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ch 14 monopolistic competition.docx

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ECON 102
Eva Lau

14 – monopolistic competition Chapter 14: Monopolistic Competition What is Monopolistic Competition?  monopolistic competition: a market structure in which:  a large number of firms compete  each firm produces a differentiated product  firms compete on product quality, price and marketing  firms are free to enter and exit the market Large Number of Firms  small market share  each firm has only limited power to influence the price of its product because it supplies only a small part of total industry output  ignore other firms  must be sensitive to the average market price of the product  doesn’t pay attention to any one individual competitor  no one firm can dictate market conditions and so no one firm’s actions directly affect the actions of the other firms  collusion impossible  collusion: firms in monopolistic competition would like to be able to conspire to fix a higher price  coordination is difficult and collusion is not possible because there’s a lot of firms Product Differentiation  product differentiation: making a product slightly different from the products of competing firms  a differentiated product is a close substitute, but not a perfect substitute Competingon Quality,Price and Marketing  quality: the physical attributes that make it different from the products of other firms  design, reliability, the services provided  is a spectrum (low quality to high quality)  price  a firm in monopolistic competition faces a downward-sloping demand curve  the firm can set its price and output  charge more for higher-quality and vice versa  marketing  advertising and packaging products to convince buyers to buy the good Entry and Exit  there are no barriers to prevent new firms from entering the industry in the long run  however, firms in monopolistic competition cannot make an economic profit in the long run  existing firms make economic profit in the short run causing new firms to enter, which then lowers the price and eliminates the economic profit  opposite occurs for economic loss Price and Output inMonopolistic Competition The Firm’sShort-Run Output and PriceDecision  short run: same decision making process as a monopoly firm  produce the output where MC = MR  charge the price that buyers are willing to pay for this quantity (from the demand curve) page 1 of 4 14 – monopolistic competition Profit Maximizing Might Be Loss Minimizing  if the price buyers are willing to pay is lower than the ATC, then the firm incurs an economic loss  produce the output where MC = MR to minimize the loss  the key difference between monopoly and monopolistic competition lies in what happens next, when the firms either make an economic profit or incur an economic loss Long Run: Zero Economic Profit  firms will not incur an economic loss for long as it will eventually go out of business  as supply increases, the demand curve and marginal revenue shift leftward causing the profit-maximizing quantity and prices to fall  economic profit -> entry of new firms -> decrease demand for each firm  when the demand curve touches the ATC curve at the quantity which MC = MR the market is in long-run equilibrium Monopolistic Competition and Perfect Competition  2 key differences between monopolistic competition and perfect competition: excess capacity and mark-up  excess capacity: when a firm produces below its efficient scale  efficient scale: the quantity at which ATC is a minimum  excess capacity = efficient scale – quantity where MC = MR  firms have excess capacity when they can sell more by cutting their prices, but they would then incur losses  mark-up: the amount by which price exceeds marginal cost  in perfect competition, price always equals MC IsMonopolistic Competition Efficient?  resources are used efficiently when margin social benefits = marginal social costs  if there’s no external benefits/costs then: price = marginal social benefits = marginal social costs  if prices exceeds the marginal cost then the quantity produced is less than the efficient quantity  in long run monopolistic competition, price does exceed marginal cost  mark-up drives a gap between price and marginal cost is caused by product differentiation  if there was no product differentiation, the total benefit would be less than with product differentiation  people value variety, but there aren’t infinite choices because variety is costly  product variety is valued but is costly  the efficient degree of product variety is when the marginal social benefit of product variety equals its margina
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