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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

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
firm behaviour1
Firm Behaviour

Short run

  • Acts like monopolies
    • Use market power to generate revenue

Long run

  • Acts like perfect competition
    • No economic profit
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
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.