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Chapter 10

HON 1302 Chapter Notes - Chapter 10: Production Quota, Advantageous, Tacit Collusion

Course Code
HON 1302

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Economics Textbook Chapter 10
Monopolistic Competition and Oligopoly
The Monopolistic Competition Market Structure
Monopolistic Competition = a market structure characterized by many small sellers, a
differentiated product, and easy market entry and exit
Most common market structure in the U.S.
Examples include:
o Grocery stores, hair salons, restaurants, and gas stations
Characteristics of Monopolistic Competition
Many Small Sellers
Number of sellers in smaller than the number of sellers in perfect competition
No single seller has a large enough share of the market to control prices
Individual firms can set prices slightly higher or improve service independently without fear that
competitors will react by changing their prices or giving better service
CONCLUSION: The many-sellers condition is met when each firm is so small relative to the
total market that its pricing decisions have a negligible effect on the market price.
Differentiated Product
Product differentiation = the process of creating real or apparent differences between goods
and services
Has close, but not perfect substitutes
Such differences include:
o Location
o Atmosphere
o Quality of food
o Quality of service
o Etc.
Can be real or imagined
o For example, some people may say a restaurant has the best food in town, but the
quality of food may actually be the same as other restaurants
Unlike monopolies and perfect competition, a monopolistically competitive market centers on
nonprice competition rather than price competition
o Non-price competition = the situation in which a firm competes using advertising,
packaging, product development, better quality, and better service, rather than lower
CONCLUSION: Whe a produt is differetiated, uyers are ot idifferet as to whih seller’s
product they buy
Easy Entry and Exit
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Low barriers to entry, but still not as easy to enter as in perfect competition
Barrier to entry = product differentiation
o “oe arkets hae usiesses ith loal reputatios, so hile it’s easy to start up a
new firm, the difficult part is attracting new customers, since they may already be loyal
to other local businesses
The Monopolistically Competitive Firm as a Price Maker
In monopolistic competition, firms are price makers because of price differentiation
Has limited control over prices
Firs a raise pries eause ustoer loyalty esures they o’t lose revenue
Results in a downward sloping demand curve
CONCLUSION: The demand curve for a monopolistically competitive firm is less elastic
(steeper) than for a perfectly competitive firm and more elastic (flatter) then for a monopolist.
Advertising Pros and Cons
Example of non-price competition
Advertising helps businesses differentiate their product, by promoting a cheaper or better
quality good in the hopes that it will make the demand curve less elastic and increase demand
Short Run Effects of Advertising (if successful):
o Upward shift in the average cost curve
o Quantity demanded increases
Short Run Effects of Advertising (if unsuccessful)
o Demand remains unchanged
o Costs still increases, and the use of advertising is self-cancelling in terms of costs
Price and Output Decisions for a Monopolistically Competitive Firm
In the short run, monopolistic competition resembles monopolies
In the long run, there is a more competitive market structure
Monopolistic Competition in the Short Run
Demand curve slopes down
Maximizes short run profit by producing at the quantity where MR = MC
o If, at this point, price exceeds ATC, a profit is made
o If price is equal to ATC, the firm earns a short-run normal profit
o If price is less than ATC, the firm suffers a short-run loss
o If price is below average variable costs curve, the firm shuts down
Monopolistic Competition in the Long Run
Will not earn an economic profit in the long run
Earn only a normal profit in the long run
o Normal profit = the minimum profit necessary to keep a firm in operation
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