ECO 202 Chapter 13: Monopolistic Competition

monopolistic competition

1. many firms

2. no barriers to entry for new firms entering the industry

3. products are NOT identical to competitors

we expect MC to have zero long-run profit, but not face a horiztontal demand curve, face a downward-sloping demand curve

products sold by MC firms are differentiated from one another in some way

demand curve for MC

downward-sloping

if a MCF raises their price, some but not all of its customers wills switch to buy the product elsewhere

total revenue increases initially and then decreases, so marginal revenue is initially positive, then negative

when a MCF reduces price, its revenue increases because the extra sales (output effect) BUT revenue also decreases because others were willing to pay the old price (price effect)

marginal revenue will always be lower than price (demand)

maximizing profit in the short run

produce until MC = MR

profits in the long run

when total revenue > total cost, firms make a profit, giving entrepreneurs incentive to enter the market

when new firms enter, demand decreases

demand becomes more elastic in the long run because cutomers have an easier time switching to competitors (so demand curve is flatter in the long run)

firm must break even, average total cost curve is tangent to demand curve

is zero economic profit inevitable

model predicts firms will earn no profit in the long run

BUT firms could innovate so their costs are lower or convince customers their product is better

demand will continue to fall to zero profit unless the firm is able to do something about it

efficiency in monopolistic competition

results in neither productive nor allocative efficiency

• don’t produce at MC = MB (DC) so not allocatively efficient

• average cost is above minimum point, so not productively efficient

has excess capacity: if it increased its output, the firm could produce at a lower average total cost

marketing

all the activities necessary for a firm to sell a product to a consumer

brand management

actions of a firm intended to maintain the differentiation of a product over time

effects of marketing on differentiation

effective advertising can increase demand and differentiate products, effectively making the demand curve more inelastic which allows firms to charge a higher price and earn more short run profit

it is critical to create a successful brand name to maintain differntiation and delay competition for profits

what makes a firm successful?

differentiation and production at lower costs creates value

value + chance events + factors affecting market beyond a firm’s control = profitability