L17 monopolistic competition

Microeconomics ECA002: Topic 5 - Monopolistic Competition

Overview

• Presenter: Luke Garrod

• Focus: Monopolistic competition as a form of market structure

Competition Spectrum

• Extremes: Perfect competition and pure monopoly

  • Perfect competition: many sellers, price takers

  • Monopoly: single seller, price maker

• Reality: Most firms operate in an imperfect competition environment

  • Firms face some competition and are not price takers

• Forms of Imperfect Competition:

  • Monopolistic competition

  • Oligopoly

Aims of the Lecture

• Understanding monopolistic competition:

  • Hybrid model between monopoly and competition

  • Many sellers competing with differentiated products

  • Market power allows setting prices above marginal costs

• Analysis of production and pricing in monopolistically competitive markets compared to perfect competition and monopoly

Product Differentiation

• Importance of variety in products:

  • Example: Valentine’s Day

  • Perfectly competitive markets lack product variety

• Types of Product Differentiation:

  1. Horizontal differentiation: Same quality but based on consumer preferences (e.g., different car brands)

  2. Vertical differentiation: Differences in quality, regardless of consumer taste (e.g., luxury vs. economy cars)

Lecture Outline

1. Assumptions of monopolistic competition

2. Appropriate market structure

3. Short-run equilibrium

4. Long-run equilibrium

5. Comparison with perfect competition

• Reading Material:

  • Core: Lipsey & Chrystal, ch. 8

  • Extra: Perloff, Ch. 13.6

Assumptions of Monopolistic Competition

• Retaining assumptions from previous lectures:

  • Buyers as price takers

  • Complete information for buyers and sellers

• New Assumptions:

  1. Sellers as price makers (influence price, demand curve downward sloping)

     • Seller sells more at lower prices; output choice does not trigger rivals' reactions.

  2. Free entry and exit involve no additional costs compared to incumbents

Characteristics of Market Structure

• Key Elements:

  • Number of Sellers:

    • Many small sellers (contrasts with oligopoly and monopoly)

  • Barriers to Entry:

    • Low barriers promoting competition

  • Product Substitutability:

    • Differentiated products allow some pricing power

Short-run Equilibrium

• Demand curve for each seller is influenced by the number of firms:

  • More firms imply less average demand per firm

• Example: 4000 individuals in a market divided amongst 40 pubs leads to approximately 100 customers per pub

  • Increase in pubs causes a decrease in average customers per pub

  • Symmetric cost structures simplify analysis

Long-run Equilibrium

• Long-run analysis similar to perfect competition:

  • All factors of production are variable, influencing costs

  • Market entry leads to zero economic profit in equilibrium

• Zero Profit Condition:

  • Ensures no incentive for firms to exit or enter the market

Effects of Entry on Long-run Equilibrium

• Firms will enter until profits reach zero:

  • Price equals average total cost in equilibrium

Comparison with Perfect Competition

• Two Main Differences:

  1. Price-Cost Margin:

     • Monopolistic competition prices above marginal cost

     • Perfect competition prices equal marginal cost

  2. Excess Capacity:

     • Monopolistically competitive firms operate below efficient scale

     • Perfectly competitive firms achieve efficient scale

Summary of Differences

• Comparison Table:

  Feature	Perfect Competition	Monopolistic Competition
  Output Rule	MR = MC	MR = MC
  Short-run Profits?	Yes	Yes
  Price Taker?	Yes	No
  Price	Equals MC	Above MC
  Efficient Output?	Yes	No
  Number of Firms	Many	Many
  Long-run Profits?	Normal	Normal
  Entry in Long Run?	Yes	Yes

Conclusion

• Short-run Dynamics: Prices above marginal costs allow for supernormal profits

• Long-run Dynamics: Prices stabilize at normal profit levels as market entry balances the market conditions

• Post-lecture, students should be able to articulate the assumptions, structure, equilibrium analyses, and differences with other market forms.