Monopolistic Competition and Product Differentiation
Monopolistic Competition and Product Differentiation
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The Meaning of Monopolistic Competition
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Product Differentiation
Product differentiation plays an even more crucial role
in monopolistically competitive industries. Why?
Tacit collusion: is it possible?
Product differentiation market power.
Then, how do firms in the same industry differentiate
their products? E.g. hotels in Vung Tau
Is the difference mainly in the minds of consumers or
in the products themselves?
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Product Differentiation
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Product Differentiation
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Economics in Action:
Case: “Any Color, So Long as It’s Black”
Ford’s strategy was to offer just one style of car,
which maximized his economies of scale but made
no concessions to differences in taste Model T
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The firm in panel (a) can be profitable The firm above can never be
for some output levels: the levels at profitable because the ATC lies
which its ATC, lies below its demand above its demand curve, DU. The
curve, DP. The profit-maximizing best that it can do if it produces at
output level is QP, the output at which all is to produce output QU and
marginal revenue, MRP, is equal to charge PU. This generates a loss,
marginal cost. The firm charges price indicated by the area of the shaded
PP and earns a profit, represented by rectangle. Any other output level
the area of the shaded rectangle. results in a greater loss. 9
Monopolistic Competition in the Long Run
If the typical firm earns positive profits, new firms will
enter the industry in the long run, shifting each
existing firm’s demand curve to the left. If the typical
firm incurs losses, some existing firms will exit the
industry in the long run, shifting the demand curve of
each remaining firm to the right.
In the long run, equilibrium of a monopolistically
competitive industry, the zero-profit-equilibrium, firms
just break even. The typical firm’s demand curve is just
tangent to its average total cost curve at its profit-
maximizing output.
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Entry and Exit into the Industry Shift the Demand Curve
of Each Firm
Entry will occur in the long run when existing firms are profitable. In panel (a),
entry causes each firm’s demand curve and marginal revenue curve to shift to the
left. The firm receives a lower price for every unit it sells, and its profit falls. Entry
will cease when remaining firms make zero profit.
Exit will occur in the long run when existing firms are unprofitable. In panel (b), exit
out of the industry shifts each remaining firm’s demand curve and marginal revenue
curve to the right. The firm receives a higher price for every unit it sells, and profit
rises. Exit will cease when the remaining firms make zero profit. 11
The Long-Run
Zero-Profit
Equilibrium
A monopolistically
competitive firm is like a
monopolist without
monopoly profits.
If existing firms are profitable, entry will occur and shift each
firm’s demand curve leftward. If existing firms are unprofitable,
each firm’s demand curve shifts rightward as some firms exit the
industry. In long-run zero profit equilibrium, the demand curve of
each firm is tangent to its average total cost curve at its profit-
maximizing output level: at the profit-maximizing output level,
QMC, price, PMC, equals average total cost, ATCMC. 12
Monopolistic Competition versus
Perfect Competition
In the long-run equilibrium of a monopolistically
competitive industry, there are many firms, all
earning zero profit.
Price exceeds marginal cost so some mutually
beneficial trades are exploited.
The following figure compares the long-run
equilibrium of a typical firm in a perfectly competitive
industry with that of a typical firm in a
monopolistically competitive industry.
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Panel (a) shows the situation of the typical firm in long-run equilibrium in a perfectly
competitive industry. The firm operates at the minimum-cost output QC , sells at the
competitive market price PC , and makes zero profit. It is indifferent to selling another
unit of output because PC is equal to its marginal cost, MCC .
Panel (b) shows the situation of the typical firm in long-run equilibrium in a
monopolistically competitive industry. At QMC it makes zero profit because its price, PMC,
just equals average total cost. At QMC the firm would like to sell another unit at price PMC,
since PMC exceeds marginal cost, MCMC. But it is unwilling to lower price to make more
sales. It therefore operates to the left of the minimum-cost output and has excess
capacity. 14
Is Monopolistic Competition Inefficient?
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Controversies about Product
Differentiation
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The Role of Advertising
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