Chapter 15

List the characteristics of monopolistic competition, and be able to compare it with a pure competitive market and a monopolist

A. Monopolistic competition refers to a market situation in which a relatively large number of sellers offer similar but not identical products. 1. Each firm has a small percentage of the total market. 2. Collusion is nearly impossible with so many firms. 3. Firms act independently; the actions of one firm are ignored by the other firms in the industry. B. Product differentiation and other types of nonprice competition give the individual firm some degree of monopoly power that the purely competitive firm does not possess. 1. Product differentiation may be physical (qualitative). 2. Services and conditions accompanying the sale of the product are important aspects of product differentiation. 3. Location is another type of differentiation. 4. Brand names and packaging lead to perceived differences. 5. Product differentiation allows producers to have some control over the prices of their products. C. Similar to pure competition, under monopolistic competition firms can enter and exit their industries relatively easily.

Identify the reasons for excess capacity in monopolistic competition

B. Excess capacity will tend to be a feature of monopolistically competitive firms 1. Price exceeds marginal cost in the long run, suggesting that society values additional units that are not being produced. 2. Firms do not produce the lowest average-total-cost level of output 3. Average costs may also be higher than under pure competition, due to advertising and other costs involved in differentiation.

Describe a monopolistically competitive market in the long run

C. In the long‑run situation, the firm will tend to earn a normal profit only, that is, it will break even 1. Firms can enter the industry easily and will if the existing firms are making an economic profit. As firms enter the industry, this decreases the demand curve facing an individual firm as buyers shift some demand to new firms; the demand curve will shift until the firm just breaks even. If the demand shifts below the break‑even point (including a normal profit), some firms will leave the industry in the long run. 2. If firms were making a loss in the short run, some firms will leave the industry. This will raise the demand curve facing each remaining firm as there are fewer substitutes for buyers. As this happens, each firm will see its losses disappear until it reaches the break‑even (normal profit) level of output and price. 3. Complicating factors are involved with this analysis. a. Some firms may achieve a measure of differentiation that is not easily duplicated by rivals (brand names, location, etc.) and can realize economic profits even in the long run. b. There is some restriction to entry, such as financial barriers that exist for new small businesses, so economic profits may persist for existing firms. c. Long‑run below‑normal profits may persist, because producers like to maintain their way of life as entrepreneurs despite the low economic returns.

Explain why a monopolistic competitor will realize only normal profit in the long run

Complicating factors are involved with this analysis. a. Some firms may achieve a measure of differentiation that is not easily duplicated by rivals (brand names, location, etc.) and can realize economic profits even in the long run. b. There is some restriction to entry, such as financial barriers that exist for new small businesses, so economic profits may persist for existing firms. c. Long‑run below‑normal profits may persist, because producers like to maintain their way of life as entrepreneurs despite the low economic returns.

Determine the profit-maximizing price and output level for a monopolistic competitor in the short run when given cost and demand data

In the short‑run situation, the firm will maximize profits or minimize losses by producing where marginal cost and marginal revenue are equal, as was true in pure competition and monopoly.

Analyze the welfare costs of monopolistic competition

Like any deviation from the equilibrium price and quantity that would prevail under perfect competition, monopolistic competition is inefficient. Because firms maximize profits at a price that is higher than marginal cost, some mutually beneficial trades never occur. This means that there is deadweight loss- the market does not maximize total surplus. However, regulating monopolistic competitive markets to increase efficiency is difficult, and usually comes at the expense of product variety

Explain how product differentiation occurs in similar products

Product differentiation and other types of nonprice competition give the individual firm some degree of monopoly power that the purely competitive firm does not possess. 1. Product differentiation may be physical (qualitative). 2. Services and conditions accompanying the sale of the product are important aspects of product differentiation. 3. Location is another type of differentiation. 4. Brand names and packaging lead to perceived differences. 5. Product differentiation allows producers to have some control over the prices of their products. C. Similar to pure competition, under monopolistic competition firms can enter and exit their industries relatively easily.