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EC120 (572)

Chapter 17 Monopolistic Competition

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Wilfrid Laurier University

Keith Diaz Chapter 17: Monopolistic Competition  Differentiated products are everywhere; examples of monopolistic competition abound 2 Extremes Between monopoly and competition 1. Perfect competition: many firms, identical products 2. Monopoly: one firm In between these extremes: imperfect competition  Oligopoly: only a few sellers offer similar/identical products  Monopolistic competition: may firms sell similar but not identical products Characteristics of monopolistic competition 1. Many sellers (firms) 2. Product differentiation 3. Free entry and exit - Books - Bottled water - Clothing - Fast food - Gas: location is a critical dimension of product differentiation Perfect competition Monopolistic competition Monopoly Number of sellers Many Many One Free entry/exit Yes Yes No LR economic profits Zero Zero Positive (due to barriers to entry) The product firms sell Identical Differentiated Firm has market power None, price-taker Yes (product kind of different) Yes D curve facing firm horizontal Downward sloping Downward-sloping (market demand) Close substitute Many (more elastic) None (less elastic) Flatter D and MR curves than monopolist due to competition Monopolistically Competitive firm earing profits in SR  Firm faces a downward-sloping D curve  At each Q, MR < P  To maximize profit, firm produces Q where MR = MC, and uses D to set P  It is a loss if P < ATC  Markup: difference in MC and P Keith Diaz Monopolistic competition and monopoly  Short run: under monopolistic competition, firm behaviour is similar to monopoly  Long run: in monopolistic competition, entry and exit drive economic profit to zero (P = ATC) - If profits in SR: new firms enter, taking D away from existing firms, P and profits fall - If losses in SR: some firms exit, remaining firms enjoy higher D and P less welfare? Monopolistic Competition less efficient than Perfect Competition 1. Excess capacity  Monopolistic competitor operates on downward-sloping part of ATC curve, produces less than the cost-minimizing output  each firm in monopolistically competitive market has excess capacity  Under perfect competition, firms produce the Q that minimizes ATC 2. Markup over marginal cost  Under monopolistic competition, P > MC  Under perfect competition, P = MC Monopolistic Competition and Welfare  Monopolistically competitive markets don’t have all the desirable welfare properties of perfectly competitive market  Because P > MC (markup), the market Q is below the socially efficient Q  deadweight loss  Yet, not easy for policymakers to fix
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