Microeconomics: Principles, Applications, and Tools

NINTH EDITION

Chapter 9
Market Entry and
Monopolistic
Competition

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Learning Objectives
1. Describe and explain the effects of market entry.
2. List the conditions for equilibrium in monopolistic
competition.
3. Contrast monopolistic competition and perfect
competition.
4. Explain the role of advertising in monopolistic competition.

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Market Entry and Monopolistic Competition

• Monopolistic competition
A market served by many firms that sell slightly different products.

The term monopolistic competition actually conveys the two key features
of the market:
• Each firm in the market produces a good that is slightly different from the
goods of other firms, so each firm has a narrowly defined monopoly.
• The products sold by different firms in the market are close substitutes for one
another, so there is intense competition between firms for consumers.

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9.1 THE EFFECTS OF MARKET ENTRY (1 of 3)

MARGINAL PRINCIPLE
Increase the level of an activity as long as its marginal benefit exceeds
its marginal cost. Choose the level at which the marginal benefit equals
the marginal cost.

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9.1 THE EFFECTS OF MARKET ENTRY (2 of 3)
(A) A monopolist maximizes profit at
point a, where marginal revenue
equals marginal cost. The firm sells
300 toothbrushes at a price of $2.00
(point b) and an average cost of
$0.90 (point c). The profit of $330 is
shown by the shaded rectangle.

(B) The entry of a second firm shifts

the firm-specific demand curve for
the original firm to the left. The firm
produces only 200 toothbrushes
(point d) at a lower price ($1.80,
shown by point e) and a higher
average cost ($1.00, shown by point
f). The firm’s profit, shown by the
shaded rectangle, shrinks to $160.

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9.1 THE EFFECTS OF MARKET ENTRY (3 of 3)
Entry Squeezes Profits from Three Sides
Entry shrinks the firm’s profit rectangle because it is squeezed from three
directions. The top of the rectangle drops because the price decreases. The
bottom of the rectangle rises because the average cost increases. The right side
of the rectangle moves to the left because the quantity decreases.

Examples of Entry: Stereo Stores, Trucking, and Tires

Empirical studies of other markets provide ample evidence that entry decreases
market prices and firms’ profits. In other words, consumers pay less for goods
and services, and firms earn lower profits.

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APPLICATION 1
SATELLITE VS. CABLE
APPLYING THE CONCEPTS #1: How does market entry affect prices?

• Consider the market for television signals provided to residential consumers.

How will an existing cable-TV provider respond to the entry of a firm that
provides TV signals via satellite?
• In most cases, the entry of a satellite firm causes the cable firm to improve the
quality of service and decrease its price, so consumer surplus increases. In
some cases, the cable company improves the quality of service and increases
price.
• Because the service improvement is typically large relative to the price hike,
consumer surplus increases in this case too. On average, the entry of a
satellite firm increases the monthly consumer surplus per consumer from
$3.96 to $5.22, an increase of 32 percent.

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9.2 MONOPOLISTIC COMPETITION (1 of 3)
Under a market structure called monopolistic competition, firms will
continue to enter the market until economic profit is zero. Here are the
features of monopolistic competition:

• Many firms.

• A differentiated product.

• Product differentiation
The process used by firms to distinguish their products from the products
of competing firms.

• No artificial barriers to entry.

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9.2 MONOPOLISTIC COMPETITION (2 of 3)
When Entry Stops: Long-
Run Equilibrium
Under monopolistic competition, firms
continue to enter the market until
economic profit is zero.

Entry shifts the firm specific demand

curve to the left.

The typical firm maximizes profit at

point a, where marginal revenue
equals marginal cost.

At a quantity of 80 toothbrushes, price

equals average cost (shown by point
b), so economic profit is zero.

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9.2 MONOPOLISTIC COMPETITION (3 of 3)
Differentiation by Location
Book stores and other retailers
differentiate their products by selling
them at different locations.

The typical book store chooses the

quantity of books at which its
marginal revenue equals its marginal
cost (point a).

Economic profit is zero because the

price equals average cost (point b).

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APPLICATION 2
OPENING A MOTEL
APPLYING THE CONCEPTS #2: Are monopolistically competitive firms profitable?

• One way to get into a monopolistically competitive market is to get a franchise for a
nationally advertised product.
• If you’d like to get into the economy motel market, you could pay a $35,000 franchise fee
to Accor, the owner of the Motel 6 brand. The term for the renewable franchise
agreement is 15 years. In addition, you will pay Accor a royalty of 5 percent of your sales
revenue.
• How much money are you likely to earn in your motel? You will compete with nearby
motels and hotels for customers, and because the barriers to entering the industry are
relatively low, the competition is likely to be keen.
• You are likely to earn zero economic profit, with the total revenue equal to total cost.
SOURCE: Based on data from www.entrepreneur.com (accessed February 27, 2015).

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9.3 TRADE-OFFS WITH ENTRY AND
MONOPOLISTIC COMPETITION (1 of 3)

Average Cost and Variety

• There are some trade-offs associated with monopolistic competition.
Although the average cost of production is higher than the minimum,
there is also more product variety.
• When firms sell the same product at different locations, the larger the
number of firms, the higher the average cost of production. But when
firms are numerous, consumers travel shorter distances to get the
product. Therefore, higher production costs are at least partly offset by
lower travel costs.

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9.3 TRADE-OFFS WITH ENTRY AND
MONOPOLISTIC COMPETITION (2 of 3)
Monopolistic Competition
versus Perfect Competition
(A) In a perfectly competitive market,
the firm-specific demand curve is
horizontal at the market price, and
marginal revenue equals price.

In equilibrium, price = marginal cost

= average cost.

The equilibrium occurs at the

minimum of the average-cost curve.

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9.3 TRADE-OFFS WITH ENTRY AND
MONOPOLISTIC COMPETITION (3 of 3)
Monopolistic Competition
versus Perfect Competition
(B) In a monopolistically
competitive market, the firm-
specific demand curve is
negatively sloped and marginal
revenue is less than price.

In equilibrium, marginal revenue

equals marginal cost (point b)
and price equals average cost
(point c).

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APPLICATION 3
HAPPY HOUR PRICING
APPLYING THE CONCEPTS #3: How does monopolistic competition compare to
perfect competition?
• Consider the phenomenon of “happy hour.” Many bars and restaurants near workplaces
face an increase in demand for food and drink around 5:00 p.m., and many cut their
prices for an hour or two. According to the model of perfect competition, an increase in
demand will lead to higher, not lower prices. What explains the happy-hour combination
of higher demand and lower prices?
• Bars are subject to monopolistic competition. Each bar has a local monopoly within its
neighborhood, but faces competition from other bars outside its neighborhood. For an
individual consumer, the higher the demand for food and drink, the greater the incentive
to consider alternatives to the nearest bar. If you expect to purchase large quantities of
bar food and drink, the savings achieved by finding a lower price at an alternative bar will
be relatively large. In other words, when individual demand increases, each bar faces a
more elastic demand for its products.
• In a market subject to monopolistic competition, the bar’s rational response to more
elastic demand (more sensitive consumers) is to decrease its price. In graphical terms,
the demand curve facing each bar becomes flatter, and the demand curve will be
tangent to the average-cost curve at a larger quantity and a lower price and average
cost.
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APPLICATION 4
PICTURE OF MAN VS. PICTURE OF WOMAN
APPLYING THE CONCEPTS #4: How does advertising affect consumer
choices?
• A South African consumer lender decided to use a mass mailing of 53,000 loan
offers to test the sensitivity of consumers to variations in interest rates and
other features of loan offers. The interest rates in the offer letters ranged from
3.75% to 11.75% per month.
• As expected, the uptake rate (the number of consumers who accepted a
particular loan offer) was higher for offer letters with low interest rates. The
elasticity of the uptake rate with respect to the interest rate was -0.34: a 10%
decrease in the interest rate (from say an interest rate of 7.0% to 6.3%)
increased the uptake rate by 3.4%.
• More surprising was the finding that the uptake rate among men was much
higher when the offer letter included a picture of a woman rather than a picture
of a man. Replacing a male model with a female model was equivalent to
cutting the interest rate by 25 percent, for example, from 7.0 percent to 5.25
percent. In contrast, the uptake rate for women consumers was unaffected by
the gender of the model. Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
9.4 ADVERTISING FOR PRODUCT
DIFFERENTIATION
An advertisement that doesn’t provide any product information may
actually help consumers make decisions.

TABLE 11.1 Advertising Profitability and Signaling

Number of Number Profit per Profit from

Consumers Who of Repeat Repeat Repeat Cost of
Product Try the Product Customers Customer Customers Advertisement

Energy bar A 10 million 5 million $4 $20 million $10 million

Energy bar B 10 million 1 million 4 4 million 10 million

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KEY TERMS
Monopolistic competition
Product differentiation

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