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Lecture 16

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Economics 2150A/B
Kristin Denniston

Economics 2151B Monday March 10 Lecture 16 Chapter 13 (con’t…) and 14 Homework 3 • Due tonight at midnight Chapter 13 (con’t) – Monopolistic Competition • Monopolistic competition is characterized by: 1. Many firms in the industry 2. Product differentiation (slight, but gives us market power if we can differentiate from our competitor)  A sign of market power is a downward sloping demand curve  A firm will maximize its profit by MR = MC 3. Free entry and exit in the market  If we are making money in the short run, people will enter the market and try to compete with us  This drives our long run profits to 0  Though you may look like a monopolist in the short run, you can’t make long run profits like a monopolist would • Examples of monopolistic competition: o Movie industry o Restaurants o Drug stores • We usually see much advertising and the attempt to establish brand names o eg. there is a lot of advertising from McDonalds and Burger King trying to tell you their hamburger is different and better than the other o If you can convince people that your product is different and better, you can price your product higher • Example: Unilever has 8 different brands of margarine o They are creating product differentiation (trying to tell you they are selling a different product to make money off of each one) o Similarly, one company makes many different brands of bottled water • Short Run Graph o You can have positive profits in the short run, but you will have entry by other people which will drive your profits to 0 in the long run o The short run graph looks like a monopolist, but the demand curve will be a little flatter (but still downward sloping) because there are competitive products out there o Set MR = MC • Long Run Graph o Positive profits triggers entry by competitors o This makes your demand curve more elastic (because of the availability of substitutes), and demand decreases and shifts left o Still producing where MR = MC, but profits are still 0 because P = AC o There are 2 potential economic inefficiencies: 1) There is still a monopoly markup where P > MC • You still have a deadweight loss (society is valuing the unit more than it costs to produce it, but you’re not producing it) 2) Excess capacity • Exists when you are producing at an AC > min AC • In a perfectly competitive market, all of the firms produce at their minimum cost. We are producing at a level higher than the minimum average cost. • We will never reach our full economic capacity Short Answer Questions (monopolistic competition): a) Does advertising increase competition or decrease competition? • The market may become less competitive if advertising strengthens brand names o If less competitive, then E is more inelastic and monopoly markup ( P−MC P ) is higher • Can advertising make the market more competitive? o Advertising also gives the consumer information about prices and products o Consumers may use flyers to price match o If the market is more competitive, E becomes more elastic and the monopoly markup decreases • Therefore advertising can make the market more or less competitive • Study: They looked at optometrist advertising across different states. In some states, optometrists were banned from advertising by their association, and they found that in those states, the prices went up. Advertising gave people more information about where to find the cheaper optometrist. b) How do we know that the beef market is actually monopolistically competitive? • We have different brands of beef (grass fed, Australian beef, supermarket brand beef, Angus beef, corn fed), and therefore it is monopolistically competitive. • These are all attempts at pr
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