Monopolistic Competition Topic 7(a) Contents 1. 2. 3. 4. 5. Characteristics of MC Short run profit maximisation Long run equilibrium Assessment of MC Product differentiation and Advertising Characteristics of MC  Large number of small firms   Differentiated products   so individual decisions have little or no impact on other firms’ decisions similar but not identical Low barriers to entry   low economies of scale low set-up costs Price and Output Determination The Firm’s Demand Curve in MC is:  Highly elastic, Why?    More close substitutes than a pure monopolist Not perfect substitutes (as is the case with perfect competition) Elasticity depends on   number of rivals degree of product differentiation Short-Run Price and Output Determination Rules for Profit maximization same as under Perfect Competition    MR = MC (where MC cuts MR from below) Short Run: P ≥ AVC Long Run : P ≥ ATC Short-Run Price and Output Determination: Short-Run Profits Price and Costs P MC Economic Profits AC D MR Q Q Short-Run Price and Output Determination: Short-Run Losses MC Price and Costs P ATC Losses D MR Q Q Long Run  How much to produce?   MR = MC Firms tend to break even, i.e. normal profit   Tangency solution: profit-maximising firm will produce an output when its demand curve is at a tangent to its ATC curve When ATC = Price Long run Equilibrium Long-Run Equilibrium  Why monopolistically competitive firms tend to break even in the long run?    Profits attract new entrants Losses encourage exits Some complications    Some product differentiation Some entry is partially restricted Some economic losses may be tolerated by firms in the long run Assessment of MC (vs. PC)  Higher price, lower output    P > MC   No allocative eff. P = AC   lower consumer surplus like monopoly like PC but P ≠ AC  No productive eff. Monopolistic Competition & Economic Efficiency  Productive inefficiency: Minimum ATC is not necessarily chosen   Allocative inefficiency:   excess capacity price does not necessarily equal MC Good feature  product variety Non-price Competition (ie. competition not based on price) Product differentiation: Real and/or perceived differences created by factors such as: quality, brands, service, location, advertising and packaging Advantages  More choice  Innovation => Better products  Avoid price war  Disadvantages  Too much choice?  Superficial product changes – waste of resources Non-price Competition Advertising Firm Advantages of Advertising  influences consumer preferences (the power of persuasion)  makes demand more price inelastic  Increases market power, market share Disadvantages of Advertising  Increases cost of production Non-price Competition – Advertising (cont.) Society Advantages of Advertising    Provides information Promotes competition Advertising revenue – cheaper media (television, newspapers etc) for users Disadvantages of Advertising     Misleading or false information Waste of resources if overall market demand stays constant Creates barriers to entry (financial, brand loyalty) Media bias towards advertisers [...]... consumer surplus like monopoly like PC but P ≠ min AC  No productive eff Monopolistic Competition & Economic Efficiency  Productive inefficiency: Minimum ATC is not necessarily chosen   Allocative inefficiency:   excess capacity price does not necessarily equal MC Good feature  product variety Non-price Competition (ie competition not based on price) Product differentiation: Real and/or perceived differences... resources Non-price Competition Advertising Firm Advantages of Advertising  influences consumer preferences (the power of persuasion)  makes demand more price inelastic  Increases market power, market share Disadvantages of Advertising  Increases cost of production Non-price Competition – Advertising (cont.) Society Advantages of Advertising    Provides information Promotes competition Advertising . Monopolistic Competition Topic 7(a) Contents 1. Characteristics of MC 2. Short run profit maximisation 3. Long run equilibrium 4 perfect competition)  Elasticity depends on  number of rivals  degree of product differentiation Short-Run Price and Output Determination Rules for Profit maximization same as under Perfect Competition  MR. inefficiency :  price does not necessarily equal MC  Good feature  product variety Non-price Competition (ie. competition not based on price) Product differentiation: Real and/or perceived differences