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Chapter 14 Lecture Notes.doc

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University of Waterloo
ECON 101
Corey Van De Waal

CHAPTER 14: MONOPOLISTIC COMPETITION 1. What Is Monopolistic Competition? 2. The Firm’s Short-Run Output and Price Decision 3. Price and Output in Monopolistic Competition 4. Profit Maximizing Might Be Loss Minimizing 5. Long Run: Zero Economic Profit 6. Monopolistic Competition and Perfect Competition 7. Is Monopolistic Competition Efficient? 1 1. What Is Monopolistic Competition? Monopolistic competition is a market with the following characteristics:  There are a large number of firms, with each firm producing a differentiated product.  Firms compete on product quality, price, and marketing. Large Number of Firms The presence of a large number of firms in the market implies:  Each firm has only a small market share and therefore has limited market power to influence the price of its product.  Each firm is sensitive to the average market price, but no firm pays attention to the actions of the other, and no one firm’s actions directly affect the actions of other firms.  Collusion, or conspiring to fix prices, is impossible. Product Differentiation Firms in monopolistic competition practice product differentiation, which means that each firm makes a product that is slightly different from the products of competing firms. Competing on Quality, Price, and Marketing Product differentiation enables firms to compete in three areas: quality, price, and marketing.  Quality includes design, reliability, and service.  Because firms produce differentiated products, each firm has a downward-sloping demand curve for its own product. But there is a tradeoff between price and quality.  Differentiated products must be marketed using advertising and packaging. 2 Entry and Exit There are no barriers to entry in monopolistic competition, so firms cannot earn an economic profit in the long run. 2. Price and Output in Monopolistic Competition Short-Run Economic Profit A. A firm that has decided the quality of its product and its marketing program produces the profit maximizing quantity at which its marginal revenue equals its marginal cost (MR = MC). a) Price is determined from the demand curve for the firm’s product and is the highest price the firm can charge for the profit-maximizing quantity. b) A firm in monopolistic competition can earn an economic profit in the short run if: P > ATC. It operates much like a single-price monopolist. B. Figure 1 shows a short-run equilibrium output and price for a firm in monopolistic competition. C. Figure 2 shows a short-run equilibrium output and price for a firm making economic losses.
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