ECON 1B03 - Unit 9 Monopolistic Competition

Product Differentiation

Features of a product that make it different from other firms’ products.

Not Perfect Substitutes

The outputs of different firms when products are differentiated.

Sources of Differentiation

Actual or perceived difference in materials, quality, etc.

Brand name and reputation (Starbucks vs. Paisley Coffeehouse)

Location and Convenience

Transaction costs, lock-in, switching costs (reward apps, contracts)

Incomplete Information, people tend to stick with their old sellers because they trust them and already have all the necessary information on them. This makes them hesitant to gather information on newer sellers as the effort may not seem worth it.

Monopoly

When a firm dominates a market, monopolistically competitive firms do face competition but dominates own little segment in the market

Features of Monopolistically Competitive Markets

1. Many buys, each buyer is very small relative to the overall market size, so they can’t affect the market price with their actions.

2. Many sellets, each seller is very small relative to the overall market, but each produces a differentiated good; sellers have some control over the price, different firms can charge different prices (price setters).

3. Firms can easily enter or exit the market.

Monopolistic Firms’ Product Demand Curves

Monopolistic firms make differentiated goods, so they appeal to different segments in the overall market and face a downward-sloping demand curve within their own market segment, but it’s less steep (more elastic) than the overall market’s demand curve.

Variables for Single Firms

All variables have the same meaning for single firms as they do for the whole market, but now they’re all lowercase and only use the data from only that firm (demand is d, quantity is q, etc)

Price Elasticity of Demand in Monopolistic Firms

A single monopolistic firm has a greater elasticity of demand than the overall market, this makes a single firm’s demand curve flatter (ex. go to the coffee shop down the street if you don’t like the one right beside you)

For-Profit Firm’s Goal

Maximize Profit

Profit Calculation

TR-TC, P*q - TC

Total Cost and Revenue Determinants

TC determined by technology and the factors of production used in the manufacturing process and revenues are determined by consumer demand for a product

Marginal Revenue and Marginal Cost Equations

MR = Change in TR/Change in q, MC = Change in TC/change in q

Marginal Revenue in Monopolistically Competitive Markets

Linear demand curves cause the slope of the MR curve to be exactly double the slope of the demand curve

Summary of Monopolistically Competitive Markets

Firms sell differentiated goods so there are no perfect substitutes for a firm’s goods (people may prefer one firm over the other). Firms are price setters, causing the price to be greater than the marginal revenue, which means that customers pay a price markup.

Marginal Revenue and Total Revenue’s Non-Linearity

Since price changes each time with increased output, the marginal revenue per unit is less than the market price and causes the the total revenue to be non-linear due to its slope (MR) also being non-linear.

Profit Maximization

Profit = TR - TC or P*q - TC, when TR < TC (MR < MC) profit is negative, when TR > TC (MR > MC), profit is positive, TR = TC is the break-even point. Profit is maximized at the biggest gap between the TR and TC curves or when MR = MC.

Price Markup in Monopolistic Competition

The price consumers pay is greater than the marginal cost to make the good, so the markup = P - MC. At the profit maximization point, the firm can charge a higher price.

Price Elasticity and Marginal Revenue and Demand Curves in Monopolistic Firms

When MR is greater than 0, demand is elastic, which causes TR to increase when P decreases. When the MR = 0, the TR is at its maximum and demand is unit elastic. When MR is less than 0, a decrease in P causes a decrease in TR, and demand is inelasitc. Price-setting firms only operate in the elastic portion of the demand curve.

Profit per Unit

Profit/quantity or P-ATC, when the P > ATC.

Loss per Unit

When P < ATC, the profit maximizing point becomes the loss minimizing point.

Short Run Losses

When TR > VC and the total loss < FC, the firm operates as some producer surplus covers the FC’s. When TR < VC, the total loss > FC, the firm can’t operate since would it would cost more to operate, the VC > FC.

Long Run Profits and Entry

Economic Profits encourage new firms to enter and as new competition enters, the demand for existing firm's’ output decreases, The demand will fall fall until P=ATC. When ATC is tangent to the d curve for a firm, P = ATC.

Long Run Losses and Exit

Economic losses encourage firms to exit. As competition leaves, demand for remaining firms’ output increases and the demand increases until the P = ATC.

Monopolisitc Competition in the Long Run

1. In the long Run, P = ATC, capital is allocated efficiently. Firms break even, zero economic profit is earned.

2. P > MC as the ATC > MC under monopolistic competition, so the production isn’t efficient. Firms can get away with inefficiency in their segment, that’s how it usually is.

Welfare Effects of Monopolistic Competition Compared to Perfect Competition

• As monopolisitc firms face downward sloping MR curves, they charge a P > MC (price markup)

• Price higher than PCM, but Q sold is lower

• Consumer surplus is lower and in the long run, the producer surplus is the same as perfect competition as P = ATC, the Producer Surplus is equal to the total fixed cost

Monopolisitic Competition and Inefficiency

Since Monopolistic Competition is economically inefficient, deadweight loss exists