17 - Monopolistic Competition#
17.1 - Between Monopoly and Perfect Competition#
An oligopoly is a market structure in which only a few sellers offer similar or identical products.
The concentration ratio is the percentage of total output in the market supplied by the four largest firms.
Monopolistic competition is a market structure in which many firms sell products that are similar but not identical. Monopolistic competition describes a market with the following characteristics:
Many sellers
Product differentiation
Free entry and exit
17.2 - Competition with Differentiated Products#
The Monopolistically Competitive Firm in the Short Run#
In the short run, monopolistic competitors, like monopolists, maximize profit by producing at which marginal revenue equals marginal cost.
The Long-Run Equilibrium#
The following characteristics describe the long-run equilibrium in a monopolistically competitive market:
As in a monopoly market, price exceeds marginal cost (\(P > MC\)). This occurs because profit maximization requires marginal revenue to be equal to marginal cost (\(MR = MC\)) and because the downward-sloping demand curve makes marginal revenue less than the price (\(MR < P\)).
As in a perfectly competitive market, price equals average total cost (\(P = ATC\)). This arises because free entry and exit drive economic profit to zero in the long run.
Monopolistic vs. Perfect Competition#
The long-run equilibrium under monopolistic competition differs from that of perfect competition in two noteworthy ways:
Excess capacity: The process of entry and exit in a monopolistically market drive the demand and average-total-cost curves to a point of tangency.
The quantity that minimizes average total cost is called the efficient scale of the firm.
A monopolistically competitive firm could increase the quantity it produces and lower the average total cost of production.
Markup over marginal cost: For a monopolistically competitive firm, price exceeds marginal cost, because the firm always has some market power. Since this is the case, the firm is always excited to get another customer.
Monopolistic Competition and Welfare of Society#
One source of inefficiency in monopolistically competitive markets is the markup of price over marginal cost.
Another source of inefficiency is that the number of firms in the market may not be ideal. The entry of a new firm to the market has two effects that are external to the firm:
The product-variety externality: Because consumers benefit from the introduction of a new product, the entry of a new firm confers a positive externality on consumers.
The business-stealing externality: Because other firms lose customers and profits when faced with a new competitor, the entry of a new firm imposes a negative externality on existing firm.
17.3 - Advertising#
The Debate over Advertising#
Critiques of advertising:
Advertising manipulates people’s taste
Advertising impedes competition, since it tries to convince consumers that similar products are more different than they really are
Support for advertisement:
Advertising informs customers
Advertising fosters competition
In many markets, advertising fosters competition, leading to lower prices for consumers.
Advertising as a Signal of Quality#
In some cases, it is rational to think that a quality is higher quality because its company can afford to advertise for it.
Brand Names#
Critics of brand names argue that they provide customers with false information about the quality of the good.
Defenders of brand names argue that they provide customers with information about the product and producers with an incentive to create high quality products.