CHAPTER 4CHAPTER 4MONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITION

CHARACTERISTICSCHARACTERISTICS

1)1) Many small sellersMany small sellers2)2) Differentiated productDifferentiated product3)3) Easy entry and exitEasy entry and exit4)4) Practice non-price competitionPractice non-price competition5)5) Limited control over its priceLimited control over its price

DEMAND & REVENUEDEMAND & REVENUE

Good slightly differentiated Good slightly differentiated →→ firm has some influence/control firm has some influence/control over P over P →→ downward sloping dd downward sloping dd curve & very elastic curve & very elastic →→ bec the bec the large number of firms and large number of firms and closeness of substitutes.closeness of substitutes.

Bec P is not constant Bec P is not constant →→ D=P=AR D=P=AR but AR but AR ≠≠ MR MR

Demand & MR CurveDemand & MR Curve

SHORT-RUN EQUILIBRIUMSHORT-RUN EQUILIBRIUM

Equil (max profit): MC = MREquil (max profit): MC = MR In SR, firms can earn 3 types of In SR, firms can earn 3 types of

profits.profits. Diagrams are the same as in Diagrams are the same as in

monopolymonopoly

a)a)Supernormal ProfitSupernormal Profit TR > TCTR > TC AR > ACAR > AC

b)b) Normal ProfitNormal Profit TR = TCTR = TC AR = ACAR = AC

b)b) Subnormal ProfitSubnormal Profit TR < TCTR < TC AR < ACAR < AC

LR EQUILIBRIUMLR EQUILIBRIUM

Firms get only normal profit bec no Firms get only normal profit bec no barrier to entry.barrier to entry.

Stage I – gets supernormal profit in Stage I – gets supernormal profit in SR SR →→ attract new firms to enter attract new firms to enter →→ firms firms ↑↑ non-P competition & prodn non-P competition & prodn →→ S S ↑↑, cost , cost ↑↑ & D/P & D/P ↓↓ →→ revenue revenue ↓↓

Stage II – gets normal profit only Stage II – gets normal profit only →→ no new firms attracted to enterno new firms attracted to enter

LR equil: MR = SMC = LMCLR equil: MR = SMC = LMC

LR EquilibriumLR Equilibrium

Revenue,Cost (RM)

Quantity0 Q1 Q2

LAC

D1=P1

D2=P2MR1MR2

SMC1

SMC2

SAC1

SAC2

LMCP1

C1

C2=P2

E2

COMPARISON WITH PERFECT COMPARISON WITH PERFECT COMP.COMP.

Price Price →→ P PMCMC > P > PPCPC

Q Q →→ Q QMCMC < Q < QPCPC

AC AC →→ AC ACMCMC > AC > ACPCPC →→ allocation of allocation of resources is less efficient in MCresources is less efficient in MC

PRODUCT VARIATION & PRODUCT VARIATION & SELLING EXPENSESSELLING EXPENSES

Firms slightly change characteristics of Firms slightly change characteristics of the product to attract buyers.the product to attract buyers.

Advertisement is used Advertisement is used →→ selling selling expenses expenses ↑↑..

Product variation & selling exp can Product variation & selling exp can ↑↑ sales and profits but cost also sales and profits but cost also ↑↑..

If MR > MC, firms can If MR > MC, firms can ↑↑ exp on exp on product variation until MC = MR.product variation until MC = MR.

EFFECTS OF ADVERTISING IN EFFECTS OF ADVERTISING IN MONO. COMP.MONO. COMP.

Revenue,Cost (RM)

Quantity0 Q1 Q2

D2=P2

D1=P1MR2MR1

MC

P2

P1

C2

C1

E2

E1

AC2

AC1

ECONOMIC INEFFICIENCYECONOMIC INEFFICIENCY

Firms produce at o/p level where P Firms produce at o/p level where P > MC. > MC.

However, deadweight loss in MC is However, deadweight loss in MC is not as large as in monopoly bec D not as large as in monopoly bec D curve is more elastic.curve is more elastic.

In LR, firm does not produce o/p at In LR, firm does not produce o/p at min AC.min AC.

However, consumers gain from However, consumers gain from product differentiation (wide variety product differentiation (wide variety of products)of products)