Chapter 13 Microeconomics
Comparing Monpolistic Competition and Perfect Competition
Monopolistic competition and perfect competition share the characteristic that in long-run equilibrium, firms earn zero eocnomic profit Two important differences between long-run equilibrium in the two markets: -Monopolistically competitive firms charge a price greater than marginal cost -Monopolistically competitive firms do not produce at minimum average total cost
Brand Management
Once a firm has succeeded in differentiating its product, it must try to maintain that differentation over time through brand management Whenever a firm successfully introduces a new product or a significantly different version of an old product, it earns an economic profit in the short run But the sucesss of the firm inspires competitiors to copy the new or improved product, and, in the long run, the firm's economic profit will be competed away Firms use brand managment to postpone the time when they will no longer be able to earn an economic profit
Is Zero Economic Profit Inevitable in the Long Run?
The economic analyiss of the long run shows the effects of market forces over time Owners of monopolistcally competitive firms doe not have to passive accept this long-run result The key to earning an economic profit is either to sell a differentiated product or to find a way of producign an existing product at a lower cost If a monopolistically competitive firm selling a differianted product is earning a profit, the profit will attract the entry of additional firms, and the entry of those firms will eventually eliminate the firm's profit If a firm introduces new technology that allows it to sell a good or service at a lower cost, competing firms will eventually duplicate that technology and eliminate the firm's profit -but this result holds only if the firm stands still and fails to find new ways of differentiating its product or fails to find new ways of lowering the cost of producing its product The shadow of the end of their profits haunts owners of every firm Firms try to continue earning a profit by reducing costs, by improving their pdocuts, by providing exceptional customer service, or by convincing consumers that their products are indeed different from what competitors offer To stay one step ahead of its competitiors, a firm has to offer consumers goods or services that they perceive to have greater value than those that competing firms offer Value can take the form of product differentiation that makes the good or service more suited to consumers' preferences, or it can take the form of a lower price
Excess Capacity under Monopolisitc Competition
A firm in a perfectly competitive market faces a perfectly elastic demand curve that is also its marginal revenue curve The firm maximizes profit by producing the quantity where price equals marginal cost In long run equilibrium, a perfectly competitive firm produces at the minimum point of its average total cost cruve The profit-maximizing level of output for a monopolistically competitive firm comes at a level of output where price is greater than marginal cost, and the firm is not at the minimum point of its average total cost curve A monopolistically competitive firm has excess capacity: If it increased its output, it could produce at a lower average total cost.
What Happens to Profits in the Long Run?
A firm makes an economic profit when its total revenue is greater than all of its cost, including the opportunity cost of the funds invested in the firm by its owners Economic profit gives entrepreneurs an incentive to enter the market and establish new firms
What Makes a Firm Successful?
A firm's owners and managers control some of the factors that make a firm successful and allowe it to earn an economic profit -the most important of these is the firm's ability to differentiate its product or to produce it at a lower average cost than competing firms -a firm that successfully does one or both of these thigns creates value for its customres Consumers will buy a product if they believe it meets a need not met only by competing produdcts or if its price is below that of competitors Some factors that affect a firm's profitability are not directly under the firm's control -Certain factors will affect all the firms in a market Sheer chance also plays a role in business, as it does in all other aspects of life
How a Monopolistically Competitive Firm Maximizes Profit in the Short Run
All firms use the same approach to maximize profit: They produce the quantity where marginal revenue is equal to marginalc cost In the short run, at least one factor of production is fixed, and there is not enough time for new firms to enter the market A firm's marginal cost is the increase in total cost resulting from producing another unit of output For many firms, the marginal cost curve has a U shape As long as the marginal cost of selling 1 more sandwich is less than the marginal revenue, the firm should make and sell additional sandwiches Profit = (P-ATC) x Q Unlike a perfectly competitive firm, which produces where P=MC, a monopolistically competitive fiirm produces where P>MC For a perfectly competitive firm, price equals marignal revenue, P=MR - to fufill the MR=MC condition for profit maximization, a perfectly competitive firm will produce where P=Mc P>MR for a monopolistically competitive firm because the firm's marginal revennue curve is below its demand -therefore, a monpolistically competitive firm will maximize profit by producing where P>MC
Advertising
An innovative advertising campaign can make even long-established and familar products seem more desirable than competing products When a firm advertises a product, it is trying to shift the demand curve for the product to the irght and to make it more inelastic If the firm is successfu, it will sell more of the product at every price, and it will be able to increase the price it charges without losing as many customers Advertising also increases a firm's costs If the increase in revenue that results from the advertising is greater than the increase in costs, the firm's profit will increase
How Does the Entry of New Firms Affect the Profits of Existing Firms?
As new restaurants open near your local Panera, the firm's demand curve will shift to the left The demand curve will shift because the Panera will sell fewer sandwiches at each price when there are additional restaurants in the area The demand curve will also become more elastic because consumers have additional restauraunts from which to buy turkey sandwhiches, so the Panera will lose more sales if it raises its prices As long as this Panera is making an economic profit, there is an incnetive for additional restaurants to open in the area and sell turkey sandwhiches, and the demand curve will continue shifting to the left -eventually the demand curve will have shifted to the point where it is just touching the average total cost curve IN the long run, at the point where the demand curve is tangent to the average total cost curve, price is equal to average total cost, the firm is breaking even, and it no longer earns an economic profit In the long run, the demand curve is also more elastic because the more restaurants there are in the area, the more sales this Panera will lose to other restaurants if it raises its price It is possible that a monopolistically competitive firm will suffer an economic loss in the short run -as a consequence, the owners of the firm will not be covering the opportunity cost of their investment -we expect that, in the long run, firms will exit an industry if they are suffering an economic loss -if firms exit, the demand cruve for the output of a remaining firm will shift to the right ( this process will continue until the representative firm in the industry is able to charge a price equal to its average total csot and break even) therefore, in the long run, monpolistically competitive firms will experience neither an economic profit nor an economic loss
How Marketing Differentiates Products
Firms can differentiate their products through marketing, which refers to all the activities neessary for a firm to sell a product to a consumer Marketing includes activities such as determing which product to sell, designing the product, advertising the product, deciding how to distribute the product, and monitoring how changes in consumer tastes are affecting the market for the product For monopolistically competitive firms to earn an economic profit and defend the profit from competitiors, they must differentiate their products -Firms use two marketing tools to differentiate their products; brand management and advertising
Conclusion
Firms that fail to adequately anticipate changes in consumer tastes or that fail to adopt the latest and most efficient production technology do not survive in the long run
Marginal Revenue for A Firm with a Downward-Sloping Demand Curve
For a firm in a perfectly competitive market, the demand curve and the marginal revenue curve are the same A perfectly competitive firm faces a horizontal demand curve and does not have to cut the price to sell a larger quantity A monopolistically competitive firm must cut the price to sell more, so its marginal revenue curve will slope downward and will be below its demand curve Average revenue is equal to total revenue divided by quantity Because total revenue equals price multiplied by quantity, dividing by quantity leaves price Average revenue is always equal to price For a perfectly competitive firm, the additional revenue received from selling 1 more unit is just equal to the pirce Every firm that has the ability to affect the price of the good or service it sells will have a marginal revenue curve that is below its demand curve Only firms in perfectly competitive markets, which can sell as many units as they want at the market price, have marginal revenue curves that are the same as their demand curves
Is Monopolistic Competition Inefficient?
Productive efficiency refers to the situation in which a good is produced at the lowest possibel cost. For productive efficency to hold, firms must produce at the minimum point of the average total cost ruve Allocative efficiecny refers to the situation in which every good or service is produced up to the point where the last unit provides a marginal benefit to consumers euqal to the marginal cost of producing it. For allocative efficiecny to hold, firms must charge a price equal to marginal cost. In a perfectly competitive market, both productive efficency and allocative efficency are achieved, but in a monpolistically competitive market, neither is achieved -does it matter? -Economists have debated whether monopolistaclly competitive markets being neither productively nor allocatively efficent results in a signficant loss of well-being to society in these markets compared with perfectly competitive markets
How Consumers Benefit from Monopolistic Competition
The key difference between the monpolistically competitive firm and the perfectly competitive firm is that the demand curve for the monopolistically competive firm slopes downward, while the demand curve for the perfectly competitive firm is a horizontal line The demand curve for the monopolistically competitive firm slopes downward becaues the good or service the firm is selling is differentiated from those being sold by competing firms The perfectly competitive firm is selling a good or service identical to those being sold by its competitors Firms differentiate their products to appeal to consumers The success of these product differentiation strategies indicates that some consumers find these products preferable to the altenratives -consumers are better off than they would have been had these compnaies not differeniated their products Consumers face a trade-off when buying the product of a monpolistically competitive firm: They are paying a price that is greater than marginal cost, and the product is not being produced at minimum average cost, but they benefit from being able to purchase a product that is differentiated and more closely suited to their tastes
Defending a Brand Name
To defend a brand name, a firm can apply for a trademark, which grants legal protection against other firms using its product's name One threat to a trademarked name is the possibility that it will become so widely used for a type of product that it will no longer be associated with the product of a specific company -courts in the US have ruled that when this happens, a firm is no logner entitled to legal protection of the brand name Legally enforcing trademarks can be difficult -estimates are that each year, US firms lose hundreds of billions of dollars in sales worldwide as a result of unauthorized use of their trademarked brand names US firms often find it difficult to enforce their trademarks in the courts of some foreign countries, although recent international agreements have increased the legal protections for trademarks Firms that sell their products through franchines rather than through company-owned stores encounter the problem that if a franchisee does not run his or her business well, the firm's brand may be damanged Firms can take steps to keep such damage from happening