PRINCIPLES OF
ECONOMICS
PART III Market Imperfections and the Role of Government
TENTH EDITION
CASE FAIR OSTER
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Prepared by: Fernando Quijano & Shelly
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PART III Market Imperfections and the Role of Government
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Monopolistic
Competition
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CHAPTER OUTLINE
Industry Characteristics
PART III Market Imperfections and the Role of Government
Product Differentiation and Advertising
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How Many Varieties?
How Do Firms Differentiate Products?
Advertising
Price and Output Determination in Monopolistic
Competition
Product Differentiation and Demand Elasticity
Price/Output Determination in the Short Run
Price/Output Determination in the Long Run
Economic Efficiency and Resource Allocation
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PART III Market Imperfections and the Role of Government
 FIGURE 15.1 Characteristics of Different Market Organizations
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Industry Characteristics
PART III Market Imperfections and the Role of Government
monopolistic competition A common form of industry
(market) structure in the United States, characterized by a large
number of firms, no barriers to entry, and product differentiation.
TABLE 15.1 Percentage of Value of Shipments Accounted for by the Largest Firms in
Selected Industries, 2002
Industry Designation
Travel trailers and campers
Games, toys
Wood office furniture
Book printing
Curtains and draperies
Fresh or frozen seafood
Women’s dresses
Miscellaneous plastic products
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Four Largest
Firms
38
39
34
33
17
14
18
6
Eight Largest
Twenty
Number of
Firms
Largest Firms
Firms
45
48
43
54
25
24
23
10
58
63
56
68
38
48
48
18
733
732
546
560
1,778
529
528
6,775
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Product Differentiation and Advertising
product differentiation A strategy that firms use to
achieve market power. Accomplished by producing products
that have distinct positive identities in consumers’ minds.
PART III Market Imperfections and the Role of Government
How Many Varieties?
In well-working markets, the level of product variety reflects the
underlying heterogeneity of consumers’ tastes in that market, the gains
if any from coordination, and cost economies from standardization.
In industries that are monopolistically competitive, differences in
consumer tastes, lack of need for coordination, and modest or no scale
economies from standardization give rise to a large number of firms,
each of which has a different product.
Even within this industry structure, however, these same forces play a
role in driving levels of variety.
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Product Differentiation and Advertising
How Do Firms Differentiate Products?
PART III Market Imperfections and the Role of Government
horizontal differentiation Products differ in ways that make them
better for some people and worse for others.
behavioral economics A branch of economics that uses the insights
of psychology and economics to investigate decision making.
commitment device Actions that individuals take in one period to try
to control their behavior in a future period.
vertical differentiation A product difference that, from everyone’s
perspective, makes a product better than rival products.
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Product Differentiation and Advertising
Advertising
The Case for Advertising
PART III Market Imperfections and the Role of Government
Differentiated products and advertising give the market
system its vitality and are the basis of its power.
Product differentiation helps to ensure high quality and
variety, and advertising provides consumers with valuable
information on product availability, quality, and price that they
need to make efficient choices in the marketplace.
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Economic Efficiency and Resource Allocation
PART III Market Imperfections and the Role of Government
Because entry is easy and economic profits are eliminated in the long run, we
might conclude that the result of monopolistic competition is efficient. There are
two problems, however.
First, once a firm achieves any degree of market power by differentiating its
product (as is the case in monopolistic competition), its profit-maximizing
strategy is to hold down production and charge a price above marginal cost.
Second, the final equilibrium in a monopolistically competitive firm is necessarily
to the left of the low point on its average total cost curve, which means a typical
firm in this industry will not realize all the economies of scale available.
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REVIEW TERMS AND CONCEPTS
behavioral economics
PART III Market Imperfections and the Role of Government
commitment device
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horizontal differentiation
monopolistic competition
product differentiation
vertical differentiation
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