Micro l16 Monopolistic Competition

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Monopolistic Competition

Chapter 11

Definitions and Descriptions of MonopolisticCompetition

Product Differentiation Identifying the Monopolistic Competitor

Profit Maximization in Short-Run and Long-Run

Price Discrimination

Efficiency or Inefficiency Closing Thoughts


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On one extreme is the Perfect Competition model

On the other extreme is the Monopoly Model

Monopolistic Competition & Oligopoly are competitive scenariosthat lie between these two extremes

Therefore, competitive features of Monopolistic Competition andOligopoly will emulate either Perfect Competition or Monopoly

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Characteristics of Monopolistic

Competition

Power to set prices somewhat like a monopoly

Face competition like perfect competition

********************************************* Large number of firms

-- Each firm has relatively small market share

-- Each firm must be sensitive to average market price of itsproduct

-- Collusion is not possible due to the number of firms No barriers to entry or exit

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Characteristics of Monopolistic

Competition

Product Differentiation Each firm makes a product that isslightly different from the products of competing firms.

-- Close substitutes but no perfect substitutes

-- An attempt to increase price will normally results in a lowervolume sold

Competition on Quality, Price, Marketing

-- Quality is design, reliability, service provided to buyer andease of access to product

-- Price downward sloping demand curve

-- Marketing firm must market = promotion, distribution,packaging 3


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Product Differentiation

Product differentiation is crucial to monopolistic

competition People value variety, even if it is not material (real)

Product differentiation takes place in buyers mind

Americans are provided with a wide variety of

products and services Variety is valued but costly we pay for it


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The Typical Monopolistic Competitor

The monopolistic competitor tries to set his orher product apart from the competition

The main way of doing this is throughadvertising

When this is done successfully, the demand curvebecomes more vertical or inelastic

Buyers are willing to pay more for a product orservice because they believe it is much betterthan their other choices

24-14Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.


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Basis for Product Differentiation

Physical differences

Convenience

Ambience Reputations

Appeals to vanity

Unconscious fears and desires

Snob appeal

Customized products


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Product Differences

Product differentiation does not necessarily

mean there are any physical differencesamong products

They might all be the same, but how they are soldmay make all the difference

There are, of course, some very real physicalproduct differences.

Buyers often differentiate based on real physicaldifferences, but differentiation is still taking place inthe buyers mind, and it may or may not be based onreal physical differences



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Advertising and Branding

Whats to be gained by pouring money intoadvertising? It works!

-- Continuous signals regarding productdifferentiation

-- coca-cola vs pepsi

Brand has tremendous value

-- e.g. Budweiser-- Brands tend to capture in a single name all the

values a firm wants to impress upon the buyer


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The Typical Monopolistic Competitor

Tries to set his firm apart from his competition

-- New Product Development and Innovation

1. Striving to maintain an economic profit-- Advertising

1. Create consumer perception of productdifferentiation real or imagined

2. Attempting to keep demand as inelastic aspossible

Selling costs can be extremely high


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Identifying Monopolistic Competition

How much is the industry dominated or not dominated by fewsuppliers

-- geographical scope national, regional, global

An industry can be almost perfectly competitive on anational scope, but almost a monopoly locally e.g.Concrete Mixing

-- Barriers to entry and exit industries may appearconcentrated but few barriers exist to prevent entry: e.g

a community with only one restaurant-

there is no barrier to other restaurants coming in4


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The four-firm concentration ratio The percentage ofthe value of total market revenue accounted for bythe four largest firms in the industry

-- A low concentration ratio indicates a high degreeof competition

-- A high concentration ratio indicates an absence of

competition

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The Herfindahl-Hirschman Index the square of the percentagemarket share of each firm summed over the largest 50 firms inthe industry (or all of the firms if there is less than 50)

-- In perfect competition, the HHI is small

-- In monopoly, the HHI is 10,000 (100 squared)

-- A popular measure with the Justice Dept in the 1980s

HHI < 1000 characterized competitive markets

HHI > 1800 would bring Justice Dept challengeto proposed mergers

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Examples of Monopolistic Competition

Banks Sporting Goods

Radio Stations Fish and Seafood

Clothing JewelryComputers Health Spas

Frozen Foods Apparel Stores

Canned Goods Convenience Stores

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Since the Monopolistic Competitor prices at demand

where MR=MC, the firm may have1. excess production capacity, and is

2. operating below its efficient scale where ATC is

minimum

Markup The amount by which price exceeds MC


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The Monopolistic Competitor in the ShortRun

The monopolistic competitor can make a profit

or take a loss

As only one firm in a crowded industry it has avery elastic demand curve

No one firm can get too far out of line on pricebecause buyers can always purchase asubstitute from some one else

D

MR

Monopolistic competitor

DMR

Monopoly


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Monopolistic Competitor Making a Profit in the

Short Run

Output

24

22

20

18

16

14

12

10

8

6

4

2

0

MC

ATC

D

MR

0 10 20 30 40 50 60 70 80 90 100 120 140 160

O

utput is 60

Price is $15

ATC is $12.10

Total Profit=(Price-ATC) X Output

=($15-$12.10) X 60

=($2.90) X 60= $174


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Monopolistic Competitor Taking a Loss in the

Short Run

Out

ut

T

O

utput is 42

Price is $11ATC is $12.80

Total Profit=(Price-ATC) X Output

=($11-$12.80) X 42

=(-$1.80) X 42= -$75.60


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Monopolistic Competitor Breaking Even in the

Long Run

Output

24

22

20

18

16

14

12

10

8

6

4

2

0

MC

ATC

D

MR

0 10 20 30 40 50 60 70 80 90 100 120 140 160

O

utput is 40

At the output level

associated with MC=MR,

the ATC curve is tangentto the demand curve


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Question Does price discrimination raise or lowerprofit?

Price discrimination selling the same good orservice at a number of different prices.

Basically an illegal activity under the Clayton Act

unless there is a cost justification for the price

discrimination Answer Price discrimination is a marketing means

to increase economic profit


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Methods of price discrimination

-- Discriminate among groups of buyers

works when different buying groups are willingto pay different prices (on the average) for thesame good or service

Example: Airline travel prices target business

travelers vs leisure time travelers-- discriminator is advance notice, shorter the

notice, the higher the price


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Some Examples of PriceDiscrimination

Doctors often charge rich patients morethan poor patients

They may have one price for those with insuranceand another price for those without insurance

Movies in the evening cost more than thosein the early afternoon

Senior citizen, youth, and student discounts

New and used cars

Youth fairs on airlines Evening meals in restaurants often cost

more than the same meal at lunch



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Practicing Price Discrimination

The firm that practices price discriminationmust be able to distinguish between two ormore separate groups of buyers

Price discriminators must also be able toprevent buyers from reselling the product orservice

For example, if a fifteen-year-old could resell hisyouth fare seat to an adult who could then use it, theprice discrimination effort would fail



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Motives for Price Discrimination

In most cases, price discrimination is basicallya mechanism for rationing goods and services

The main motivation for price discrimination is

to raise profits The greater the price discrimination, the greater the

profits because buyers lose some of their consumersurplus

If price discrimination were carried to its logical

conclusion, we would have perfect pricediscrimination

The buyers would lose all of their consumer surplus



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Methods of discrimination

-- Discriminate among units firm charges the same

price to all customers but there are volume discounts

The key idea is to figure a way to charge thoseincremental buyers who are willing to pay more a

higher price

Result Consumer Surplus is converted to ProducerSurplus


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Perfect Price discrimination occurs when a firmfigures out how to extract the entire consumer

surplus (page 357)

Once the firm has the entire consumer surplus, theMR curve becomes the Demand Curve

At that point, the firm extracts even more economicprofit by increasing production to the point where

MR(D) = MC (page 357)


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Efficiency When the firm increases output to thepoint where MC = D, the efficient quantity is

produced, but The producer has taken all the consumer surplus,

and

Since there is ample economic profit, the firm may beinduced to spend money (increase costs) to protectits economic profit (rent seeking and is usuallypolitical in nature)


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Is the Monopolistic CompetitorInefficient?

From a purely economic standpoint . . .Yes! The firms do not produce at the minimum point on the

ATC

There may be too many firms in most industries Are there too many beauty parlors? Not if you want to

get your hair done on Friday afternoon or Saturdaymorning

Are there too many restaurants? Not on Sunday

There may be overdifferentiation

Would Americans want the drab businesses thatcharacterize eastern Europe and the old soviet union?

Would Americans want only one brand of toothpaste orone brand and model of a car?

In America, it would be hard to imagine a no-frillsworld


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Closing Thoughts

More than 99% of the over 23 million business firms

in the United States are monopolistic competitors

While price competition exists, they compete morevigorously over differentiation characteristics such as

ambience, service, convenience, quality, brandawareness, etc.

Micro l16 Monopolistic Competition

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