Monopolistic competition
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Monopolistic Competition. Madelyn Au & Christie Park. Agenda. Characteristics Product Differentiation Role of Advertising Firm Behaviour Short Run Long Run Allocative Efficiency Excess Capacity. Monopolistic Competition. Falls between perfect competition and monopolies

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Monopolistic Competition

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Monopolistic competition

Monopolistic Competition

Madelyn Au & Christie Park



  • Characteristics

  • Product Differentiation

  • Role of Advertising

  • Firm Behaviour

    • Short Run

    • Long Run

  • Allocative Efficiency

  • Excess Capacity

Monopolistic competition1

Monopolistic Competition

  • Falls between perfect competition and monopolies


  • Many competitors

  • Differentiated products

  • Few barriers to entry and exit

  • Low market power

  • Examples: Restaurant & Clothing Stores

Product differentiation

Product Differentiation

Non-price differences

  • Type, style, quality, reputation, appearance, location

  • Three forms of product differentiation:

    • Style or Type (i.e. Sedans vs. SUVs

    • Location (i.e. Closer vs. Cheaper but further away)

    • Quality (i.e. Ordinary vs. Gourmet)

  • Product differentiation1

    Product Differentiation

    • Two features:

      • Competition among sellers

      • Value in diversity

    • Competitive advantage

      • Only way to acquire market power

        • No collusion

    Role of advertising

    Role of Advertising

    • Information provided by a company about its product/service

    • 2 purposes:

    • Product differentiation

    • Market control

      • Increase demand, reduce demand elasticity

    • Is advertising worth the expense?

    Role of advertising1

    Role of Advertising


    • Manipulate people’s tastes

    • Impede competition

    • Defense

    • Willingness of a firm to spend advertising dollars can be a signal to consumers about the quality of the product

    Role of advertising2

    Role of Advertising

    • Brand Names

      • Creates a perceived difference that may or may not exist

    • Economically Valuable

    • Economically Wasteful

    Firm behaviour

    Firm Behaviour

    Short run

    • Acts like monopolies

      • Use market power to generate revenue

    Monopolistic competition

    Short Run: Profit

    Monopolistic competition

    Short Run: Loss

    Firm behaviour1

    Firm Behaviour

    Short run

    • Acts like monopolies

      • Use market power to generate revenue

        Long run

    • Acts like perfect competition

      • No economic profit

    Monopolistic competition

    Long Run

    Allocative efficiency

    Allocative Efficiency

    • Occurs when price consumers pay equals the cost of the resources used up in production

      • MC=MR

    • Neither allocatively efficient in the short run or long run

      • Consumers are being charged at P* when it costs A to produce the good

    • Total economic welfare is not maximized

    Monopolistic competition

    Allocative Efficiency

    Excess capacity

    Excess Capacity

    • Firms produce less than the output at which average total cost is minimized

      • Want more profit

    • Produce less than the minimum-cost output

      • Have higher costs that firms in a perfectly competitive market

    • Higher price or greater product diversity?

    Deadweight loss

    Deadweight Loss

    • People who would have more marginal benefit than marginal cost are not buying

    • People who have more marginal cost than marginal benefit are buying

    • Caused by markup of price over marginal cost + firm’s decision to produce less than the socially optimal quantity



    Review question 1

    Review Question 1

    Monopolistically-competitive firms exercise market power because of:

    A. Product differentiation.

    B. Government franchises.

    C. Patent protection.

    D. High entry barriers.

    Review question 2

    Review Question 2

    In the short run, monopolistically-competitive firms:

    A. May earn positive economic profit.

    B. May earn negative economic profit.

    C. May earn a normal, above normal, or

    below normal rate of return.

    D. Will continue to produce if

    AVC < P < ATC.

    E. All of the above

    Review question 3

    Review Question 3

    A profit-maximizing, monopolistically-competitive firm will produce at an output level where:

    A. P = ATC.

    B. MR = MC.

    C. MR = ATC.

    D. AVC > MR.

    E. P = MR.

    Group question

    Group Question

    Group answer

    Group Answer

    Group answer1

    Group Answer

    Individual question

    Individual Question

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