Monopolistic competition and product differentiation

Содержание

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The meaning of monopolistic competition
Why oligopolists and monopolistically-competitive firms differentiate their

The meaning of monopolistic competition Why oligopolists and monopolistically-competitive firms differentiate their
products
How prices and profits are determined in monopolistic competition in the short run and the long run
Why monopolistic competition poses a trade-off between lower prices and greater product diversity
The economic significance of advertising and brand names

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The Meaning of Monopolistic Competition

Monopolistic competition is a market structure in which:
there

The Meaning of Monopolistic Competition Monopolistic competition is a market structure in
are many competing producers in an industry
each producer sells a differentiated product
there is free entry into and exit from the industry in the long run

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Product Differentiation

Product differentiation plays an even more crucial role
in monopolistically competitive industries.

Product Differentiation Product differentiation plays an even more crucial role in monopolistically

Why?
Tacit collusion is virtually impossible when there are many producers. Hence, product differentiation is the only way monopolistically competitive firms can acquire some market power.

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Product Differentiation

How do firms in the same industry—such as fast-food vendors, gas

Product Differentiation How do firms in the same industry—such as fast-food vendors,
stations, or chocolate companies—differentiate their products?
Is the difference mainly in the minds of consumers or in the products themselves?

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There are three important forms of product differentiation:
Differentiation by style or

There are three important forms of product differentiation: Differentiation by style or
type – sedans vs. SUVs
Differentiation by location – dry cleaner near home vs. cheaper dry cleaner far away
Differentiation by quality – ordinary ($) vs. gourmet chocolate ($$$)

Product Differentiation

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Product Differentiation

Whatever form it takes, however, there are two important features of

Product Differentiation Whatever form it takes, however, there are two important features
industries with differentiated products:
Competition among sellers: Producers compete for the same market, so entry by more producers reduces the quantity each existing producer sells at any given price.
Value in diversity: In addition, consumers gain from the increased diversity of products.

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Understanding Monopolistic Competition

As the term monopolistic competition suggests, this market structure combines

Understanding Monopolistic Competition As the term monopolistic competition suggests, this market structure
some features typical of monopoly with others typical of perfect competition:
Because each firm is offering a distinct product, it is in a way like a monopolist: it faces a downward-sloping demand curve and has some market power—the ability within limits to determine the price of its product.
However, unlike a pure monopolist, a monopolistically competitive firm does face competition: the amount of its product it can sell depends on the prices and products offered by other firms in the industry.

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The MC Firm in the Short Run

The following figure shows two possible

The MC Firm in the Short Run The following figure shows two
situations that a typical firm in a monopolistically competitive industry might face in the short run.
In each case, the firm looks like any monopolist: it faces a downward-sloping demand curve, which implies a downward-sloping marginal revenue curve.
We assume that every firm has an upward-sloping marginal cost curve, but that it also faces some fixed costs, so that its average total cost curve is U-shaped.

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D

P

Profit

Loss

MR

P

A

T

C

(a) A Profitable Firm

(b) An Unprofitable Firm

Q

P

P

P

Quantity

ATC

P

D

U

MR

U

MC

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T

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Q

U

P

U

Quantity

ATC

U

Profit-maximizing quantity

Loss-minimizing quantity

MC

Price, cost, marginal revenue

Price, cost,

D P Profit Loss MR P A T C (a) A Profitable
marginal revenue

The MC Firm in the Short Run

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Monopolistic Competition in the Long Run

If the typical firm earns positive profits,

Monopolistic Competition in the Long Run If the typical firm earns positive
new firms will enter the industry in the long run, shifting each existing firm’s demand curve to the left. If the typical firm incurs losses, some existing firms will exit the industry in the long run, shifting the demand curve of each remaining firm to the right.
In the long run, equilibrium of a monopolistically competitive industry, the zero-profit-equilibrium, firms just break even. The typical firm’s demand curve is just tangent to its average total cost curve at its profit-maximizing output.

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Entry and Exit Shift Existing Firm’s Demand Curve and Marginal Revenue Curve

(a)

Entry and Exit Shift Existing Firm’s Demand Curve and Marginal Revenue Curve
Effects of Entry

(b) Effects of Exit

Exit shifts the existing firm’s demand curve and its marginal revenue curve rightward.

MR

2

MR

2

MR

1

MR

1

D

1

D

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D

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D

2

Entry shifts the existing firm’s demand curve and its marginal revenue curve leftward.

Price, marginal revenue

Price, marginal revenue

Quantity

Quantity

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MR

MC

D

MC

MC

A

T

C

Z

Q

MC

P

MC

=

A

T

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MC

Point of tangency

Price, cost, marginal revenue

Quantity

The Long-Run Zero-Profit Equilibrium

MR MC D MC MC A T C Z Q MC P

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Monopolistic Competition versus Perfect Competition

In the long-run equilibrium of a monopolistically competitive

Monopolistic Competition versus Perfect Competition In the long-run equilibrium of a monopolistically
industry, there are many firms, all earning zero profit.
Price exceeds marginal cost so some mutually beneficial trades are exploited.
The following figure compares the long-run equilibrium of a typical firm in a perfectly competitive industry with that of a typical firm in a monopolistically competitive industry.

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Comparing LR Equilibrium in PC and MC

MC

A

T

C

(b) Long-Run Equilibrium in Monopolistic Competition

Comparing LR Equilibrium in PC and MC MC A T C (b)

MC

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T

C

P

MC

=

A

T

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MC

MC

MC

Q

PC

Q

MC

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MC

MR

MC

P

PC

= MC

PC

=

A

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PC

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=

MR

=

P

PC

(a) Long-Run Equilibrium in Perfect Competition

Price, cost, marginal revenue

Price, cost, marginal revenue

Minimum-cost output

Minimum-cost output

Quantity

Quantity

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Is Monopolistic Competition Inefficient?

Firms in a monopolistically competitive industry have excess capacity:

Is Monopolistic Competition Inefficient? Firms in a monopolistically competitive industry have excess
they produce less than the output at which average total cost is minimized.
Price exceeds marginal cost, so some mutually beneficial trades are unexploited.
The higher price consumers pay because of excess capacity is offset to some extent by the value they receive from greater diversity.
Hence, it is not clear that this is actually a source of inefficiency.

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Controversies About Product Differentiation

No discussion of product differentiation is complete without spending

Controversies About Product Differentiation No discussion of product differentiation is complete without
at least a bit of time on the two related issues:
advertising
brand names

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The Role of Advertising

In industries with product differentiation, firms advertise in order

The Role of Advertising In industries with product differentiation, firms advertise in
to increase the demand for their products.
Advertising is not a waste of resources when it gives consumers useful information about products.
Advertising that simply touts a product is harder to explain.
Either consumers are irrational, or expensive advertising communicates that the firm's products are of high quality.

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Brand Names

Some firms create brand names.
A brand name is a name

Brand Names Some firms create brand names. A brand name is a
owned by a particular firm that distinguishes its products from those of other firms.
As with advertising, the social value of brand names can be ambiguous.
The names convey real information when they assure consumers of the quality of a product.

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1. Monopolistic competition is a market structure in which there are many

1. Monopolistic competition is a market structure in which there are many
competing producers, each producing a differentiated product, and there is free entry and exit in the long run. Product differentiation takes three main forms: by style or type, by location, or by quality.
2. Short-run profits will attract entry of new firms in the long run. This reduces the quantity each existing producer sells at any given price and shifts its demand curve to the left. Short-run losses will induce exit by some firms in the long run. This shifts the demand curve of each remaining firm to the right.

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3. In the long run, a monopolistically competitive industry is in zero-profit

3. In the long run, a monopolistically competitive industry is in zero-profit
equilibrium: at its profit-maximizing quantity, the demand curve for each existing firm is tangent to its average total cost curve. There are zero profits in the industry and no entry or exit.
4. In long-run equilibrium, firms in a monopolistically competitive industry sell at a price greater than marginal cost. They also have excess capacity because they produce less than the minimum-cost output; as a result, they have higher costs than firms in a perfectly competitive industry.
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