The Chamberlin Model of Monopolistic Competition

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The Chamberlin Model of Monopolistic Competition

• Monopolistic competition occurs if many firms
  serve a market with free entry and exit, but in
  which one firms products are not perfect
  substitutes for the products of other firms.

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The Chamberlin Model of Monopolistic Competition

• Two important implications
• Each firms is confronted by a downward sloping
  demand curve.
• Price and quantity decisions have no effect on
  the behaviour of other firms in the industry.
• A fundamental feature of the Chamberlin model is
  the perfect symmetry of the position of all firms
  in the industry.

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The Chamberlin Model of Monopolistic Competition

• This results in the firm facing 2 different
  demand curves
• One describing what happens when the firm alone
  changes its price (dd).
• One describing what happens when all prices
  change in unison (DD).

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The Chamberlin Model of Monopolistic Competition

• Although firms realise that the prices of
  similarly situated firms tend to move together,
  they also realise that its own price movements is
  not what causes other firms to change their
  behaviour.
• Thus firms are forced to think in terms of
  movements along dd, in Fig 13.11, about the
  consequences of a price move.

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Figure 13-11 The Monopolistic Competitors Two
Demand Curves
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Chamberlinian Equilibrium in the Short Run

• Note that at the profit-maximising price, P, the
  demand curve DD intersects the demand curve dd.
• This is as a result of the fundamental symmetry
  that exists within the Chamberlinian firms.
• In the short run there are economic profits.

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Figure 13-12 Short-Run Equilibrium for the
Chamberlinian Firm
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Chamberlinian Equilibrium in the Long Run

• Because of economic profits in the short run,
  additional firms are lured into the
  monopolistically competitive industry.
• Assuming each firm competes on an equal footing,
  the effect of entry is to cause an equal
  proportional reduction in the quantity that each
  firm can sell at any given price.
• ? causing a leftward shift in demand curve dd.

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Chamberlinian Equilibrium in the Long Run

• As long as economic profits exist, entry will
  continue.
• The demand curve, dd, shifts leftward to the
  point where it is tangent to the LAC curve.

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Figure 13-13 Long-Run Equilibriumin the
Chamberlin Model
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Chamberlinian Equilibrium in the Long Run

• The profit-maximising level of output, where MR
  MC, is exactly the same as the output level for
  which the dd curve is tangent to the LAC curve.
• It would not be in the interest of any firm to
  maintain its price above P, profit-maximising
  price level.

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Perfect Competition VS Chamberlinian Monpolistic
Competition

• Several points of comparison
• Perfect competition satisfies allocative
  efficiency, whilst monopolistic competition does
  not.
• Its is argued that monopolistic competition is
  less efficient than perfect competition.
• Monopolistic competition is more realsitic.
• Long run economic profits is zero in both.

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Criticisms of the Chamberlin Model

• Chamberlins theory significantly complicates the
  theory of perfect competition, without altering
  its most important predictions.
• The Chamberlin model assumes that each firm has
  an equal chance to attract any of the buyers in
  an industry. This may or may not be true!

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Criticisms of the Chamberlin Model

• Models have been developed that incorporate the
  specific features of a product that make buyers
  choose it over all others.
• We discuss one such model next.

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A Spatial Interpretation of Monopolistic
Competition

• The degree of substitutability between
  monopolistically competitive firms products
  indicates how closely their industry resembles
  perfect competition.
• Products may differentiate along more than one
  dimension location, size, quality, etc. And all
  of these need to be taken into consideration.

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A Spatial Interpretation of Monopolistic
Competition

• For example (taking distance into account)
• Suppose you live on a doughnut shape island that
  has a circumference of 1 mile.
• People are uniformly scattered around the island.
• There are 4 restaurants on the island that serve
  a standardised meal.
• Everyone one the island eats one meal at a
  restaurant a day.

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A Spatial Interpretation of Monopolistic
Competition

• How should these restaurants be spread out in
  order to minimise the cost of eating out?
• Costs
• Cost of travel t dollars/mile
• Restaurant costs TC F M.Q
• ATC F/Q M

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Figure 13-14 An Industry in Which Location is
the Important Differentiating Feature
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A Spatial Interpretation of Monopolistic
Competition

• If TC 50 5Q
• L (population) 100
• t 20/mile
• What will be the ATC of a meal served by a
  restaurant?
• What will be the overall ATC of a meal for person
  living on the island?

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The Optimal Number of Locations

• The optimal number of locations is the result of
  a trade-off between the start-up and fixed costs
  of opening new locations, and the savings from
  lower transportation costs.
• We need to calculate whether opening an
  additional restaurant would result in the overall
  average costs per meal to decline. If so then it
  is feasible to open another restaurant.

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The Optimal Number of Locations

• What is the overall average cost of a meal if 5
  restaurants are opened?
• More specifically, if there are N restaurants
• Average round-trip distance 1/2N
• Total transportation costs, Ctrans t.L/2N
• Total cost of meals served,
• Cmeals L.M N.F

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Figure 13-15 Distances with N Outlets
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Figure 13-16 The Optimal Numberof Outlets
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The Optimal Number of Locations

• Our objective is to choose N so as to minimise
  the sum of the 2 types of costs
• Ctrans Cmeals.
• The slope of the Cmeals curve is equal to F.
  Representing the cost of an additional outlet.

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The Optimal Number of Locations

• The slope of the Ctrans curve is t.L/N2.
  Representing the savings in transportation costs
  from adding an additional outlet.
• If F lt -t.L/N2, ten build an additional
  restaurant, since the savings in transportation
  costs more than compensates for the costs of an
  additional restaurant.

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The Optimal Number of Locations

• Optimal number of restaurants, N, is one for
  which F t.L/N2
• ? N
• What is the economic interpretation of this
  expression?

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The Analogy to Product Characteristics

• The Spatial interpretation of monopolistic
  competition can be applied not only to geographic
  location but also to a variety of other product
  characteristics.
• For example the air-travel market
• grocery stores
• motor vehicles

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Figure 13-17 A Spatial Interpretationof Airline
Scheduling
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The Analogy to Product Characteristics

• The Spatial model is primarily concerned with the
  trade-off between cost and convenience.

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Paying for Variety

• Variety is costly.
• People who care a lot about special product
  features are willing to pay more than others for
  a product whose special features suit their
  particular tastes.
• Demand for variety increases with income
• ? luxury good

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Figure 13-18 Distributing the Costof Variety
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Paying for Variety

• The cost of variety is not distributed evenly
  among all buyers.
• People who do not place a high value on variety
  get to enjoy it at the expense of those who care
  most about it.

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Figure 13-19 The Hot Dog Vendor Location Problem
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Consumer Preferences and Advertising

• In monopolistically competitive and oligopolistic
  markets products are differentiated, allowing
  producers to shift their demand curves outwards
  through advertising.
• Traditional sequence Producers are agents of
  consumers.

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Consumer Preferences and Advertising

• Revised sequence Corporations decide what
  products are cheapest and most convenient to
  produce, and through advertising demand is
  created.
• Where products are slightly differentiated,
  advertising may have a significant influence on
  which product a consumer chooses.
• ? traditional sequence.