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Chapter 16

Chapter 16 EC120.docx

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Peter Sinclair

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EC120 Chapter 16-Monopolistic Competition Week 10 A buyer in the book market has thousands of competing products from which to choose Between Monopoly and Perfect Competition -One type of imperfectly competitive market is an oligopoly, which is a market with only a few sellers, each offering a product that is similar or identical to the produces offered by other sellers -A second type of imperfectly competitive market is called monopolistic competition. This describes a market structure in which there are many firms selling products that are similar but not identical. -To be more precise, monopolistic competition describes a market with the following attributes: -Many sellers: there are many firms competing for the same group of customers -Product differentiation: each firm produces a product that is at least slightly different from those of other firms. Thus, rather than being a price taker, each firm faces a downward-sloping demand curve -Free entry and exit: Firms can enter or exit the market without restriction. Thus, the number of firms in the market adjusts until economic profits are drive to zero -There is a long list of markets with these attributes: CDs, movies, computer games, restaurants, etc. -A monopolistically competitive market departs from the perfectly competitive ideal because each of the sellers offers a somewhat different product -There is no way to determine when products are differentiated and when they are identical Competition with Differentiated Products The Monopolistically Competitive Firm in the Short Run -Each firm in a monopolistically competitive market, is, in many ways, like a monopoly because of the downward sloping demand curve -A monopolistically competitive firm chooses its quantity and price just as a monopoly does. In the short run, these two types of market structure are similar EC120 Chapter 16-Monopolistic Competition Week 10 The Long-Run Equilibrium -When firms are making profits, new firms have an incentive to enter the market -As firms exit, customers have fewer products from which to choose -As the demand for the remaining firms’ product rises, these firms experience rising profit -The process of entry and exit continues until the firms in the market are making exactly zero economic profit -Two characteristics describe the long-run equilibrium in a monopolistically competitive market: 1.As a monopoly market, price exceeds marginal cost. This conclusion arises because profit maximization requires marginal revenue to equal marginal cost and because the downward- sloping demand curve makes marginal revenue less than the price 2. As in a competitive market, price equals average total cost. This conclusion arises because free entry and exit drive economic profit to zero Monopolistic vs. Perfect Competition Excess Capacity -Under monopolistic competition firms produce on the downward-sloping portion of their average total cost curves. -The quantity that minimizes the average total cost is called the efficient scale of the firm. In the long run, perfectly competitive firms product at the efficient scale, whereas monopolistically competitive firms produce below this level. -Firms are said to have excess capacity under monopolistic competition. In other words, a EC120 Chapter 16-Monopolistic Competition Week 10 monopolistically competitive firm, unlike a perfectly competitive firm, could increase the quantity it produces and lower the average total cost of production Markup over Marginal Cost -For a monopolistically competitive firm, price exceeds marginal cost because the firm always has some market power -For price to equal average total cost, price must be above marginal cost Monopolistic Competition and the Welfare of Society -A monopolistically competitive market has the normal deadweight loss of mono
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