Monopolistic Competition

1
Monopolistic Competition

• Price and Output Determination Product
  Differentiation

2
Assumptions

• Large number of buyers and sellers
• No barriers to entry
• Product differentiation
• Perfect Information/no uncertainty
• U-Shaped cost curves

3
Price and Output - Short Run

• Each firm is a price setter.
• Price and output chosen so as to maximize
  profits MRMC

4
Price and Output - Long Run

• Positive profits will attract entry by close
  substitutes
• As entry occurs, demand for brand x will decrease
  and become more elastic
• In long run equilibrium, zero economic profits

5
Economic Efficiency

• MBgtMC
• Firms do not operate at lowest point on ATC
• Excess capacity
• Trade-off between variety and efficiency

6
Product Variety Under Monopolistic Competition

• Hotellings Model of Ice Cream Vendors at the
  beach

7
Hotellings Model

• Sunbathers are distributed evenly along the beach
• Vendors arrive sequentially, but can move their
  carts
• Price is fixed
• Sunbathers buy from closest vendor

8
Equilibrium with Two Vendors
A
A
B
Firms will locate on either side of the midpoint.
9
Equilibrium with Three Vendors
A
C
B
Firm A has no market share so would try to
relocate to the other side of either C or B, but
then that vendor would want to move. No
equilibrium.
10
Equilibrium with Four Vendors
0.75
0.25
With four vendors, they group together at the 1/4
mile marker and the 3/4 mile marker.
11
Too Much Sameness?

• Hotelling argued that competition tends to
  produce too much sameness. Applications to
  sweetness of cider and positions of political
  parties
• With monopoly, there is a tendency to produce the
  least common denominator product.