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Monopolistic Competition


Monopolistic Competition. Market Structures - Review. Competitive: many firms, identical products Monopoly: single firm, no close substitutes Oligopoly: several firms, similar products, degree of product differentiation varies depending upon the market

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Monopolistic Competition

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Monopolistic competition l.jpg

Monopolistic Competition


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Market Structures - Review

  • Competitive: many firms, identical products

  • Monopoly: single firm, no close substitutes

  • Oligopoly: several firms, similar products, degree of product differentiation varies depending upon the market

  • Monopolistic competition: many firms, similar products, slightly differentiated products


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Competitive Market

  • This is the classic “textbook” market structure.

  • Firms in a competitive market all make a product that is perfectly substitutable: all demanders are equally satisfied with any supplier’s product. Firms are price takers.

  • Hot dogs!


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Monopoly

  • The single seller makes a product that has no good substitute.

  • Other firms may be able to produce the good or service but choose not to enter the market or are barred from it. Firms are price makers.

  • Some pharmaceuticals


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Oligopoly

  • A few sellers make products that are good, but not perfect, substitutes.

  • Consumers can be induced to change suppliers but have only a limited number of choices.


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Monopolistic Competition

  • The market has many firms but each supplier’s product is differentiated.

  • Consumers can be induced to change brands but they have brand preferences.


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Question

  • What is the appropriate market structure model for each of these products or firms: competitive, monopoly, oligopoly, monopolistic competition?

    • The Campus Store

    • Kinko’s

    • Pepperidge Farm’s Whole Wheat Bread

    • PowerMac computer

    • Windows computer

    • Viagra

    • Morton salt

    • AT&T long distance


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Answers

  • The Campus Store: most products competitive, textbooks oligopoly

  • Kinko’s: monopolistic competition (differentiated service)

  • Pepperidge Farm’s Whole Wheat Bread: competition or monopolistic competition (slightly differentiated recipes)

  • PowerMac computer and clones: monopoly, under license.

  • Windows computer: monopolistic competition (differentiated features)

  • Viagra: monopoly

  • Morton salt: competitive

  • AT&T long distance: oligopoly


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Monopolistic Competition

  • Structure:

    • Several firms in the market.

    • Producing differentiated products.

    • “Free” entry and exit.

    • Full and symmetric information.

  • 1st and 3rd smack of perfect competition.

  • 2nd adds a monopoly ingredient.


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On Differentiation

  • Could be:

    • actual: taste, color, location, service, etc.

    • perceived: L.e.i. jeans vs. Wranglers!

  • Advertising often plays a big role in monopolistically competitive markets


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An Historical Note:

  • Intellectual “parents”

    • Joan Robinson (economist at Cambridge in the U.K.)

    • Edward Chamberlin (economist at Harvard in Cambridge, MA)

    • Both pioneered the work on monopolistic competition in the early 1930’s.


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srmc

sratc

PMC

atc

d

xMC

mr

Monopolistic Competition - Short Run Conduct

  • The monopolistically competitive firm looks and acts just like a mini-monopolist.

  • Example: Gloria Vanderbilt Jeans

$

x


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$

lratc

lrmc

PMC

d

x

xMC

mr

Monopolistic Competition - Long Run Conduct

  • Free entry will force firm long run economic profits to zero.

  • So: 1) profit max;2) zero profit; and3) a downward sloping firm demand and corresponding marginal revenue.

  • Firm demand will be tangent to its long run average total cost curve.


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Why tangent?

  • Firms profit maximize but free entry will force firm long run economic profits to zero.

    • 1) profit max implies that mr=mc at xmc

    • 2) zero profit implies that P=lratc at xmc

    • 3) product differentiation implies a downward sloping firm demand and corresponding marginal revenue

  • Firm demand must be tangent to the long run average total cost curve - which must occur to the left of the lratc curve’s minimum point.


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Monopolistic Competition- Performance

  • Efficiency:

    • Is the monopolistically competitive firm Pareto Efficient? That is, at xMC is net social surplus maximized? Does $MB=$MC at xMC?

      • answer: No.

    • Is the monopolistically competitive firm productively efficient? Does the firm operate at minimum efficient scale?

      • answer: NO! There is “excess capacity.”

    • Is this “excess capacity” bad?

    • Isn’t variety really the spice of life?

  • Don’t forget there’s always equity to consider, too.