AP Economics Chapter 16

irrationality of buying brand name

charge you more money when generic just as good of quality

not an oligopoly because

collusion is impossible due to: number of producers in industry no barriers to entry firms behave non-cooperatively

2 features of industries with differentiated products

competition among sellers for limited market (if another gas station opens up, both old and new will have less business) value in diversity (consumer happier with more choices because they can get exactly what they want) benefits to consumers

monopolistic competition combination of

features of monopoly and perfect competition monopoly: different product, market power, downward sloping demand curve perfect competition: competition (amount sold depends on prices/products of other firms)

excess capacity

firms in a monopolistically competitive industry have excess capacity: they produce less than the output at which average total cost is minimized

wasteful duplication

monopolistically competitive industries offer too many varieties fewer firms, lower ATC, lower prices higher price consumers pay is offset by value they receive from greater diversity

producers in monopolistic competition are

monopolists without monopoly profits set MR=MC to maximize profits but this is just enough to achieve zero economic profit

the trade offs

more producers: higher ATC and prices but greater product diversity fewer producers: lower ATC and prices but less product diversity

rationality of buying brand name

name conveys information traveler goes with brand name instead of independent firm that might be better, but might be worse have a reputation and provide consistent quality (assurance)

P=ATC in long run equilibrium

no profit

advertising

only worthwhile for firms with market share purpose: get people to buy more product at given price

differentiation by location

people may choose closest rather than cheapest gas stations for example

advertising especially works

when people don't know much about the product/service or don't use it often ex: moving company a big ad makes you think "this company is large and successful"

brand name

a name owned by a particular firm that distinguishes its products from those other firms

entry/exit of firms affect profits of existing firm

affects the demand curve of every existing producer addition of producers: leftward shift of demand and MR curve (firm receives lower price for each unit and lower profit) exit of firms: rightward shift of demand and MR curves (firm receives higher price for each unit and higher profit)

demand curve role in profits/loss

demand curve cross ATC curve: where D curve is above ATC curve is profitable (price/quantity combo where P>ATC) demand curve always below ATC curve: at all quantities of output P<ATC. Minimize loss by producing where MR=MC

equilibrium demand curve in long run

demand curve tangent to ATC curve where MR=MC

monopolistic competition in the short run

downward sloping demand curve (thus downward sloping MR curve) profit maximization MR=MC

zero profit equilibrium

each firm makes zero profit at its profit maximizing quantity entry/exit will occur until the firms in industry make zero profit

expensive advertisement

establishes a firms quality we think "they paid that money for the celebrity spokesperson, quality company"

reaching long run equilibrium

existing firms losing profits: firms will exit market existing firms making profits: firms enter market

firms in monopolistic competition are not willing to cut prices to gain more customers

if firm gets more customers than expected at the posted price it increases its revenue more than its costs because the posted price exceeds marginal cost (unlike perfect competition where MC=MR=D=P=ATC) see graphs on page 399

differentiation by style or type

imperfect substitutes (fast food - Chinese vs Italian) people have different tastes

conditions for monopolistic competition

large numbers differentiated products (somewhat different, still considered close substitutes) free entry/exit in long run (eliminates possibility to collude outruling oligopoly)

P<ATC

loss

differentiation by quality

low quality, low money high quality, high money

monopolistic competition

market structure in which there are many competing producers in an industry, each producer sells a differentiated product, has some market power (ability to set their own price depends on prices of competition) and there is free entry/exit in the long run too many firms to make tacit collusion feasible hotels, gas stations, fast food

P>ATC

profitable

product differentiation

reduces intensity of competition between firms when tacit collusion cannot be achieved too many firms for collusion this is the only way for firms to gain market power

monopolistic competition in the short run vs long run

short run equilibrium takes number of firms as a given long run equilibrium is reached after enough time has lapsed for firms to enter/exit industry for monopolistic competition we will focus on the short run and how an industry moves form the short run to the long run