In-Depth Notes on Market Power and Monopolistic Competition

Importance of Early Preparation

• Start Early: Emphasize the need to begin working on papers early to avoid last-minute rush.
• Time Management: Reminder that time flies, thus planning ahead is essential.

Measuring Market Power

• Market Power Definition: The ability of a firm to influence prices or quantities in the market.
• Methods of Measurement: Two primary metrics to measure market power:
  • Herfindahl-Hirschman Index (HHI):
  • Calculation: Sum of the squares of market shares of all firms in the market.
  • Interpretation: Higher values indicate more concentrated industries.
  • Concentration Ratio:
  • Focuses on the market share of the top four firms (often referred to as CR4).
  • Indicates the level of competition within the market.

Monopoly vs. Monopolistic Competition

• Profit Maximization:
  • Firms under monopolistic competition determine pricing and quantity based on marginal cost and marginal revenue.
  • Graphs are crucial for analyzing outputs:
  • Graphical Analysis:
    • Average costs and profits can be identified through the slopes of curves where profit is maximized (i.e., where marginal revenue equals marginal cost).
• Short Run vs. Long Run:
  • In the short run, firms can experience profits or losses, similar to pure competition.
  • Transition from short-run profits to long-run equilibrium is characterized by:
  • Increased supply leading to lower prices.
  • Average revenue shifts downward as prices decline.

Graphical Interpretation

• Peak and Trough of Graphs:
  • Identifying tangents and points where average revenue becomes equal to average total cost is crucial.
  • Comparison with Pure Competition:
  • Monopolistic competition results in higher prices and lower output compared to pure competition.

Excess Capacity in Monopolistic Competition

• Excess Capacity:
  • Characteristic of monopolistic competition where firms do not produce at the minimum average cost.
  • Firms operate with some excess capacity since they cannot exploit all efficiencies due to many sellers.
• Production and Pricing Dynamics:
  • Compare outcomes of monopolistic competition with pure competition:
  • Monopolistic firms charge higher prices and produce less output than in perfect competition.

Consumer and Producer Dynamics

• Utility Maximization:
  • Consumers aim to maximize total utility, while producers focus on maximizing profits.
  • Equilibrium Condition:
  • In monopolistic competition, marginal revenue will often exceed marginal cost:
    • Further incentives for firms to produce more until marginal cost meets marginal revenue.
  • The equilibrium price may be higher in monopolistic competition compared to perfect competition due to market power.
• Cost to Producers vs. Benefit to Consumers:
  • Consumers benefit if marginal utility exceeds costs, indicating a beneficial disparity between price and marginal cost.