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Chapter 14 Notes.docx

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Western University
Economics 1021A/B
Jeannie Gillmore

Chapter 14 Notes Monopolistic Competition  a large number of firms compete o each firm has a small market share  each firm has only limited power to influence the price of its product  each firm’s price can deviate from the average price of other firms by only a relative small amount o ignore other firms  firms do not pay attention to any one individual competitor  no firm can dictate market conditions, so no one firm’s actions directly affect the actions of the other firms o collusion impossible  firms in monopolistic competition would like to be able to conspire to fix a higher price (collusion)  because the number of firms in monopolistic is large, coordination is difficult and collusion is not possible  each firm produces a differentiated product o product differentiation is the production of a slightly different product compared to competing firms  differentiated product is a close substitute, but not a perfect substitute for the products of other firms  when the price of one variety increases, quantity demanded decreases, but not necessarily decreases  firms compete on product quality, price, and marketing o the quality of the product is the physical attributes that make it different from the products of other firms o because of product differentiation, a firm in monopolistic competition faces a downward-sloping demand curve  a firm can set both its price and output  a firm can only charge a high price with a high quality product o firms must market products due to product differentiation  firms that produce a high quality product (and want to sell it at a high price) must advertise and package that product in way that convinces buyers that they are getting the higher quality for which they are paying for  low-quality producers use advertising and packaging to persuade buyers that although quality is low, price compensates for this  firms are free to enter and exit the industry o no barriers to prevent new firms from entering an industry in the long run, thus no economic profit made by a firm in the long run o entry occurs when firms currently experience economic profit  lowers prices and eliminates profit o exit occurs when firms experience economic loss  increase prices and eliminates economic loss o in the long run, firms neither enter nor leave the industry and the firms in the industry make zero economic profit Price and Output  in the short run, a firm in monopolistic competition produces where marginal revenue equals marginal cost  economic profit occurs when the profit maximizing quantity occurs at a point where ATC is less than demand  economic loss results when ATC is greater than demand at the profit maximizing quantity Economic Profit in the Long Run  as firms enter a profitable industry, the demand for one firms product decreases o demand curve and marginal revenue curve shift leftward  profit maximizing quantity and price fall  in the long run, average total cost equals demand, and the demand curve is tangent to the average total cost curve Monopolistic Competition and Perfect Competition  excess capacity o a firm has excess capacity if it produces below its efficient scale, which is the quantity at which average total cost is a minimum o average total cost is the lowest possible only in perfect competition o firms in monopolistic competition have excess capacity, as they could sell more by cutting their prices (but would incur losses)  markup o a firm’s markup is the amount by which price exceeds marginal cost o in perfect competition, a price always equals marginal cost and there is no markup o in monopolistic competition, buyers pay a higher price than in perfect competition and also pay more than marginal cost Efficiency in Monopolistic Competition  resource are used efficiently when marginal social benefit equals marginal social cost o price equals marginal social benefit and the firm’s marginal cost equals marginal social cost  in long run equilibrium in monopolistic competition, price does exceed marginal cost  people value variety, because it provides an external benefit o infinite variety isn’t seen as it is costly  each different variety of any product must be designed, and then consumers must be informed about it  the costs of design and marketing (setup costs) mean that some varieties that are too close to others already available are just not worth creating  the efficient degree of product variety is the one for which the marginal social benefit of product variety equals its marginal social cost o the loss that arises because the quantity produced is less than the efficient quantity is offset by the gain that arises from having a greater degree of p
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