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Chapter 10

HON 1302 Chapter 10: Economics Textbook Chapter 10 - Monopolistic Competition and Oligopolies

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St. John's University
HON 1302

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 prices. • CONCLUSION: When a product is differentiated, buyers are not indifferent as to which seller’s product they buy Easy Entry and Exit • Low barriers to entry, but still not as easy to enter as in perfect competition • Barrier to entry = product differentiation o Some markets have businesses with local reputations, so while 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 • Firms can raise prices because customer loyalty ensures they won’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 o Reason for only normal profit: short-run profits and easy entry make the industry attractive to new firms • Over time, the firm’s demand curve shifts left, and the average cost curve shift upward, eventually leading to the point where the demand curve is tangent to the long run average costs curve at the point where MR = MC • Once long-run equilibrium is achieved in an industry, there is a lack of incentive for new firms to enter the industry Comparing Monopolistic Competition and Perfect Competition The Monopolistic Competitor as a Resource Misallocator • Monopolistically competitive firms fail the efficiency test o Meaning that price is greater than marginal costs • Firms use less resources and restrict output in order to maximize profits where MR = MC Monopolistic Competition Means Less Output for More • Long-run equilibrium is established in perfect competition when P = MR = MC = LRAC • Both monopolistic competitor and perfect competitors earns zero economic profit in the long run • Both monopolistic competitors and monopolies have a long-run equilibrium to the left of the minimum point on the LRAC curve and price exceeds MC, so prices are higher and outputs are lower than perfectly competitive firms • Criticism of monopolistic competition: o Leads to too many firms producing too little output, meaning inflated prices and wasted resources o If there were fewer firms, more could be produced at a lower average cost • Benefits of monopolistic competition: o Consumers have greater variety of options o Having more businesses means consumers time due to convenience of locations Oligopoly – Competition Among the Few • An imperfectly competitive market where a few large firms dominate the market • Examples of oligopoly industries: automobiles, aircrafts, drugs, steel, etc. • Found in real world industries • Involves large-scale advertising • Characterized by few large sellers, either a homogeneous or a differentiated product, and difficult market entry Characteristics of Oligopoly Few Sellers • There is no specific number used to define a “few” sellers • Basically, oligopolies result is the few large firms have mutual interdependence o Mutual interdependence = a condition in which an action by one firm may cause a reaction from other firms • Decision
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