Ch 9

Monopolistic Competition

Features of Monopolistic Competition

Monopolistic Competition is the combination of Perfect Competition and Monopoly: Monopoly 1. Imperfect information 2. Differentiated Goods Perfect 3. Many sellers in the marketCompetition 4. Free Entry

Monopolistic Competition
Monopolistic Competition is the most common market structure in HK. Example:
Computer Shops in Boutiques in Hong Kong-Style Caf Mini-Bus (Red, non-franchised) Shops in a small-scale mall (Allied Plaza , Sincere Podium , Sino Centre )

Profit Maximization
The monopolistic competitive firm targets at maximizing its Economic Profit. To know how it meet this target, we need to know how
How much should it produce? What price should it set?

We need to look at the demand facing the firm and its costs.

Demand Facing a Mono. Comp. Firm

Although there are many firms in the market, each one is producing heterogeneous good.
the fish ball sold by different shops are different.

There is no Perfect Substitute to the firms product. The raise of price will not lead to a drop in Qd down to zero. The firms demand curve is DownwardSloping.

Demand Facing a Mono. Comp. Firm

Properties of a Monopolys demand curve: 1. Downward Sloping
A Monopolistic Competitive firm is also a Price Searcher.

2. The firm needs to lower the price in order to sell more. 3. Price = Average Revenue (AR) > Marginal Revenue (MR)
Similar to the Demand Curve of a Monopolist

Demand Facing a Mono. Comp. Firm

The demand curve of a monopolistic competitive firm
P

Firm

MR

Dfirm DMarket Q

How much should the firm facing demand D produce in the Short Run? Equilibrium condition: MR = MC P
SMC1 ATC1 AVC1

SR Profit Maximization

Pe

MR
Qe

Q In the short run, a monopolistic competitive firm behaves the same as a monopolist.

SR Profit Maximization
1. E. Profit > 0
The analysis TR > Explicit Costs +Implicit Costs of E. Profit is 2. Break-Even the same for all TR = Explicit Costs + Implicit Costs the market structure.

3. Loss but stay

TR < Explicit Costs + Implicit Costs, but TR > Explicit Costs

4. Shut down
TR < Explicit Costs + Implicit Costs, and TR < Explicit Costs

Supply Curve
Question: Will the MC curve of the firm be the supply curve? Not on So long as the demand SMC SMC curve is downward Pe sloping, the MC is not the Supply curve.
MR Qe D

LR Profit Maximization
If the firm makes E. Profit in the SR, what will it do in the LR? Expand increases capital investment
E. profit P1 E. profit P2 LMC SMC ATC LAC

MR Q1 Q2

LR Profit Maximization
Question Will the monopoly be able to keep this E. Profit in the LR? No! The market is Free Entry. As long as the existing firms are making E. Profit, the potential entrants will enter the market. Similar to perfect competition, no firm can earn positive E. profit in the LR.

LR Profit Maximization
New entrants lower the demand of the existing firms.
P Break-even
P1 ATC = P2 E. profit

LMC1 LAC1 MR1 MR2

Q2 Q1 D1 D2

Q In the long run, a monopolistic competitive firm behaves the same as a competitive firm.

Comparative Static
If there is an increase in market demand, how will the firm be affected? Market demand increases, Firms demand increases. In the LR, new entrants lower the demand of P firms.
P2 ATC P1 E. profit
LMC LAC D2 D1 D
3

Q1Q2

MR2 MR1 MR3

Market Efficiency
Economists generally agree that Monopolistic Competition is regarded as inefficient. The output level is determined by MR = MC, where D > MR. In the equilibrium, P > MC: Consumers willing to pay > cost of production of the firm. Underproduction DWL > 0

Market Efficiency
P Is this triangle representing the DWL? MC F E

PM

MR QM

D Q

No! This is the diagram of a firm only, but not a market.

Conclusion
As each firm is producing heterogeneous goods, the demand of a firm is downwardsloping. In the short run, a monopolistic competitive firm behaves like a monopoly. In the long run, as there is free entry, entry of new firms will render every firm makes zero E. Profit, like under the perfect competition. Monopolistic competition is the combination of Monopoly and Perfect

Concept Map
Competition Price Competition Market Economy How market work?
P P1 D S
e

Non-Price Competition
(Order)

Command Economy
SMC
1

P P

SMC
1

ATC1 P
e

ATC1 MR D Q

Q1

MR

D Q

Perfect competition

Qe

Qe

Monopoly

Monopolistic competition