ECON111 Lecture Notes - Lecture 11: Shampoo, Marginal Cost, Social Cost
Monopolistic Competition
Monopolistic competition is a market structure in which
ā¢ Many firms compete on product quality, price, and marketing.
ā¢ Each firm produces a differentiated product.
ā¢ There are no barriers to exit or entry.
For example, Producers of audio and video equipment, clothing, shampoo, ice cream, computers
and sporting goods operate in monopolistic competition.
Firms in this market structure have only a small market share. But, because of product
differentiation that have a limited market power to influence the price, making them price makers.
Product differentiation enables firms to compete in three areas: quality, price, and marketing.
ā¢ Quality includes design, reliability, and service.
ā¢ Because firms produce differentiated products, the demaī
¶d for each firī
µās product is
downward sloping. But there is a trade-off between price and quality.
ā¢ Because products are differentiated, a firm must market its product.
The more the firm differentiates their product, the more unique it becomes, and the more influence
it has on the price. Patents exist to encourage innovation. This makes their demand more inelastic,
like a monopoly.
On the other hand, the less differentiated the market is, the more identical the products are, and so
firms have less influence on the price. This makes their demand more elastic, bringing it closer to the
perfect coī
µpetitioī
¶ās perfectly elastic slope.
Therefore, the slope of the demand curve can be used to judge how differentiated the produces are.
Pay attention to the slope of your graphs.
The large number of firms also implies that each firm is sensitive to the average market price, but no
firm pays attention to the actions of others. So, ī
¶o oī
¶e firī
µās actioī
¶s directly affect the actioī
¶s of
others. Collusion, or conspiring to fix prices, is also impossible.
Short Run vs. Long Run
The firm in monopolistic competition operates like a single-price monopoly. The firm produces the
quantity at which MR = MC, and sells that quantity for the highest possible price. In the short run, it
is possible for the firm to make economic profits (P> ATC), and economic losses (P< ATC). Because
there are no barriers to entry or exit, however, P = ATC in the long run, and firms do not make an
economic profit.
In the long runs, economic profit induces entry, increasing supply until demand curve of the firm
tilts. Then, price falls and firms earn zero economic profit. The converse happens in the case of
economic losses. Therefore, in the long run, ATC is at a tangent to the demand curve, making it
impossible for the firm to make economic profit; it will only be able to break even.
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Document Summary
Monopolistic competition is a market structure in which: many firms compete on product quality, price, and marketing, each firm produces a differentiated product, there are no barriers to exit or entry. For example, producers of audio and video equipment, clothing, shampoo, ice cream, computers and sporting goods operate in monopolistic competition. Firms in this market structure have only a small market share. But, because of product differentiation that have a limited market power to influence the price, making them price makers. Product differentiation enables firms to compete in three areas: quality, price, and marketing: quality includes design, reliability, and service, because firms produce differentiated products, the dema(cid:374)d for each fir(cid:373)"s product is downward sloping. But there is a trade-off between price and quality: because products are differentiated, a firm must market its product. The more the firm differentiates their product, the more unique it becomes, and the more influence it has on the price.
