Econ 102 CH 25; 24.4-24.5

product heterogeneity & monopolistic competition

"variations in product characteristics—and advertising" did not show up in our analysis of perfect competition. They play large roles, however, in industries that *cannot be described as perfectly competitive but* *cannot be described as pure monopolies, either* *A combination of consumers' preferences for variety and competition among producers has led to similar but differentiated products in the marketplace. This situation has been described as monopolistic competition, the subject of this chapter*

how a drug-dealing monopoly boosts profits via loyalty cards

*A drug-dealing operation differs from other firms because it sells an illegal product*. The structure of the dealer's loyalty-discount-card program, however, parallels similar programs offered by many other firms, such as grocery stores. Under these programs, firms charge customers who display loyalty cards lower overall prices than buyers who do not, even though the marginal cost of the items is the same across customers. - *Hence, firms use the cards to engage in price discrimination*. They do so to boost their profits - Keeping records of customer transactions using these cards reveals to a retailer whether a buyer goes to the trouble to seek the lowest available price - If so, that buyer is sensitive to changes in the item's price. As you learned in another chapter, this buyer's demand is elastic, so charging a lower price generates an increase in quantity demanded that is proportionately large in relation to the proportionate decrease in price. *Reducing the price for the cardholder, therefore, raises the drug dealer's revenues and profits* (more customers overall = greater revenues & profits; exceeds the deduction in price; benefit) *If a consumer does not use a loyalty card, this fact reveals to the drug dealer—just as it would to any other firm—that the consumer is less sensitive to price changes, so the consumer's demand is relatively inelastic* - Charging a higher price for the consumer who does not use a card thereby leads to a proportionate reduction in quantity demanded that is smaller in relation to a proportionate increase in the price that the consumer pays. - *Maintaining a higher price for the consumer without a loyalty card thereby also raises the drug dealer's revenues and profits*

information products and monopolistic competition

*A number of industries sell information products, which entail relatively high fixed costs associated with the use of knowledge and other information-intensive inputs as key factors of production* *Once the first unit has been produced, however, it is possible to produce additional units at a relatively low per-unit cost* - Most information products can be put into digital form. Good examples are operating systems for digital devices, online games, digital music and videos, educational and training software, electronic books and encyclopedias, and office productivity software.

brand names and advertising

*Because "differentness" has value to consumers*, monopolistically competitive firms regard their brand names as valuable. Firms use trademarks—words, symbols, and logos—to distinguish their product brands from goods or services sold by other firms Consumers associate these trademarks with the firms' products. Thus, *companies regard their brands as valuable private (intellectual) property, and they engage in advertising to maintain the differentiation of their products from those of other firms*

underproduction at a higher price

*Because the price of a good indicates the amount that buyers are willing to pay for the last unit produced, that price represents society's valuation of that unit* The monopoly outcome of P exceeding MC means that the value to society of the last unit produced is greater than its cost (MC). Hence, not enough of the good is being produced. - *As we have pointed out before, these differences between monopoly and perfect competition arise not because of differences in costs but rather because of differences in the demand curves the individual firms face* - The monopolist faces a downward-sloping demand curve. The individual perfect competitor faces a perfectly elastic demand curve.

special cost characteristics of information products

*Creating the first copy of an information product often entails incurring a relatively sizable up-front cost. Once the first copy is created, however, making additional copies can be very inexpensive* For instance, a firm that sells an online game can simply make properly formatted copies of the original digital file of the game available for consumers to download, at a price, via the Internet. (lower marginal costs)

sales promotion and advertising

*Monopolistic competition differs from perfect competition in that no individual firm in a perfectly competitive market will advertise*. A perfectly competitive firm, by definition, can sell all that it wants to sell at the going market price anyway. Why, then, would it spend even one penny on advertising? Furthermore, by definition, the perfect competitor is selling a product that is identical to the product that all other firms in the industry are selling. Any advertisement that induces consumers to buy more of that product will, in effect, be helping all the competitors too A perfect competitor therefore cannot be expected to incur any advertising costs (except when all firms in an industry collectively agree to advertise to urge the public to buy more beef or drink more milk, for example). The monopolistic competitor, however, has at least some pricing power. Because consumers regard the monopolistic competitor's product as distinguishable from the products of the other firms, the firm can search for the most profitable price that consumers are willing to pay for its differentiated product. *Advertising, therefore, may result in increased profits* Advertising is used to increase demand and to differentiate one's product. *How much advertising should be undertaken*? It should be carried to the point at which the additional revenue from one more dollar of advertising just equals that one dollar of additional cost.

the long run: zero economic profits

*The long run is where the similarity between perfect competition and monopolistic competition becomes more obvious*. In the long run, because so many firms produce substitutes for the product in question, any economic profits will disappear with competition. They will be reduced to zero either through entry by new firms seeing a chance to make a higher rate of return than elsewhere or by changes in product quality and advertising outlays by existing firms in the industry. (Profitable products will be imitated by other firms.) *As for economic losses in the short run, they will disappear in the long run* because the firms that suffer them will leave the industry. They will go into another business where the expected rate of return is at least normal. - Panels (a) and (b) of Figure 25-1 therefore represent only short-run situations for a monopolistically competitive firm. *In the long run, the individual firm's demand curve d will just touch the average total cost curve at the particular price that is profit maximizing for that particular firm. This is shown in panel (c) of Figure 25-1* *A word of warning*: This is an idealized, long-run equilibrium situation for each firm in the industry. It does not mean that even in the long run we will observe every single firm in a monopolistically competitive industry making exactly zero economic profits or just a normal rate of return. We live in a dynamic world. All we are saying is that if this model is correct, the rate of return will tend toward normal—economic profits will tend toward zero.

marginal cost pricing and information products

*What if the company making this particular online game were to behave as if it were a perfectly competitive firm by setting the price of its product equal to marginal cost*? Panel (a) of Figure 25-5 provides the answer to this question.

brand names and trademarks

A firm's ongoing sales generate current profits and, as long as the firm is viable, the prospect of future profits. *A company's value in the marketplace depends largely on its current profitability and perceptions of its future profitability* Table 25-1 gives the market values of the world's most valuable product brands. Each valuation is calculated as the estimated amounts that the listed companies' brands would be worth if the companies sold them to other firms Brand names, symbols, logos, and unique color schemes such as the color combinations trademarked by FedEx relate to consumers' perceptions of product differentiation and hence to the market values of firms. Companies protect their trademarks from misuse by registering them with the U.S. Patent and Trademark Office. Once its trademark application is approved, a company has the right to seek legal damages if someone makes unauthorized use of its brand name, spreads false rumors about the company, or engages in other devious activities that can reduce the value of its brand. The market value of a company is equal to the number of shares of stock issued by the company times the market price of each share. To a large extent, the company's value reflects the value of its brand.

commercial accounting firms enter the commercial legal services industry

A large number of commercial law firms bring in more than $650 billion in global revenues by providing similar but differentiated legal services to large and small businesses. About a decade ago, a sufficient number of commercial law firms earned positive levels of economic profits to entice a new group of competitors: commercial accounting firms. - A number of the largest accounting firms gradually have increased the staffing of their legal divisions over the past several years. These divisions also bring in billions of dollars in revenues each year that contribute to the overall profit flows of the accounting firms - Naturally, the entry and expansion of accounting firms' legal divisions have generated reductions in demands for the legal services provided by traditional law firms. The consequence has been reductions in economic profits earned across the market for legal services.

loyalty cards as tools of price differentiation or discrimination?

A local drug-dealing monopoly might establish different prices for similar products for two very different reasons. One reason could be to engage in price differentiation by taking into account differences in marginal costs of providing those items to different groups of buyers. Another reason might be to implement price discrimination by selling an item at more than one price, with the price difference being unrelated to differences in marginal cost. The marginal cost of obtaining and selling drugs illegally is the same for a French drug dealer irrespective of who the buyer might be. *Thus, charging the bearer of a loyalty card a lower price than a buyer who does not display a card does not involve price differentiation*

beginning intro. info.

A majority of U.S. household and business expenditures involve spending on services rather than on physical goods - Among the services purchased are the professional services provided by personal financial-planning firms and commercial law firms. - *These companies provide services that are similar but that each seller strives to differentiate*, through activities such as advertising and sales promotions, from those of its competitors. In this chapter, you will learn about *monopolistic competition, a market environment in which numerous sellers, such as firms that sell professional services, produce similar but not identical products* You will also learn how greater ease with which new competitors can enter markets for professional services has generated a variety of adjustments by firms in these industries—*not just to quantities of services provided but also to the nature of those services*

experience goods

A product that an individual must consume before the product's quality can be established.

the individual firm's demand and cost curves

Because the individual firm is not a perfect competitor, its demand curve slopes downward, as in all three panels of Figure 25-1 - Hence, it faces a marginal revenue curve that is also downward sloping and below the demand curve. To find the profit-maximizing rate of output and the profit-maximizing price, we go to the output where the marginal cost (MC) curve intersects the marginal revenue (MR) curve from below. - That gives us the profit-maximizing output rate. - Then we draw a vertical line up to the demand curve - That gives us the price that can be charged to sell exactly that quantity produced. - This is what we have done in Figure 25-1. In each panel, a marginal cost curve intersects the marginal revenue curve at A. The profit-maximizing rate of output is q, and the profit-maximizing price is P. Figure Explanation: - In panel (a), the typical monopolistic competitor is shown making economic profits. In this situation, there would be entry into the industry, forcing the demand curve for the individual monopolistic competitor leftward. - Eventually, firms would find themselves in the situation depicted in panel (c), where zero economic profits are being made. - In panel (b), the typical firm is in a monopolistically competitive industry making economic losses. In this situation, firms would leave the industry. Each remaining firm's demand curve would shift outward to the right. Eventually, the typical firm would find itself in the situation depicted in panel (c).

A key assumption

Before we leave the topic of the cost to society of monopolies, we must repeat that our analysis is based on a heroic assumption: *The monopolization of the perfectly competitive industry does not change the cost structure* - If monopolization results in higher marginal cost, the net cost of monopoly to society is even greater. *Conversely, if monopolization results in cost savings, the net cost of monopoly to society is less than we infer from our analysis*. Indeed, we could have presented a hypothetical example in which monopolization led to such a dramatic reduction in cost that society actually benefited. Such a situation is a possibility in industries in which ECONOMIES OF SCALE (not operation) exist for a very great range of outputs.

short-run economies of operation

By definition, average total cost equals the sum of average fixed cost and average variable cost. The average total cost (ATC) curve for this online game company slopes downward over its entire range. (ATC = AFC + AVC) Recall from Chapter 22 that along the downward-sloping range of an individual firm's long-run average cost curve, the firm experiences economies of scale. For the producer of an information product such as an online game, the short-run average total cost curve slopes downward. - *Consequently, sellers of information products typically experience short-run economies of operation* *The average total cost of producing and selling an information product declines as more units of the product are sold. Short-run economies of operation are a distinguishing characteristic of information products that sets them apart from most other goods and services*

similar but distinguishable goods and services

Consider the abundance of brand names for smartphones, tablet devices, apps, and most other consumer goods and a great many services. We are not obliged to buy just one type of video game, just one type of jeans, or just one type of footwear. We can usually choose from a number of similar but differentiated products. *The greater a firm's success at product differentiation, the greater the firm's pricing options*

product substitutability and price elasticity of demand

Each separate differentiated product has numerous similar substitutes. This clearly has an impact on the price elasticity of demand for the individual firm *Recall that one determinant of price elasticity of demand is the availability of substitutes*: The greater the number and closeness of substitutes available, other things being equal, the greater the price elasticity of demand. If the consumer has a vast array of alternatives that are just about as good as the product under study, a relatively small increase in the price of that product will lead many consumers to switch to one of the many close substitutes. Thus, the ability of a firm to raise the price above the price of close substitutes is very small *At a given price, the demand curve is highly elastic compared to a monopolist's demand curve*. In the extreme case, with perfect competition, the substitutes are perfect because we are dealing with only one particular undifferentiated product. In that case, the individual firm has a perfectly elastic demand curve.

methods of advertising

Figure 25-3 shows the current distribution of advertising expenses among the various advertising media. Today, as in the past, firms primarily rely on two approaches to advertising their products. - *One is direct marketing*, in which firms engage in personalized advertising using postal mailings, phone calls, and e-mail messages (excluding so-called banner and pop-up ads on Web sites). - *The other is mass marketing*, in which firms aim advertising messages at as many consumers as possible via media such as television, newspapers, radio, and magazines. - *A third advertising method is called interactive marketing*. This advertising approach allows a consumer to respond directly to an advertising message. (Often the consumer is able to search for more detailed information and place an order as part of the response. Sales booths and some types of Internet advertising, such as banner ads and video clips with links to sellers' Web pages, are forms of interactive marketing)

ease of entry

For any current monopolistic competitor, potential competition is always lurking in the background. The easier—that is, *the less costly—entry is, the more a current monopolistic competitor must worry about losing business* A good example of a monopolistic competitive industry is the app industry. Many small firms provide different programs for many applications. The fixed capital costs required to enter this industry are small. All you need are skilled programmers. In addition, there are few legal restrictions. The firms in this industry also engage in extensive advertising in more than 150 publications directed toward programmers.

personal finance apps push financial planners to differentiate their products

For many years, firms that specialize in providing personal financial-planning services have offered one-on-one counseling about borrowing, allocating funds among different types of financial firms and accounts, and engaging in long-term pension saving. During the past decade, however, a growing number of companies have begun offering so-called robo-financial-advising services. - These services, often offered via low-priced apps, guide households through financial-planning processes. Therefore, decreases in demands for services of traditional firms in the industry have generated reductions in their economic profits. Two types of long-run adjustments have taken place in the financial-planning industry. One is that a number of traditional firms have, after years of experiencing negative economic profits, exited the industry. - Another adjustment has been efforts by traditional firms to become regarded as providers of "financial therapy" services. = Such services help people overcome emotional impediments to determine appropriate amounts to borrow, to correctly allocate funds they hold, and to ensure that they save enough for their retirements. - By making these adjustments, traditionally human-centered financial-planning firms have sought to better differentiate their products and maintain demands for their services—thereby allowing them to earn at least zero long-run economic profits.

comparing perfect competition with monopolistic competition

If both the monopolistic competitor and the perfect competitor make zero economic profits in the long run, how are they different? The answer lies in the fact that the demand curve for the individual perfect competitor is perfectly elastic. - Such is not the case for the individual monopolistic competitor—its demand curve is less than perfectly elastic. (This firm has some control over price) -. *Price elasticity of demand is not infinite*

what if government decided that monopolistically competitive prices exceeding marginal costs constitutes social "waste" and banned such "waste" from occurring?

If the government were to prohibit prices from exceeding marginal costs at monopolistically competitive firms, in the short run each firm would be required to set its price at the point at which its marginal cost curve crosses through the demand curve for its product. - This would be the point at which consumers would be willing and able to buy the monopolistically competitive firm's product when its price was equal to its marginal cost. This price, however, would be less than the average total cost of producing any quantity of output, so *the firm would earn a short-run economic loss* In the long run, some firms would exit their industries. Remaining firms likely would respond by altering their products to reduce the costs that they incur in producing "differentness." Thus, *enforcement of the government's policy likely would reduce both the number of firms from which consumers could buy products and the variety of products available for consumers to consider purchasing*

on making higher profits: price discrimination

In a *perfectly competitive market*, each buyer is charged the same price for every constant-quality unit of the particular commodity (corrected for differential transportation charges). *Because the product is homogeneous and we also assume full knowledge on the part of the buyers, a difference in price cannot exist* - Any seller of the product who tried to charge a price higher than the going market price would find that no one would purchase it from that seller. In this chapter, we have assumed until now that the monopolist charged all consumers the same price for all units. *A monopolist, however, may be able to charge different people different prices or different unit prices for successive units sought by a given buyer* - When there is no cost difference, such strategies are called price discrimination - *A firm will engage in price discrimination whenever feasible to increase profits. A price-discriminating firm is able to charge some customers more than other customers* *It must be made clear at the outset that charging different prices to different people or for different units to reflect differences in costs of production does not amount to price discrimination. This is price differentiation: differences in price that reflect differences in marginal cost* We can also say that a uniform price does not necessarily indicate an absence of price discrimination. Charging all customers the same price when production costs vary by customer is actually a situation of price discrimination.

number of firms

In a perfectly competitive industry, there are an extremely large number of firms. In pure monopoly, there is only one. *In monopolistic competition, there are a large number of firms, but not so many as in perfect competition*. This fact has several important implications for a monopolistically competitive industry. 1. Small share of market. With so many firms, each firm has a relatively small share of the total market. 2. Lack of collusion. With so many firms, it is very difficult for all of them to get together to collude—to cooperate in setting a pure monopoly price (and output). Collusive pricing in a monopolistically competitive industry is nearly impossible - Also, barriers to entry are minor, and the flow of new firms into the industry makes collusive agreements less likely. The large number of firms makes the monitoring and detection of cheating very costly and extremely difficult. This difficulty is compounded by differentiated products and high rates of innovation. Collusive agreements are easier for a homogeneous product than for differentiated ones. 3. Independence. Because there are so many firms, each one acts independently of the others. No firm attempts to take into account the reaction of all of its rival firms—that would be impossible with so many rivals. Thus, an individual producer does not try to take into account possible reactions of rivals to its own output and price changes.

economic losses

In panel (a) of Figure 25-5, the company sets the price of the online game equal to marginal cost; it will charge only $2.50 per game it sells. Naturally, a larger number of people desire to purchase online games at this price, and given the demand curve in the figure, the company could sell 20,000 copies of this game. *The company would face a problem, however*. At a price of $2.50 per online game, it would earn $50,000 in revenues on sales of 20,000 copies. - The average fixed cost of 20,000 copies equals $250,000/20,000, or $12.50 per game. Adding this to the constant $2.50 average variable cost implies an average total cost of selling 20,000 copies of $15 per game. - Under marginal cost pricing, therefore, the company would earn an average loss of $12.50 (price−average total cost=$2.50−$15.00=−$12.50) - per online game for all 20,000 copies sold The company's total economic loss from selling 20,000 online games at a price equal to marginal cost would amount to $250,000. Hence, the company would fail to recoup the $250,000 total fixed cost of producing the game. If the company had planned to set its price equal to the online game's marginal cost, it would never have developed the game in the first place!

monopolistic competition

In the 1920s and 1930s, economists realized that both the perfectly competitive model and the pure monopoly model did not seem to yield very accurate predictions regarding various industries. Theoretical and empirical research was instituted to develop some sort of middle ground. - Two separately developed models of monopolistic competition resulted. At Harvard, Edward Chamberlin published Theory of Monopolistic Competition in 1933. The same year, Britain's Joan Robinson published The Economics of Imperfect Competition. In this chapter, we will outline the theory as presented by *Chamberlin* Chamberlin defined monopolistic competition as a market structure in which a relatively large number of producers offer similar but differentiated products. *Monopolistic competition therefore has the following features*: 1. Significant numbers of sellers in a highly competitive market 2. Differentiated products 3. Sales promotion and advertising 4. Easy entry of new firms in the long run Even a cursory look at the U.S. economy leads to the conclusion that *monopolistic competition is an important form of market structure in the United States*. Indeed, that is *true of all developed economies*

monopolistic competition and information products

In the example depicted in Figure 25-4, the information product is an online game. There are numerous online games among which consumers can choose. Hence, there are many products that are close substitutes in the market for these games. *Yet no two online games are exactly the same* - This means that the particular online game product sold by the company in our example is distinguishable from other competing products. For the sake of argument, therefore, let's suppose that this company participates in a monopolistically competitive market for this online game. Panels (a) and (b) of Figure 25-5 display a possible demand curve for the online game manufactured and sold by this particular company. fig. explanation: - In *panel (a)*, if the firm with the average total cost and marginal cost curves shown in Figure 25-4 sets the price of the online game equal to its constant marginal cost of $2.50 per copy, then consumers will purchase 20,000 copies. This yields $50,000 in revenues. (20,000 x $2.50) - The firm's average total cost of 20,000 games is $15 per copy, so its total cost of selling that number of copies is $15×20,000=$300,000 - Marginal cost pricing thereby entails a $250,000 loss, which is the total fixed cost of producing the online game (300,000 - 50,000) - PANEL B - - illustrates how the price of the game is ultimately determined under monopolistic competition. - Setting a price of $27.50 per game induces consumers to buy 10,000 copies, and the average total cost of producing this number of copies is also $27.50. - Consequently, total revenues equal $275,000, which just covers the sum of the $250,000 in total fixed costs and $25,000 (the 10,000 copies times the constant $2.50 average variable cost) in total variable costs. *The firm earns zero economic profits* = normal profit

short-run equilibrium

In the short run, it is possible for a monopolistic competitor to make economic profits—profits over and above the normal rate of return or beyond what is necessary to keep that firm in that industry. We show such a situation in panel (a) of Figure 25-1. The average total cost (ATC) curve is drawn below the demand curve, d, at the profit-maximizing rate of output, q. Economic profits are shown by the blue-shaded rectangle in that panel. Losses in the short run are clearly also possible. They are presented in panel (b) of Figure 25-1. Here the average total cost curve lies everywhere above the individual firm's demand curve, d. The losses are indicated by the pink-shaded rectangle. Just as with any market structure or any firm, in the short run it is possible to observe either economic profits or economic losses. In either case, the *price does not equal marginal cost but rather is above it*

social "waste" versus "differentness"

It has consequently been argued that monopolistic competition involves waste because minimum average total costs are not achieved and price exceeds marginal cost. *There are too many firms, each with excess capacity, producing too little output*. According to critics of monopolistic competition, society's resources are being wasted. *Chamberlin had an answer to this criticism*. He contended that the difference between the average cost of production for a monopolistically competitive firm in an open market and the minimum average total cost represented what he called the *cost of producing "differentness."* Chamberlin did not consider this difference in cost between perfect competition and monopolistic competition a waste. In fact, he argued that it is rational for consumers to have a taste for differentiation. *Consumers willingly accept the resultant increased production costs in return for more choice and variety of output*

the social costs of monopolies

Let's run a little experiment. We will start with a purely competitive industry with numerous firms, each one unable to affect the price of its product. The supply curve of the industry is equal to the horizontal sum of the marginal cost curves of the individual producers above their respective minimum average variable costs. In panel (a) of Figure 24-8, we show the market demand curve and the market supply curve in a perfectly competitive situation. The perfectly competitive price in equilibrium is equal to Pe, and the equilibrium quantity at that price is equal to Qe. Each individual perfect competitor faces a demand curve (not shown) that is coincident with the price line Pe. No individual supplier faces the market demand curve, D. (they face individual demand, "d" based on the market demand "D") Fig. Explanation: - In panel (a), we show a perfectly competitive situation in which equilibrium is established at the intersection of D and S at point E. The equilibrium price is Pe and the equilibrium quantity is Qe. Each individual perfectly competitive producer faces a demand curve that is perfectly elastic at the market clearing price, Pe. *What happens if the industry is suddenly monopolized?* - We assume that the costs stay the same. The only thing that changes is that the monopolist now faces the entire downward-sloping demand curve - In panel (b), we draw the marginal revenue curve, MR. Marginal cost is S because that is the horizontal summation of all the individual marginal cost curves. - The monopolist therefore produces at Qm and charges price Pm. This price Pm in panel (b) is higher than Pe in panel (a), and Qm is less than Qe. (charge more, supply less = monopolized)

Could some firms be gathering large amounts of online data about their customers in an effort to induce some consumers to pay higher prices than the prices paid by other buyers?

Most of today's companies have integrated the Internet into their internal business operations. Many also have found ways to use the Web as a means of collecting data on consumer transactions. *A number of firms even use so-called "big data" techniques that combine data they collect online with additional sources of information* - Doing so often improves the firms' measurements of and predictions about the scale and scope of their business operations. In recent years, U.S. government officials have become concerned that some firms are employing these big data techniques to assist in boosting the prices paid by consumers. In some cases, officials have found, firms are applying the information they collect to create complicated pricing choices for consumers. These complex choices, officials suspect, may be intended to confuse buyers. *Using information derived from big data techniques, sellers may be carefully designing pricing options aimed at taking advantage of buyers' limited capabilities under bounded rationality* - The ultimate goal, officials worry, may be to induce some consumers to pay higher prices for the same product than other consumers. These price differences, they suggest, may be unrelated to divergences in marginal cost. = *That is, companies may be utilizing big data techniques to improve their capabilities to engage in price discrimination*

implications of higher monopoly prices

Notice from Figure 24-8 that by setting MR = MC, the monopolist produces at a rate of output where P is greater than MC (compare Pm to MCm). *The marginal cost of a commodity (MC) represents what society had to give up in order to obtain the last unit produced.* - Price, by contrast, represents what buyers are willing to pay to acquire that last unit.

Monopoly vs. Perfect Competition

Notice that Qm is less than Qe and that Pm is greater than Pe. *Hence, a monopolist produces a smaller quantity and sells it at a higher price* ////This is the reason usually given when economists criticize monopolists. Monopolists raise the price and restrict production, compared to a perfectly competitive situation.//// *For a monopolist's product, consumers pay a price that exceeds the marginal cost of production*. Resources are misallocated in such a situation—too few resources are being used in the monopolist's industry, and too many are used elsewhere. = DEADWEIGHT LOSS

comparing monopoly with perfect competition

Now let's assume that a monopolist comes in and buys up every single perfect competitor in the industry. In so doing, we'll assume that monopolization does not affect any of the marginal cost curves or demand. We can therefore redraw D and S in panel (b) of Figure 24-8, exactly the same as in panel (a). *The monopolist's price and quantity*: - How does this monopolist decide how much to charge and how much to produce? If the monopolist is profit maximizing, it is going to look at the marginal revenue curve, MR, and produce at the output where marginal revenue equals marginal cost. - *What, though, is the marginal cost curve in panel (b) of Figure 24-8? It is merely S, because we said that S was equal to the horizontal summation of the portions of the individual marginal cost curves above each firm's respective minimum average variable cost*. The monopolist therefore produces quantity Qm, and sells it at price Pm.

price and output for the monopolistic competitor

Now that we are aware of the assumptions underlying the monopolistic competition model, we can analyze the price and output behavior of each firm in a monopolistically competitive industry. We assume in the analysis that follows that the desired product type and quality have been chosen. We further assume that the budget and the type of promotional activity have already been chosen and do not change.

the case in which price equals ATC

Panel (b) of Figure 25-5 illustrates how the *price of the online game is ultimately determined in a monopolistically competitive market* After all entry or exit from the market has occurred, the price of the game will equal the producer's average cost of production, including all implicit opportunity costs. - The price charged for the game generates total revenues sufficient to cover all explicit and implicit costs and therefore is consistent with earning a normal return on invested capital. Given the demand curve depicted in Figure 25-5, at a price of $27.50 per online game, consumers are willing to purchase 10,000 copies. The company's average total cost of offering 10,000 copies for sale is also equal to $27.50 per game. Consequently, the price of each copy equals the average total cost of producing the game. - At a price of $27.50 per game, the company's revenues from selling 10,000 copies equal $275,000 (TR = P x Q) = (27.50 x 10,000) = This amount of revenues is just sufficient to cover the company's total fixed cost (including the opportunity cost of capital) of $250,000 and the $25,000 total variable cost it incurs in producing 10,000 copies at an average variable cost of $2.50 per game (2.50 x 10,000). Thus, the company earns zero economic profits.

product differentiation

Perhaps the most important feature of the monopolistically competitive market (def.) the distinguishing of products by brand name, color, and other minor attributes. Product differentiation occurs in other than perfectly competitive markets in which products are, in theory, homogeneous, such as wheat or corn We can say that each individual manufacturer of a product has an absolute monopoly over its own product, which is slightly differentiated from other similar products. This means that the firm has some control over the price it charges. Unlike the perfectly competitive firm, *it faces a downward-sloping demand curve*

issues and applications

Professional service firms, which include personal financial-planning firms, commercial accounting firms, and commercial law firms, are in monopolistically competitive industries that in years past exhibited stable long-run equilibrium conditions. During recent years, in contrast, entry into these industries has become easier. As a consequence, professional service firms are struggling to engage in adjustments to new positions of long- run equilibrium.

advertising as signaling behavior

Recall from Chapter 23 that signals are compact gestures or actions that convey information. For example, high profits in an industry are signals that resources should flow to that industry. Individual companies can explicitly engage in signaling behavior. *A firm can do so by establishing brand names or trademarks and then promoting them heavily. Such activity is a signal to prospective consumers that this is a company that plans to stay in business* - Before the modern age of advertising, U.S. banks needed a way to signal their soundness. To do this, they constructed large, imposing bank buildings using marble and granite. Stone structures communicated permanence. The effect was to give bank customers confidence that they were not doing business with fly-by-night operations. When Apple advertises its brand name heavily, it incurs substantial costs. The only way it can recoup those costs is by selling many Apple products over a long period of time. - Heavy advertising in the company's brand name thereby signals to buyers of digital devices that Apple intends to stay in business a long time and wants to develop a loyal customer base—because *loyal customers are repeat customers*

concept application: Why a French Dealer of Illegal Drugs Provides Loyalty Discount Cards

Recently, a dealer of illicit drugs in the French city of Marseilles began providing customer loyalty cards to buyers of the dealer's illegal merchandise. Printed on the cards are the hours that prospective customers can find the dealer's retail sellers on the streets and a note stating, "We look forward to seeing you around the neighborhood; thanks for your loyalty." Also printed on the card are ten spaces for retail sellers to place the dealer's official proof-of-purchase stamps. After the tenth stamp, the holder of the card is entitled to a discount of about $12 on the next illegal drug purchase. Why would a dealer offer a lower price to a buyer of illegal drugs who demonstrates customer loyalty by displaying a card and having it stamped at the time of each transaction?

do business schools' uses of their rankings persuade or inform?

Schools of business compete in monopolistically competitive markets in which product differentiation is a very important characteristic. Media outlets such as Bloomberg Businessweek, the Economist, and the Financial Times publish rankings of business schools. These rankings can differentiate schools in the minds of consumers—that is, program applicants. Michael Luca of Harvard Business School and Jonathan Smith of the College Board recently sought to assess business schools' uses of rankings. They found that schools ranked highest are least likely to post rankings. Top-rated schools instead rely on informational advertising by providing data on faculty accomplishments, graduates' job placements, and so on. Luca and Smith argue that these schools thereby engage in "countersignaling," meaning that by not advertising their high rankings, they seek to reinforce applicants' perceptions of their high quality. In contrast, business schools ranked among the lowest overall engage in persuasive advertising by reporting only specific category rankings in which they received good ratings. Thus, top business programs are search goods marketed with informational advertising, whereas weaker programs are experience goods promoted via persuasive advertising.

cost curves for an information product

Suppose that a manufacturer decides to produce and sell an online game. *Creating the first copy of the game requires incurring a total fixed cost equal to $250,000* - The marginal cost that the company incurs to deliver a copy of the game online is a constant amount equal to $2.50 per game. Figure 25-4 displays the firm's cost curves for this information product. By definition, average fixed cost is total fixed cost divided by the quantity produced and sold. - Hence, the average fixed cost of the first copy of the online game is $250,000. If the company sells 5,000 copies, however, the average fixed cost drops to $50 per game. - If the total quantity sold is 50,000, average fixed cost declines to $5 per game (250,000/50,000) *The average fixed cost (AFC) curve slopes downward over the entire range of possible quantities of the online game delivered to consumers* Figure explanation: - The total fixed cost of producing an online game is $250,000. If the producer sells 5,000 copies, average fixed cost falls to $50 per copy. If quantity sold rises to 50,000, average fixed cost decreases to $5 per copy. Thus, the producer's average fixed cost (AFC) curve slopes downward. - If the per-unit cost of delivering each copy of the game online is $2.50, then both the marginal cost (MC) and average variable cost (AVC) curves are horizontal at $2.50 per copy. - Adding the AFC and AVC curves yields the ATC curve. Because the ATC curve slopes downward, the producer of this information product experiences short-run economies of operation. Average variable cost equals total variable cost divided by the number of units of a product that a firm sells. If this company sells only one copy, then the total variable cost it incurs is the per-unit cost of $2.50, and this is also the average variable cost of producing one unit. - Because the per-unit cost of producing the online game is a constant $2.50, producing two games entails a total variable cost of $5.00, and the average variable cost of producing two games is $5.00÷2=$2.50. - *Thus, as shown in Figure 25-4, the average variable cost of producing and selling this online game is always equal to the constant marginal cost of $2.50 per game that the company incurs* The average variable cost (AVC) curve is the same as the marginal cost (MC) curve, which for this company is the horizontal line depicted in Figure 25-4.

infeasibility of marginal cost pricing

The failure of marginal cost pricing to allow firms selling information products to cover the fixed costs of producing those products is intrinsic to the nature of such products. *In the presence of short-run economies of operation in producing information products, marginal cost pricing is simply not feasible in the marketplace* Recall that marginal cost pricing is associated with perfect competition. An important implication of this example is that markets for information products cannot function as perfectly competitive markets. *Imperfect competition is the rule, not the exception, in the market for information products*

informational versus persuasive advertising

The forms of advertising that firms use vary considerably depending on whether the item being marketed is a search good or an experience good *If the item is a search good, a firm is more likely to use informational advertising that emphasizes the features of its product* - A video trailer for the latest movie starring Emma Stone will include snippets of the film, which help potential buyers assess the quality of the movie. In contrast, if the product is an experience good, a firm is more likely to engage in persuasive advertising intended to induce a consumer to try the product and, as a consequence, discover a previously unknown taste for it. - For example, a soft-drink ad is likely to depict happy people drinking the clearly identified product during breaks from enjoyable outdoor activities on a hot day. *If a product is a credence good, producers commonly use a mix of informational and persuasive advertising* - For instance, an ad for a pharmaceutical product commonly provides both detailed information about the product's curative properties and side effects and suggestions to consumers to ask physicians for help in assessing the drug.

search, experience, and credence goods

The qualities and characteristics of a product determine how the firm should advertise that product. *Some types of products, known as search goods, possess qualities that are relatively easy for consumers to assess in advance of their purchase* - Clothing and music are common examples of items that have features a consumer may assess, or perhaps even sample, before purchasing. Other products, known as experience goods, are products that people must actually consume before they can determine their qualities. - Soft drinks, restaurant meals, and haircutting services are examples of experience goods. A third category of products, called credence goods, includes goods and services with qualities that might be difficult for consumers who lack specific expertise to evaluate without assistance. - Products such as pharmaceuticals and services such as health care and legal advice are examples of credence goods.

necessary conditions for price discrimination

Three conditions are necessary for price discrimination to exist: 1. The firm must face a downward-sloping demand curve. 2. The firm must be able to readily (and cheaply) identify buyers or groups of buyers with predictably different elasticities of demand. 3. The firm must be able to prevent resale of the product or service.

advertising

To help ensure that consumers differentiate their product brands from those of other firms, monopolistically competitive firms commonly engage in advertising. Advertising comes in various forms, and the nature of advertising can depend considerably on the types of products that firms wish to distinguish from competing brands.

costs of producing information products

To think about the cost conditions faced by the seller of an information product, consider the production and sale of an online game. The company that creates an online game must devote many hours of labor to developing and editing its content Each hour of labor and each unit of other resources devoted to performing this task entail an opportunity cost. - The sum of all these up-front costs constitutes a relatively sizable fixed cost that the company must incur to generate the first copy of the online game. *Once the company has developed the online game in a form that is readable by digital devices, the marginal cost of making and distributing additional copies is very low*. In the case of an online game, it is simply a matter of incurring a minuscule cost to place the required files on a data disk or on the company's Web site.

perfect vs monopolistic competition

We see the two situations in Figure 25-2. Both panels show average total costs just touching the respective demand curves at the particular price at which the firm is selling the product. -*Notice, however, that the perfect competitor's average total costs are at a minimum* (it is NOT for the mono. comp., look closely) fig. explanation: - In panel (a), the perfectly competitive firm has zero economic profits in the long run. The price is set equal to marginal cost, and the price is P 1. The firm's demand curve is just tangent to the minimum point on its average total cost curve. - With the monopolistically competitive firm in panel (b), there are also zero economic profits in the long run. *The price is greater than marginal cost, though*. The monopolistically competitive firm does not find itself at the minimum point on its average total cost curve. It is operating at a rate of output, q 2, to the left of the minimum point on the ATC curve. - Average total costs are not minimized for the monopolistic competitor. The equilibrium rate of output is to the left of the minimum point on the average total cost curve where price is greater than marginal cost. - The monopolistic competitor cannot expand output to the point of minimum costs without lowering price, and then marginal cost would exceed marginal revenue. *A monopolistic competitor at profit maximization charges a price that exceeds marginal cost. In this respect it is similar to the monopolist.*

long-run equilibrium for an information product industry

When competition drives the price of an information product to equality with average total cost, *sellers charge the minimum price required to cover their production costs, including the relatively high initial costs they must incur to develop their products in the first place* = Consumers thereby pay the lowest price necessary to induce sellers to provide the item. The situation illustrated in panel (b) of Figure 25-5 corresponds to a long-run equilibrium for this particular firm in a monopolistically competitive market for online games. If this and other companies face a situation such as the diagram depicts, *there is no incentive for additional companies to enter or leave the online game industry* - Consequently, the product price naturally tends to adjust to equality with average total cost as a monopolistically competitive industry composed of sellers of information products moves toward long-run equilibrium.

monopolistic competition (def.)

a market situation in which a large number of firms produce similar but not identical products. Entry into the industry is RELATIVELY EASY.

search goods

a product with characteristics that enable an individual to evaluate the product's quality in advance of a purchase

credence goods

a product with qualities that consumers lack the expertise to assess without assistance

mass marketing

advertising intended to reach as many consumers as possible, typically through television, newspaper, radio, or magazine ads

direct marketing

advertising targeted at specific consumers, typically in the form of postal mailings, telephone calls, or e-mail messages

informational advertising

advertising that emphasizes transmitting knowledge about the features of a product

persuasive advertising

advertising that is intended to induce a consumer to purchase a particular product and discover a previously unknown taste for the item

interactive marketing

advertising that permits a consumer to follow up directly by searching for more information and placing direct product orders

information product

an item that is produced using information-intensive inputs at a relatively high fixed cost but distributed for sale at a relatively low marginal cost

price differentiation

establishing different prices for similar products to reflect differences in marginal cost in providing those commodities to different groups of buyers

price discrimination

selling a given product at more than one price, with the price difference being unrelated to differences in marginal costs