BUSS1040 Lecture Notes - Lecture 6: Product Differentiation, Economic Surplus, Opportunity Cost
28 May 2018
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WEEK 6: MONOPOLY AND MARKET POWER (II)
CHAPTER 14: MONOPOLISTIC COMPETITION
CHARACTERISTICS OF MONOPOLISTIC COMPETITION
1. Many buyers and sellers
2. Product differentiation = downward sloping demand curve
3. Free entry and exit = zero economic profit in LR b/c opportunity cost
THE SHORT RUN
• Firms behave like monopolists
o Produce where
MR#=#MC
o Firms can earn SR economic profit
o Produces less than capacity = less than
level of output that minimises total cost
• Differentiated products = firm has some control
over price charged
o GRAPH: Downward sloping D curve
§ If price increases, QD will fall,
but not to 0
• Price maker
o Sets profit-maximising price
THE LONG RUN
• Economic profit must equal 0
o Profit attracts new entrants
o GRAPH: Demand curve and marginal revenue curve shift left
• Entry of new firms:
o Decrease in demand for products of existing firms
§ GRAPH: demand curve shifts left
o Demand curve for existing firms will become more elastic
§ i.e. if raises price, will lose more consumers as there
are more alternatives to switch to
• Exit of firms: opposite of ^^^
• GRAPH: Demand curve and ATC are tangents
• Firms trade where
Pm#=#ATC
• In LR, in monopolistic competitive industry,
ATC#>#MC
à produce less
than minimum efficient scale
•
Price#>#MC
creates a DWL
WELFARE UNDER MONOPOLISTIC COMPETITION
• Business stealing: a firm entering the market is only concerned with the profit it can make à doesn’t account for
losses felt by incumbent firms
• Product variety: firm entering market offers additional differentiation = increased consumer surplus
o Greater variety of G+S better caters to individual tastes
Document Summary
Characteristics of monopolistic competition: many buyers and sellers, product differentiation = downward sloping demand curve, free entry and exit = zero economic profit in lr b/c opportunity cost. If price increases, qd will fall, but not to 0: price maker, sets profit-maximising price. Economic profit must equal 0: profit attracts new entrants, graph: demand curve and marginal revenue curve shift left. Entry of new firms: decrease in demand for products of existing firms. Graph: demand curve shifts left: demand curve for existing firms will become more elastic i. e. if raises price, will lose more consumers as there are more alternatives to switch to. Exit of firms: opposite of ^^: graph: demand curve and atc are tangents. In lr, in monopolistic competitive industry, atc > mc produce less than minimum efficient scale: price > mc creates a dwl.
