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Lecture 14

Economics 1021A/B Lecture Notes - Lecture 14: Fixed Cost, Perfect Competition, Demand Curve


Department
Economics
Course Code
ECON 1021A/B
Professor
Michael Parkin
Lecture
14

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CHAPTER 14 - MONOPOLISTIC
COMPETITION
WHAT IS MONOPOLISTIC COMPETITION?
In the real world, most markets show a form of monopolistic competition
Monopolistic competition is a market structure in which:
oA large number of firms compete
oEach firm products a differentiated product
oFirms compete on product quality, price and marketing
oFirms are free to enter and exit the industry
LARGE NUMBER OF FIRMS
Small market share
oEach firm supplies a small part of the total industry output
oEach firm has only limited power to influence the price of its product
oEach firm’s price can deviate from the average price of other firms only by a relatively
small amount
Ignore other firms
oA firm must be sensitive to the average market price of the product
But they do not pay attention to nay single competitor
Collusion is impossible
oFirms cannot get together and conspire to fix higher prices
oThe number of firms are too large so it is not possible without one firm undercutting
PRODUCT DIFFERENTIATION
Product differentiation is when a firm makes a product that is slightly different from the
products of competing firms
oDifferentiated goods are closes substitutes but not perfect substitutes of each other
Some people are willing to pay more for one kind of a good, but that does not mean that the
quantity demanded for another firm’s good will decrease to zero
oFor example: when Adidas rises its price, they will sell less shoes while Puma or Nike
will sell more
But this price raise does not decrease the quantity demanded for Adidas to zero
COMPETING ON QUALITY, PRICE AND MARKETING
Product differentiation allows firms to compete on quality, price and marketing
Quality
oInvolves the physical attributes that make it different from the products of other firms
oRanges from high quality to low quality
Price
oFaces a downward-sloping demand curve due to product differentiation
oCan set their own price and output
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oHigh quality = high price
Marketing
oInvolves advertising and packaging in order to convince customers that they offer a
higher quality product
ENTRY AND EX IT
No barriers to prevent new firms from entering the industry in the long run
As a result, in the long run, no firms can make an economic profit
oEntry will increase the market supply and will therefore decrease the price, increase the
overall quantity and eliminates economic profit
Firms will also exit when there are economic losses made
oExit increase prices and will eliminate economic loss
In long run equilibrium, firms neither enter nor leave the industry and each firm will make
zero economic profit
PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION
Decision needs to be made on the correct quantity to produce (output) and at what price
THE FIRMS SHORT-RUN OUTPUT AND PRICE DECISION
In the short run, firms in monopolistic competition make decisions about pricing and output just
like a monopoly does
The demand curve shows the demand for a firm’s product, not the demand for the product in
general
oFor example: the demand curve is for Roots jackets and not jacket in general
The MR curve is derived in the same way as a monopoly
oThe MR curve will always lie below the demand curve
The ATC and MC curve shows the average total cost and marginal cost of producing
The profit maximizing point is the output amount where MR = MC
oThe economic profit made is the area between ATC and Demand at the output where
MR=MC
Economic profit is made when ATC is lower than the demand curve at the profit maximizing
point
Economic loss is incurred when ATC is higher than the demand curve at the profit maximizing
point
PROFIT MAXIMIZ ING MIGHT BE LOSS MINIMIZING
The profit maximizing point is also where economic loss is minimized
Monopolistic competition produces the quantity at which marginal revenue equal marginal cost
oThen it charges the price that buyers are willing to pay (demand curve)
LONG-RUN: ZERO ECONOMIC PROFIT
When new firms enter, the output of each firm decreases (overall the market output increases)
For example: when Gap stars to produce jackets:
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