Robert L.

Sexton’s

Exploring Economics
Pathways to Problem Solving

Lecture Presentation in PowerPoint

by Jack A.Chambless

Copyright © 1999 by Harcourt, Inc.

All rights reserved. Requests for permission to make copies of
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Department, Harcourt College Publishers, 6277 Sea Harbor
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0-03-022948-0 Version 1.0
MODULE ELEVEN

MONOPOLISTIC
COMPETITION
 A. MONOPOLISTIC
COMPETITION
• What is monopolistic competition?
• What is product differentiation?
• What is the shape of the demand
curve for a monopolistically
competitive firm?

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 WHAT IS MONOPOLISTIC
COMPETITION?

Monopolistic competition is a market

structure that allows many producers
of somewhat different products to
compete with one another.

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 WHAT ARE THE THREE BASIC
CHARACTERISTICS OF
MONOPOLISTIC COMPETITION?

• Product differentiation
• Many sellers
• Free entry

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 WHAT IS PRODUCT
DIFFERENTIATION?

Product differentiation is the

accentuation of unique product
qualities—real or perceived—to
develop a specific product identity.

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 SOURCES OF PRODUCT
DIFFERENTIATION

• Physical differences
• Prestige
• Location
• Service

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WHAT IS THE IMPACT OF MANY
SELLERS?

When many firms compete for the same

customers in monopolistic competition,
any particular firm has little control or
interest over what other firms do.

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WHAT IS THE SIGNIFICANCE OF
FREE ENTRY?

Entry in monopolistic competition is

relatively unrestricted in the sense that
new firms may easily start the
production of close substitutes for
existing products—like restaurants.

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 B. PRICE AND OUTPUT
DETERMINATION IN
MONOPOLISTIC COMPETITION

• How is short-run equilibrium

determined?
• How is long-run equilibrium
determined?

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 HOW IS SHORT-RUN
EQUILIBRIUM DETERMINED?
Monopolistically competitive sellers are price
makers. Since each firm sells a slightly
different product, the firm’s demand curve is
downward sloping but quite flat because of
many close substitutes. Given the position of
the individual firm’s demand curve, we can
determine output and price using a method
similar to that used in the monopoly case.
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 SHORT-RUN EQUILIBRIUM
IN MONOPOLISTIC COMPETITON

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 HOW IS LONG-RUN
EQUILIBRIUM DETERMINED?
The short-run equilibrium situation,
whether involving profits or losses, will
probably not last long, because there is
entry and exit in the long run that
pushes firms back to zero economic
profit.

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WHAT HAPPENS TO ECONOMIC
PROFITS WHEN THERE IS
ENTRY?
When profits are being earned, new
firms enter the market. This means that
each new firm will cut into the demand
of the existing firms. The impact on
profits is evident in the graph on the
next slide: As demand falls from DSR to
DLR, profits converge towards zero.
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 IMPACT OF MARKET ENTRY

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 WHAT HAPPENS TO LOSSES WHEN
SOME FIRMS EXIT?
If losses are being incurred, some firms will
exit the industry, increasing the demand
for the remaining firms’ product. In the
graph on the next slide, this increase in
demand is shown in the rightward shift of
the demand curve, from DSR to DLR. The
higher demand results in smaller losses for
the existing firms until all economic losses
disappear.
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 IMPACT OF MARKET EXIT

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 ACHIEVING LONG-RUN
EQUILIBRIUM
Long-run equilibrium will occur when
each firm’s demand curve is just
tangent to its LRATC curve. This will
always occur at the same level of
output, where MR = MC. At this point,
there is no economic profit. (See graph
on next slide.)
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 LONG-RUN EQUILIBRIUM

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 C. MONOPOLISTIC
COMPETITION VERSUS
PERFECT COMPETITION

• What are the differences and

similarities between monopolistic
competition and perfect competition?
• What is excess capacity?
• What is allocative efficiency?

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 MONOPOLISTICALLY
COMPETITIVE FIRMS FAIL TO
REACH PRODUCTIVE EFFICIENCY
Because monopolistically competitive
firms face a downward-sloping demand
curve, average total cost is not minimized in
the long run. Therefore, firms in this
market structure fail to reach productive
efficiency, producing at levels below the
efficient scale. This point is illustrated in the
graph on next slide.
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MONOPOLISTIC COMPETITION

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 MONOPOLISTICALLY
COMPETITIVE FIRMS FAIL TO
REACH ALLOCATIVE EFFICIENCY
Monopolistically competitive firms also fail
to reach allocative efficiency, where price
equals marginal cost (P = MC). As you can
see in the graph on the preceding slide, price
is greater than cost in the monopolistic
competitive model. This means that society is
willing to pay more for the product than it
costs to produce it.
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 PERFECTLY COMPETITIVE FIRMS
MEET BOTH PRODUCTIVE AND
ALLOCATIVE EFFICIENCY

As you can see in the graph on the next

slide, the perfectly competitive firm has
reached both productive efficiency (P =
ATC at the minimum point on the
LRATC curve) and allocative efficiency
(P = MC).

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 PERFECT COMPETITION

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 ARE THE DIFFERENCES BETWEEN
MONOPOLISTIC COMPETITION
AND PERFECT COMPETITON
EXAGGERATED?

As the graph on the next slide

illustrates, if the preferences for
various brands are strong, there will
be more excess capacity than when
the preferences are weak.

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 THE IMPACT OF PRODUCT
DIFFERENTIATION

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 D. ADVERTISING

• Why do firms advertise?

• Is advertising good or bad from
society’s perspective?
• Will advertising always increase
costs?
• Can advertising increase demand?

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 WHY DO FIRMS ADVERTISE?

With advertising, a firm hopes it can

alter the elasticity of the demand for its
product, making it more inelastic, and
cause an increase in the demand that
will enhance profits.

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 THE IMPACT OF ADVERTISING ON
THE SHAPE AND POSITION OF
THE DEMAND CURVE
A successful
advertising
campaign can
increase
demand and
lead to a less
elastic demand
curve, like DAA.

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 IS ADVERTISING “GOOD” OR
“BAD” FROM SOCIETY’S
PERSPECTIVE?

To some, advertising manipulates

consumer tastes and creates “needs”
for trivial products. However, if one
believes people act rationally, this
argument loses much of its force.

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 WILL ADVERTISING ALWAYS
INCREASE COSTS?
Where substantial economies of scale exist,
it is possible that average production costs
will decline more than the amount of the
per-unit costs of advertising in the long
run. Even in the short run, specialization
and division of labor may cause
advertising to decrease average costs. This
point is illustrated in the graph on the next
slide.
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ADVERTISING AND ECONOMIES
OF SCALE

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 WHAT IF ADVERTISING
INCREASES COMPETITION?

If advertising reduces information

costs, this leads to more awareness
about available substitutes and,
potentially, to increasingly
competitive markets.

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 E. APPLICATION: NEW
BALANCE CARVES OUT A
MARKET NICHE
This bar graph
illustrates the
change in sales for
New Balance from
1994 to 1998.
What role do you
suppose
advertising played
in these figures?

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