Monopolistic Competition

1
Chapter 23

• Monopolistic Competition
• and Oligopoly

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Overview
In this chapter we will study the market
structure known as monopolistic competition and
the strategic nature of oligopoly industries. In
this section I will have notes on monopolistic
competition. As the name implies, this market
structure exhibits parts of competition and parts
of monopoly. Recall in competition that firms
are price takers and in the long run profit is
driven to zero (P AC) because other firms can
enter the industry to try to get some of that
profit. In monopoly the firm is a price maker
and while there is no guarantee of profit, profit
can exist in the long run because no one else
makes a close substitute.
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Monopolistic Competition
Monopolistic competition is a structure where 1)
there are many firms, like in competition, 2)
each sells a slightly differentiated product, so
this means the firm is like a monopoly, and
3)There is easy entry to and exit from the
industry because firms are somewhat small
relative to overall market. Examples of
industries of this type include retail bakeries,
jewelry stores and plastic bag makers. Since
each firm sells a differentiated product we have
some components of the monopoly structure to
think about and since there are many firms we
have the perfect competition component to think
about. I find it useful to think about the
monopoly feature in the short run and the
competitive feature in the long run.
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Monop. comp

MC
The differentiated nature of the product means
each firm is a monopoly as the seller of its own
product and thus the demand is downward sloping .
The firm will operate where MR MC and charge
the price on the demand curve at this output
level.
ATC
P
D
Q
MR
5
Long term

MC
In the long run it is thought that if monop.
comp. firms have profit other firms will enter
the industry in the hopes of also making profit.
This will likely take demand from existing firms
and drive profit to zero for firms. This firm
shown has zero
ATC
P
AVC
D
Q
MR
economic profit. Do you know why?
6
comments
Since each firm is a monopoly of its own
product the demand curve slopes downward.
Profits may be positive in the short run, but
this profit will attract other firms to enter the
market and profit will be driven to zero in the
long run. In competition in the long run AC is
at a minimum, while in monopolistic competition
AC is not at a minimum. Monopolistically
competitive industries have been criticized as
being wasteful because AC in not at a minimum.
This is a situation known as excess capacity.
Others say that is the price we pay for having
differentiated products.
7
Advertising
Another detail about monopolistic competition is
that there may be some non-price competition in
the form of advertising so that each firm can
gain consumers from the other firms. Recall in
competition that a firms demand curve was
horizontal what is called perfectly elastic
meaning the change in the quantity is huge
given even a small change in price. In a
monopoly the demand was downward sloping and
since there are no close substitutes for a
monopoly product, by definition, the demand is
considered somewhat steep (although production
occurs in the elastic range for a
monopoly). Effective advertising makes the
monopolistically competitive firms demand move
out and become steeper.
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Product Variety
A donut is a donut, right? No way! We have
variety. In monopolistic competition a firm will
think in the following way. If I can develop a
new variety of product maybe people will come to
me more and I will make more money. SO, this
development will cost money and if I think the
increased revenue will outweigh the cost, then I
will go for it!