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Lecture 19

Lecture 19-Monopolistic Competition

3 Pages
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Department
Economics
Course Code
ECO101H1
Professor
Jack Carr

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Monopolistic Competition
1. Firms maximize profits where MR=MC
2. Short-Run
Firm may:
Earn zero economic profit (P=ATC)
Earn economic profit (P>ATC)
Suffer economic loss (P<ATC)
3. Long-Run
Firms earn zero economic profit (P=ATC) Due to freedom of entry/exit
Monopolistic Competition: Entry of New Firms
Suppose
20 pizza shops
Each has 1/20th RI³PDUNH
Each earn economic profit
Result
10 new pizza shops open (no barriers to entry)
Each has 1/30th RIWKH³PDUNH
Demand curve shifts to the left
Ù Each of initial shops has 1/30th RIWKH³PDUNHW´
Ù Demand curve of initial shops have shifted leftward
Monopolistic Competition: Short-Run Equilibrium
1. P>ATC => economic profits
2. No barriers to entry => new firms enter industry
3. New firs enter industry => DD shifts leftward
P
DD
Q
MC
MR
ATC
Economic
profits
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Description
Monopolistic Competition 1. Firms maximize profits where MR=MC 2. Short-Run Firm may: Earn zero economic profit (P=ATC) Earn economic profit (P>ATC) Suffer economic loss (PATC => economic profits 2. No barriers to entry => new firms enter industry 3. New firs enter industry => DD shifts leftward P DD Q MC MR ATC Economic profits www.notesolution.com Observations: (i) there is no supply curve (since firms face downward-sloping demand curves) (ii) Unlike perfect competition, entry of new firms does not shift supply curve to right Monopolistic Competition: Long-Run Equilibrium 1. P1 < P (due to leftward shift of DD to DD1 and leftward shift of MR to MR1) 2. Excess Capacity: Q1 is lower than output at which ATC is at a minimum Results (1) Firms do not produce at minimum ATC (unlike perfect competition) Ù Excess Capacity (2) P>MC (unlike perfect competition) [Tradeoff: allocative inefficiency versus greater product variety] Imperfect Competition: Firms face downward-sloping demand curves 1) Monopoly Ù 2) Oligopoly Have some degree of market power (ability to 3) Monopolistic Competition raise price without losing all clients) Perfect Competition Firm faces perfectly elastic demand curve => no market power (would lose all customers if increased price) P1 DD1 Q1 MC MR1 ATC Demand curve has shifted leftward P = ATC www.notesolution.com Monopolistic Competition Example: Family Restaurant 1. Many Firms 2. Differentiated Products (1) Downward-Sloping demand curve (MRATC) Suffer economic loss (P
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