Unit 5: Monopoly, Monopolistic Competition,
and Oligopoly
Lecture #2, Monopolistic
Competition
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Think and Compare
• Before moving forward…
• Think about the characteristics of the market
structures we have studied
• Think about how monopolistically competitive
firms are similar/dissimilar to those that are
perfectly competitive or monopolists
LO1
11-2
Monopolistic Competition
• Relatively large number of sellers
• Differentiated products
• Easy entry and exit
• Need to advertise
LO1
11-3
Monopolistically Competitive
• Based on # of firms in an industry and
•
percent of market share
Measured by two methods:
• Four-firm Concentration Ratios
• Percentage of market held by 4 largest firms
• Herfindahl Index
• Measured by summing squared % of market
•
LO1
shares held by firms in an industry
10,000 is the highest (1 firm with 100% of the
market = 1002
11-4
Low Concentration Industries
(1)
Industry
(2)
4-Firm
Concentration
Ratio
(3)
Herfindahl
Index
(1)
Industry
(2)
4-Firm
Concentration
Ratio
(3)
Herfindahl
Index
14
114
Asphalt paving
25
207
Metal windows and
doors
Plastic pipe
24
262
Women’s dresses
13
84
Textile bags
24
263
Ready mix concrete
11
63
Bolts, nuts, and
rivets
24
205
Wood trusses
10
50
Plastic bags
23
240
Stone products
10
59
Quick printing
22
319
Metal stamping
8
31
Textile machinery
20
206
Wood pallets
7
24
Sawmills
18
117
Sheet metal work
6
25
Jewelry
16
117
Signs
5
19
Curtains and
draperies
16
111
Retail bakeries
4
7
LO1
11-5
Price and Output in Monopolistic Comp
• Demand is highly elastic
• Short-run profit or loss occur
• Produce where MR=MC
• Only long-run normal profit
• Firms enter and exit based on profit opportunity
• Inefficient
• Product variety
LO2
11-6
Price and Output in Monopolistic Comp
• Produce where P > MC
• Not socially optimal output
• Deadweight Loss results
• Not possible to regulate
• Too many firms
• Too many differentiated products
LO2
11-7
The Short Run: Profit
Price and Costs
MC
ATC
P1
A1
Economic
Profit
D1
MR = MC
MR
0
Q1
Quantity
LO2
11-8
The Short Run: Profit
• Short-run economic profits encourage new
firms to enter the market. This:
• Increases the number of products.
• Reduces demand of current firms.
• Current firms profits fall.
LO2
11-9
The Short Run: Loss
Price and Costs
MC
ATC
A2
P2
Loss
D2
MR = MC
MR
0
Q2
Quantity
LO2
11-10
The Short Run: Loss
• Short-run economic losses encourage firms
to exit the market. This:
• Decreases the number of products.
• Increases demand of remaining firms.
• Increases the remaining firms’ profits.
LO2
11-11
The Long Run: Only a Normal Profit
MC
Price and Costs
ATC
P3= A3
D3
MR = MC
MR
0
Q3
Quantity
LO2
11-12
Long-Run Normal Profits
• Why do monopolistically competitive
firms only earn normal profits in the
long-run?
LO2
11-13
Monopolistic Competition: Efficiency
• Inefficient use of resources
• Excess capacity (not found in Perfect Comp)
• Productive inefficiency
• P > ATC
• Additional capacity possible if production
occurred at ATC
• Allocative inefficiency
• P > MC
• Resources could be better-used with a
different product
LO2
11-14
Monopolistic Competition: Not Efficient
P=MC=Min ATC for pure competition (recall)
Price and Costs
MC
ATC
P3= A3
P4
Price is Lower
D3
MR = MC
Excess Capacity at
Minimum ATC
0
Q3
MR
Q4
Quantity
Monopolistic competition is not efficient
LO2
11-15
Product Variety
• The firm constantly manages price,
product, and advertising.
• Better product differentiation
• Better advertising
• The consumer benefits by greater array of
choices and better products.
• Types and Styles
• Brands and Quality
LO2
11-16
Advertising and Branding
LO2
•
Does advertising increase competition and
provide useful information to consumers or is it
used to simply manipulate our tastes and
preferences?
•
Are brand names an indicator of quality or do
they cause consumers to perceive differences
that do not really exist?
11-17