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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