Monopolistic Competition

1. Monopolistic Competition Chapter 9 Pages 121-125

2. Topics • Assumptions of the model • Profit maximization in the SR • Profit maximization in the LR • Efficiency • Price vs. Non-price competition

3. LO 1Attributes of Monopolistic Competition • Product examples include magazines, hairdressers, computer games, restaurants, piano lessons, cookies, furniture, etc. • LO 2 • Each firm has some price control. Rather than being a price taker, each firm faces a downward-sloping demand curve – but with what type of PED? • Many firms (usually small size) • Lack of barriers; Free entry and exit of firms • Product differentiation– some uniqueness

4. Price Average total cost Profit Profit- maximizing quantity LO 3Monopolistic Competitors can make a supernormal profit in the Short Run. Price MC AC Demand (AR) MR 0 Quantity

5. LO 4Why Monopolistic Competition leads to normal profits in the Long Run Short-run economic profits encourage new firms to enter the market. This… • Reduces demand faced by firms already in the market (as they switch to new firms). • Remaining firms’ demand curves shift to the left. • Thus their profits decline – eventually to normal.

6. Price A C Profit Profit- maximizing quantity A Monopolistic Competitor in the Long Run: normal profits Price MC AC Demand (AR) MR 0 Quantity

7. P=ATC Profit-maximizing quantity Short-run economic losses encourage firms to exit the marketin the Long Run and return to normal profits Price MC ATC Subnormal profits cause some firms to leave industry, increasing demand for remaining firms until profits return to normal Demand 0 Quantity

8. Is this type of market structure desirable for society? Evaluating Monopolistic competition

9. Markup pricing Excess capacity Quantity produced Productive Efficient scale LO 5i The inefficiency of MC:How is it not PE nor AE? Price There are two noteworthy differences between monopolistic and perfect competition—excess capacity (not productively efficient)andmarkup price (not allocative efficient). MC ATC P AR = MC Demand Quantity

10. How do firms attempt to increase sales/profits? • Firms that sell highly differentiated consumer goods typically spend between 10 and 20 percent of revenue on advertising. • Overall, about 2 percent of total revenue, or over $500 billion a year, is spent on advertising. • How well does this market structure serve society? When firms sell differentiated products and charge prices above marginal cost, each firm has an incentive to advertise in order to attract more buyers to its particular product.

11. LO 6Distinguish between price and non-price competition Price competition occurs when firms lower the price or keep prices low (because they have to) in order to compete against other firms. In what ways can they do this? Non-price competition occurs when firms keeps prices high but compete against other firms by either Producing a better quality product Advertising its real or imagined uniqueness

12. LO7Describe examples of non- price competition, including advertising*, packaging, product development and quality of service. • Choose two products • 1 where there is a real difference between firms. • 1 where there is only an imagined difference. • Task: Evaluate monopolistic competition in regard those aspects of non-price competition (and also price competition). • Key question: Is the money spent (ultimately by consumers) of non-price competition good for society? • [*Use and explain the term branding ]

13. Examples of non-price competitionways to create “branding” • Develop a recognisable logo • Store Loyalty cards  • Banking and other Financial Services (including travel insurance)  • Home delivery systems  • Extension of opening hours (24 hour shopping in many stores)  • Innovative use of technology for shoppers including self-scanning machines • Financial incentives to shop at off-peak times  • Internet shopping for customers

14. The Cons of Advertising • Critics of advertising argue that firms advertise in order to manipulate people’s tastes. • They also argue that it impedes competition by implying that products are more different than they truly are. • Critics argue that brand names cause consumers to perceive differences that do not really exist.

15. The Pros of Advertising • Defenders argue that advertising provides information to consumers • They also argue that advertising increases competition by offering a greater variety of products and prices. • The willingness of a firm to spend advertising dollars can be a signal to consumers about the quality of the product being offered.