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Monopolistic Competition
Chapter 11
Definitions and Descriptions of MonopolisticCompetition
Product Differentiation Identifying the Monopolistic Competitor
Profit Maximization in Short-Run and Long-Run
Price Discrimination
Efficiency or Inefficiency Closing Thoughts
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Monopolistic Competition
On one extreme is the Perfect Competition model
On the other extreme is the Monopoly Model
Monopolistic Competition & Oligopoly are competitive scenariosthat lie between these two extremes
Therefore, competitive features of Monopolistic Competition andOligopoly will emulate either Perfect Competition or Monopoly
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Characteristics of Monopolistic
Competition
Power to set prices somewhat like a monopoly
Face competition like perfect competition
********************************************* Large number of firms
-- Each firm has relatively small market share
-- Each firm must be sensitive to average market price of itsproduct
-- Collusion is not possible due to the number of firms No barriers to entry or exit
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Characteristics of Monopolistic
Competition
Product Differentiation Each firm makes a product that isslightly different from the products of competing firms.
-- Close substitutes but no perfect substitutes
-- An attempt to increase price will normally results in a lowervolume sold
Competition on Quality, Price, Marketing
-- Quality is design, reliability, service provided to buyer andease of access to product
-- Price downward sloping demand curve
-- Marketing firm must market = promotion, distribution,packaging 3
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Product Differentiation
Product differentiation is crucial to monopolistic
competition People value variety, even if it is not material (real)
Product differentiation takes place in buyers mind
Americans are provided with a wide variety of
products and services Variety is valued but costly we pay for it
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The Typical Monopolistic Competitor
The monopolistic competitor tries to set his orher product apart from the competition
The main way of doing this is throughadvertising
When this is done successfully, the demand curvebecomes more vertical or inelastic
Buyers are willing to pay more for a product orservice because they believe it is much betterthan their other choices
24-14Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Basis for Product Differentiation
Physical differences
Convenience
Ambience Reputations
Appeals to vanity
Unconscious fears and desires
Snob appeal
Customized products
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Product Differences
Product differentiation does not necessarily
mean there are any physical differencesamong products
They might all be the same, but how they are soldmay make all the difference
There are, of course, some very real physicalproduct differences.
Buyers often differentiate based on real physicaldifferences, but differentiation is still taking place inthe buyers mind, and it may or may not be based onreal physical differences
24-16Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Advertising and Branding
Whats to be gained by pouring money intoadvertising? It works!
-- Continuous signals regarding productdifferentiation
-- coca-cola vs pepsi
Brand has tremendous value
-- e.g. Budweiser-- Brands tend to capture in a single name all the
values a firm wants to impress upon the buyer
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The Typical Monopolistic Competitor
Tries to set his firm apart from his competition
-- New Product Development and Innovation
1. Striving to maintain an economic profit-- Advertising
1. Create consumer perception of productdifferentiation real or imagined
2. Attempting to keep demand as inelastic aspossible
Selling costs can be extremely high
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Identifying Monopolistic Competition
How much is the industry dominated or not dominated by fewsuppliers
-- geographical scope national, regional, global
An industry can be almost perfectly competitive on anational scope, but almost a monopoly locally e.g.Concrete Mixing
-- Barriers to entry and exit industries may appearconcentrated but few barriers exist to prevent entry: e.g
a community with only one restaurant-
there is no barrier to other restaurants coming in4
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Identifying Monopolistic Competition
The four-firm concentration ratio The percentage ofthe value of total market revenue accounted for bythe four largest firms in the industry
-- A low concentration ratio indicates a high degreeof competition
-- A high concentration ratio indicates an absence of
competition
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Identifying Monopolistic Competition
The Herfindahl-Hirschman Index the square of the percentagemarket share of each firm summed over the largest 50 firms inthe industry (or all of the firms if there is less than 50)
-- In perfect competition, the HHI is small
-- In monopoly, the HHI is 10,000 (100 squared)
-- A popular measure with the Justice Dept in the 1980s
HHI < 1000 characterized competitive markets
HHI > 1800 would bring Justice Dept challengeto proposed mergers
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Examples of Monopolistic Competition
Banks Sporting Goods
Radio Stations Fish and Seafood
Clothing JewelryComputers Health Spas
Frozen Foods Apparel Stores
Canned Goods Convenience Stores
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Monopolistic Competition
Since the Monopolistic Competitor prices at demand
where MR=MC, the firm may have1. excess production capacity, and is
2. operating below its efficient scale where ATC is
minimum
Markup The amount by which price exceeds MC
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24-5Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
The Monopolistic Competitor in the ShortRun
The monopolistic competitor can make a profit
or take a loss
As only one firm in a crowded industry it has avery elastic demand curve
No one firm can get too far out of line on pricebecause buyers can always purchase asubstitute from some one else
D
MR
Monopolistic competitor
DMR
Monopoly
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24-6Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Monopolistic Competitor Making a Profit in the
Short Run
Output
24
22
20
18
16
14
12
10
8
6
4
2
0
MC
ATC
D
MR
0 10 20 30 40 50 60 70 80 90 100 120 140 160
O
utput is 60
Price is $15
ATC is $12.10
Total Profit=(Price-ATC) X Output
=($15-$12.10) X 60
=($2.90) X 60= $174
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24-7Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Monopolistic Competitor Taking a Loss in the
Short Run
Out
ut
T
O
utput is 42
Price is $11ATC is $12.80
Total Profit=(Price-ATC) X Output
=($11-$12.80) X 42
=(-$1.80) X 42= -$75.60
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24-8Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Monopolistic Competitor Breaking Even in the
Long Run
Output
24
22
20
18
16
14
12
10
8
6
4
2
0
MC
ATC
D
MR
0 10 20 30 40 50 60 70 80 90 100 120 140 160
O
utput is 40
At the output level
associated with MC=MR,
the ATC curve is tangentto the demand curve
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Price Discrimination
Question Does price discrimination raise or lowerprofit?
Price discrimination selling the same good orservice at a number of different prices.
Basically an illegal activity under the Clayton Act
unless there is a cost justification for the price
discrimination Answer Price discrimination is a marketing means
to increase economic profit
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Price Discrimination
Methods of price discrimination
-- Discriminate among groups of buyers
works when different buying groups are willingto pay different prices (on the average) for thesame good or service
Example: Airline travel prices target business
travelers vs leisure time travelers-- discriminator is advance notice, shorter the
notice, the higher the price
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Some Examples of PriceDiscrimination
Doctors often charge rich patients morethan poor patients
They may have one price for those with insuranceand another price for those without insurance
Movies in the evening cost more than thosein the early afternoon
Senior citizen, youth, and student discounts
New and used cars
Youth fairs on airlines Evening meals in restaurants often cost
more than the same meal at lunch
24-18Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Practicing Price Discrimination
The firm that practices price discriminationmust be able to distinguish between two ormore separate groups of buyers
Price discriminators must also be able toprevent buyers from reselling the product orservice
For example, if a fifteen-year-old could resell hisyouth fare seat to an adult who could then use it, theprice discrimination effort would fail
24-19Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Motives for Price Discrimination
In most cases, price discrimination is basicallya mechanism for rationing goods and services
The main motivation for price discrimination is
to raise profits The greater the price discrimination, the greater the
profits because buyers lose some of their consumersurplus
If price discrimination were carried to its logical
conclusion, we would have perfect pricediscrimination
The buyers would lose all of their consumer surplus
24-20Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Price Discrimination
Methods of discrimination
-- Discriminate among units firm charges the same
price to all customers but there are volume discounts
The key idea is to figure a way to charge thoseincremental buyers who are willing to pay more a
higher price
Result Consumer Surplus is converted to ProducerSurplus
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Price Discrimination
Perfect Price discrimination occurs when a firmfigures out how to extract the entire consumer
surplus (page 357)
Once the firm has the entire consumer surplus, theMR curve becomes the Demand Curve
At that point, the firm extracts even more economicprofit by increasing production to the point where
MR(D) = MC (page 357)
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Price Discrimination
Efficiency When the firm increases output to thepoint where MC = D, the efficient quantity is
produced, but The producer has taken all the consumer surplus,
and
Since there is ample economic profit, the firm may beinduced to spend money (increase costs) to protectits economic profit (rent seeking and is usuallypolitical in nature)
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24-23Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Is the Monopolistic CompetitorInefficient?
From a purely economic standpoint . . .Yes! The firms do not produce at the minimum point on the
ATC
There may be too many firms in most industries Are there too many beauty parlors? Not if you want to
get your hair done on Friday afternoon or Saturdaymorning
Are there too many restaurants? Not on Sunday
There may be overdifferentiation
Would Americans want the drab businesses thatcharacterize eastern Europe and the old soviet union?
Would Americans want only one brand of toothpaste orone brand and model of a car?
In America, it would be hard to imagine a no-frillsworld
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Closing Thoughts
More than 99% of the over 23 million business firms
in the United States are monopolistic competitors
While price competition exists, they compete morevigorously over differentiation characteristics such as
ambience, service, convenience, quality, brandawareness, etc.