Monopolistic Competition: Characteristics, Welfare, and Advertising Effects

What are the two extreme forms of market structures?

Perfect competition and monopoly.

What characterizes perfect competition?

Many firms, identical products, price takers, P = MC.

What characterizes a monopoly?

One firm, price maker, P > MC.

What is oligopoly?

A market structure with only a few sellers offering similar or identical products.

What is monopolistic competition?

A market structure with many firms selling similar but not identical products.

What are the characteristics of monopolistic competition?

Numerous firms, product differentiation, downward-sloping demand curve, free entry and exit, zero economic profit in the long run.

Give examples of monopolistically competitive markets.

Books, video games, restaurants, piano lessons, cookies, clothing.

What is the concentration ratio?

A measure of a market's domination by a small number of firms, typically the percentage of total output supplied by the four largest firms.

What is the short-run equilibrium condition for a monopolistically competitive firm?

Produce the quantity where MR = MC.

What happens if P > ATC in the short run?

The firm earns profit.

What happens if P < ATC in the short run?

The firm incurs a loss.

What occurs in the long-run equilibrium of monopolistic competition?

New firms enter if profits are made, shifting demand left until profits are zero.

What is excess capacity in monopolistic competition?

Quantity is not at minimum ATC, indicating inefficiency.

How does monopolistic competition compare to perfect competition?

Monopolistic competition has P > MC and operates with excess capacity, while perfect competition has P = MC and operates at minimum ATC.

What are the sources of inefficiency in monopolistically competitive markets?

Markup of price over marginal cost, too much or too little entry, product-variety externality, business-stealing externality.

What is the product-variety externality?

Consumers gain extra surplus from the introduction of new products.

What is the business-stealing externality?

Losses incurred by existing firms when new firms enter the market.

What is deadweight loss in the context of monopolistic competition?

The loss of economic efficiency when the market quantity is less than the socially efficient quantity.

What is the long-run outcome for a firm in monopolistic competition?

Firms earn zero economic profit as new entrants reduce demand.

What is the demand curve shape for monopolistically competitive firms?

Downward-sloping.

What is the relationship between price and marginal cost in monopolistic competition?

Price is greater than marginal cost (P > MC).

What is the role of advertising in monopolistic competition?

It can create brand loyalty and differentiate products, but also incurs social costs.

What is the effect of free entry and exit in monopolistic competition?

It leads to zero economic profit in the long run.

What does it mean for a firm to charge a markup?

The firm sets a price above marginal cost.

What is the significance of the four types of market structure?

They categorize markets based on the number of firms and type of products offered.

What is the implication of firms producing on the downward-sloping portion of ATC?

It indicates that firms are not producing at efficient scale.

What happens to demand faced by each firm as new firms enter a monopolistically competitive market?

The demand curve shifts left, leading to lower prices.

What is the long-run equilibrium condition for monopolistically competitive firms?

P = ATC and profit = zero.

What are the three market structures studied in relation to advertising?

Perfect competition, monopoly, and monopolistic competition.

Under what conditions do firms have an incentive to advertise?

When firms sell differentiated products and charge prices above marginal cost.

What percentage of revenue do firms typically spend on advertising for highly differentiated goods?

10-20% of revenue.

How much advertising do firms selling homogenous products typically engage in?

No advertising.

What is one critique of advertising?

Firms advertise to manipulate people's tastes.

How does advertising affect competition according to critics?

It impedes competition by increasing the perception of product differentiation and fostering brand loyalty.

What is one defense of advertising?

It provides useful information to buyers, allowing informed customers to make better choices.

What effect can advertising have on market prices according to defenders?

Advertising promotes competition and reduces market power.

What does advertising signal about a product's quality?

The willingness to spend large amounts of money on advertising signals high quality.

In the toothpaste example, what was the cost of advertising for both Colgate and Crest?

$8 million.

What was the profit outcome for Colgate if they advertised?

A loss of $5.5 million.

What was the profit outcome for Crest if they advertised?

$22 million.

What is a characteristic of brand name products compared to generic ones?

Brand names spend more on advertising and charge higher prices.

What is one criticism of brand names?

Products are not differentiated, and consumers irrationally pay more for them.

What is one defense of brand names?

They provide information about quality and firms have an incentive to maintain high quality.

What is the long-run equilibrium in a monopolistically competitive market?

Each firm has excess capacity and charges a price above marginal cost.

What is the deadweight loss in monopolistically competitive markets caused by?

The markup of price over marginal cost.

What do critics argue about advertising's effect on consumer behavior?

It manipulates consumers' tastes and reduces competition.

What do defenders argue about advertising's role in the market?

It informs consumers and encourages competition on price and product quality.

What is the impact of advertising on the perception of product differentiation?

It increases the perception of product differentiation.

What was the outcome of allowing advertising for liquor in terms of price?

Liquor became about 20% cheaper after advertising was allowed.

What is the relationship between advertising and brand loyalty?

Advertising fosters brand loyalty, making buyers less concerned with price differences.

What is the role of advertising in informing consumers?

It helps consumers make better choices by providing useful information.

What happens to the number of firms in a monopolistically competitive market?

The number of firms can be too large or too small, leading to inefficiencies.

What is the primary function of advertising according to defenders?

To inform consumers and promote competition.

What does excess capacity in long-run equilibrium indicate?

Firms are operating on the downward-sloping portion of the average total cost curve.

What is the significance of the Nike advertisement featuring LeBron James?

It illustrates the use of celebrity endorsements in advertising without providing detailed product information.

What argument did a friend make about the Nike ad during the Super Bowl?

They believed it was a waste of resources as it did not provide informative content.

What is the general consensus about advertising's effect on competition and prices?

Advertising tends to increase competition and reduce prices for consumers.