allows rms to increase their prices without losing all of their customers. The downward slope of the demand curve contributes to the ine ciency of the market, leading to a loss in consumer surplus, deadweight loss, and excess production capacity. Key Terms market power: The ability of a rm to pro tably raise the market price of a good or service over marginal cost. A rm with total market power can raise prices without losing any customers to competitors. elastic: Sensitive to changes in price. The demand curve of a monopolistic competitive market slopes downward. This means that as price decreases, the quantity demanded for that good increases. While this appears to be relatively straightforward, the shape of the demand curve has several important Price implications for rms in a monopolistic competitive market. Consumer surplus D Deadweight loss Pm Pc MC Producer surplus MR Qm Qc Quantity … 9/26 1/13/2021 Monopolistic Competition | Boundless Economics Monopolistic Competition: As you can see from this chart, the demand curve (marked in red) slopes downward, signifying elastic demand. Market Power The demand curve for an individual rm is downward sloping in monopolistic competition, in contrast to perfect competition where the rm’s individual demand curve is perfectly elastic. This is due to the fact that rms have market power: they can raise prices without losing all of their customers. In this type of market, these rms have a limited ability to dictate the price of its products; a rm is a price setter not a price taker (at least to some degree). The source of the market power is that there are comparatively fewer competitors than in a competitive market, so businesses focus on product di erentiation, or di erences unrelated to price. By di erentiating its products, rms in a monopolistically competitive market ensure that its products are imperfect substitutes for each other. As a result, a business that works on its branding can increase its prices without risking its consumer base. Ine ciency in the Market Monopolistically competitive rms maximize their pro t when they produce at a level where its marginal costs equals its marginal revenues. Because the individual rm’s demand curve is downward sloping, re ecting market power, the price these rms will charge will exceed their marginal costs. Due to how products are priced in this market, consumer surplus decreases below the pareto optimal levels you would nd in a perfectly competitive market, at least in the short run. As a result, the market will su er deadweight loss. The suppliers in this market will also have excess production capacity. Short Run Outcome of Monopolistic Competition Monopolistic competitive markets can lead to signi cant pro ts in the short-run, but are ine cient. … 10/26 1/13/2021 Monopolistic Competition | Boundless Economics LEARNING OBJECTIVES Examine the concept of the short run and how it applies to rms in a monopolistic competition KEY TAKEAWAYS Key Points The “short run” is the time period when one factor of production is xed in terms of costs, while the other elements of production are variable. Like monopolies, the suppliers in monopolistic competitive markets are price makers and will behave similarly in the short-run. Also like a monopoly, a monopolastic competitive rm will maximize its pro ts when its marginal revenues equals its marginal costs. Key Terms short-run: The conceptual time period in which at least one factor of production is xed in amount and others are variable in amount. In terms of production and supply, the “short run” is the time period when one factor of production is xed in terms of costs while the other elements of production are variable. The most common example of this is the production of a good that requires a factory. If demand spikes, in the short run you will only be able to produce the amount of good that the capacity of the factory allows. This is because it takes a signi cant amount of time to either build or acquire a new factory. If demand for the good plummets you can cut production in the factory, but will still have to … 11/26 1/13/2021 Monopolistic Competition | Boundless Economics pay the costs of maintaining the factory and the associated rent or debt associated with acquiring the factory. You could sell the factory, but again that would take a signi cant amount of time. The “short run” is de ned by how long it would take to alter that “ xed” aspect of production. In the short run, a monopolistically competitive market is ine cient. It does not achieve allocative nor productive e ciency. Also, since a monopolistic competitive rm has powers over the market that are similar to a monopoly, its pro t maximizing level of production will result in a net loss of consumer and producer surplus, creating deadweight loss. Setting a Price and Determining Pro t Like monopolies, the suppliers in monopolistic competitive markets are price makers and will behave similarly in the short-run. Also like a monopoly, a monopolistic competitive rm will maximize its pro ts by producing goods to the point where its marginal revenues equals its marginal costs. The pro t maximizing price of the good will be determined based on where the pro t-maximizing quantity amount falls on the average revenue curve. The pro t the rm makes is the the amount of the good produced multiplied by the di erence between the price minus the average cost of producing the good.. … 12/26 1/13/2021 Monopolistic Competition | Boundless Economics Short Run Equilibrium Under Monopolistic Competition: As you can see from the chart, the rm will produce the quantity (Qs) where the marginal cost (MC) curve intersects with the marginal revenue (MR) curve. The price is set based on where the Qs falls on the average revenue (AR) curve. The pro t the rm makes in the short term is represented by the grey rectangle, or the quantity produced multiplied by the di erence between the price and the average cost of producing the good. Since monopolistically competitive rms have market power, they will produce less and charge more than a rm would under perfect competition. This causes deadweight loss for society, but, from the producer’s point of view, is desirable because it allows them to earn a pro t and increase their producer surplus. Because of the possibility of large pro ts in the short-run and relatively low barriers of entry in comparison to perfect markets, markets with monopolistic competition are very attractive to future entrants. Long Run Outcome of Monopolistic Competition In the long run, rms in monopolistic competitive markets are highly ine cient and can only break even. … 13/26 1/13/2021 Monopolistic Competition | Boundless Economics LEARNING OBJECTIVES Explain the concept of the long run and how it applies to a rms in monopolistic competition KEY TAKEAWAYS Key Points In terms of production and supply, the ” long-run ” is the time period when all aspects of production are variable and can therefore be adjusted to meet shifts in demand. Like monopolies, the suppliers in monopolistic competitive markets are price makers and will behave similarly in the long-run. Like a monopoly, a monopolastic competitive rm will maximize its pro ts by producing goods to the point where its marginal revenues equals its marginal costs. In the long-run, the demand curve of a rm in a monopolistic competitive market will shift so that it is tangent to the rm’s average total cost curve. As a result, this will make it impossible for the rm to make economic pro t; it will only be able to break even. Key Terms long-run: The conceptual time period in which there are no xed factors of production. In terms of production and supply, the “long-run” is the time period when there is no factor that is xed and all aspects of production are variable and can therefore be adjusted to meet shifts in demand. Given a long … 14/26 1/13/2021 Monopolistic Competition | Boundless Economics enough time period, a rm can take the following actions in response to shifts in demand: Enter an industry; Exit an industry; Increase its capacity to produce more; and Decrease its capacity to produce less. In the long-run, a monopolistically competitive market is ine cient. It achieves neither allocative nor productive e ciency. Also, since a monopolistic competitive rm has power over the market that is similar to a monopoly, its pro t maximizing level of production will result in a net loss of consumer and producer surplus. Setting a Price and Determining Pro t Like monopolies, the suppliers in monopolistic competitive markets are price makers and will behave similarly in the long-run. Also like a monopoly, a monopolistic competitive rm will maximize its pro ts by producing goods to the point where its marginal revenues equals its marginal costs. The pro t maximizing price of the good will be determined based on where the pro t-maximizing quantity amount falls on the average revenue curve. While a monopolistic competitive rm can make a pro t in the short-run, the e ect of its monopoly-like pricing will cause a decrease in demand in the long-run. This increases the need for rms to di erentiate their products, leading to an increase in average total cost. The decrease in demand and increase in cost causes the long run average cost curve to become tangent to the demand curve at the good’s pro t maximizing price. This means two things. First, that the rms in a monopolistic competitive market will produce a surplus in the long run. Second, the rm will only be able to break even in the long-run; it will not be able to earn an economic pro t. … 15/26 1/13/2021 Monopolistic Competition | Boundless Economics Long Run Equilibrium of Monopolistic Competition: In the long run, a rm in a monopolistic competitive market will product the amount of goods where the long run marginal cost (LRMC) curve intersects marginal revenue (MR). The price will be set where the quantity produced falls on the average revenue (AR) curve. The result is that in the long-term the rm will break even. Monopolistic Competition Compared to Perfect Competition The key di erence between perfectly competitive markets and monopolistically competitive ones is e ciency. LEARNING OBJECTIVES Di erentiate between monopolistic competition and perfect competition KEY TAKEAWAYS … 16/26 1/13/2021 Monopolistic Competition | Boundless Economics Key Points Perfectly competitive markets have no barriers of entry or exit. Monopolistically competitive markets have a few barriers of entry and exit. The two markets are similar in terms of elasticity of demand, a rm ‘s ability to make pro ts in the long-run, and how to determine a rm’s pro t maximizing quantity condition. In a perfectly competitive market, all goods are substitutes. In a monopolistically competitive market, there is a high degree of product di erentiation. Key Terms perfect competition: A type of market with many consum...
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