17Monopolistic Competition.docx
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17Monopolistic Competition.docx
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17MonopolisticCompetition
MONOPOLISTICCOMPETITION
INTHISCHAPTERYOUWILL...
Analyzecompetitionamongfirmsthat
selldifferentiatedproducts
Comparethe
outcomeundermonopolistic
competitionandunderperfect
competition
Considerthedesirabilityofoutcomesin
monopolisticallycompetitive
markets
Youwalkintoabookstoretobuyabooktoreadduringyournextvacation.Onthestore’sshelvesyoufindaJohnGrishammystery,aStephenKingthriller,aDanielleSteelromance,aFrankMcCourtmemoir,andmanyotherchoices.Whenyoupickoutabookandbuyit,whatkindofmarketareyouparticipatingin?
Ontheonehand,themarketforbooksseemscompetitive.Asyoulookovertheshelvesatyourbookstore,youfindmanyauthorsandmanypublishersvyingforyourattention.Abuyerinthismarkethasthousandsofcompetingproductsfromwhichtochoose.Andbecauseanyonecanentertheindustrybywritingandpublishingabook,thebookbusinessisnotveryprofitable.Foreveryhighlypaidnovelist,therearehundredsofstrugglingones.
Ontheotherhand,themarketforbooksseemsmonopolistic.Becauseeachbookisunique,publishershavesomelatitudeinchoosingwhatpricetocharge.Thesellersinthismarketarepricemakersratherthanpricetakers.And,indeed,thepriceofbooksgreatlyexceedsmarginalcost.Thepriceofatypicalhardcover
Examinethedebateovertheeffectsofadvertising
Examinethedebateovertheroleof
brandnames
377
monopolisticcompetitionamarketstructureinwhichmanyfirmssellproductsthataresimilarbutnotidentical
novel,forinstance,isabout$25,whereasthecostofprintingoneadditionalcopyofthenovelislessthan$5.
Inthischapterweexaminemarketsthathavesomefeaturesofcompeti-tionandsomefeaturesofmonopoly.Thismarketstructureiscalledmonopolisticcompetition.Monopolisticcompetitiondescribesamarketwiththefollowingattributes:
◆Manysellers:
Therearemanyfirmscompetingforthesamegroupofcustomers.
◆Productdifferentiation:
Eachfirmproducesaproductthatisatleastslightlydifferentfromthoseofotherfirms.Thus,ratherthanbeingapricetaker,eachfirmfacesadownward-slopingdemandcurve.
◆Freeentry:
Firmscanenter(orexit)themarketwithoutrestriction.Thus,
thenumberoffirmsinthemarketadjustsuntileconomicprofitsaredriven
tozero.
Amoment’sthoughtrevealsalonglistofmarketswiththeseattributes:
books,CDs,movies,computergames,restaurants,pianolessons,cookies,furniture,andsoon.
Monopolisticcompetition,likeoligopoly,isamarketstructurethatliesbe-tweentheextremecasesofcompetitionandmonopoly.Butoligopolyandmonop-olisticcompetitionarequitedifferent.OligopolydepartsfromtheperfectlycompetitiveidealofChapter14becausethereareonlyafewsellersinthemarket.Thesmallnumberofsellersmakesrigorouscompetitionlesslikely,anditmakesstrategicinteractionsamongthemvitallyimportant.Bycontrast,undermonopo-listiccompetition,therearemanysellers,eachofwhichissmallcomparedtothemarket.Amonopolisticallycompetitivemarketdepartsfromtheperfectlycom-petitiveidealbecauseeachofthesellersoffersasomewhatdifferentproduct.
COMPETITIONWITHDIFFERENTIATEDPRODUCTS
Tounderstandmonopolisticallycompetitivemarkets,wefirstconsiderthede-cisionsfacinganindividualfirm.Wethenexaminewhathappensinthelongrunasfirmsenterandexittheindustry.Next,wecomparetheequilibriumun-dermonopolisticcompetitiontotheequilibriumunderperfectcompetitionthatweexaminedinChapter14.Finally,weconsiderwhethertheoutcomeinamo-nopolisticallycompetitivemarketisdesirablefromthestandpointofsocietyasawhole.
THEMONOPOLISTICALLYCOMPETITIVEFIRMINTHESHORTRUN
Eachfirminamonopolisticallycompetitivemarketis,inmanyways,likeamo-nopoly.Becauseitsproductisdifferentfromthoseofferedbyotherfirms,itfacesa
(a)FirmMakesProfit
(b)FirmMakesLosses
Price
Price
Averagetotalcost
MC
ATC
ProfitDemand
Price
Averagetotalcost
Price
MC
Losses
MRDemand
0Profit-maximizing
quantity
Quantity
0Loss-minimizing
quantity
Quantity
MONOPOLISTICCOMPETITORSINTHESHORTRUN.Monopolisticcompetitors,likemonopolists,maximizeprofitbyproducingthequantityatwhichmarginalrevenue
equalsmarginalcost.Thefirminpanel(a)makesaprofitbecause,atthisquantity,priceisaboveaveragetotalcost.Thefirminpanel(b)makeslossesbecause,atthisquantity,priceislessthanaveragetotalcost.
Figure17-1
downward-slopingdemandcurve.(Bycontrast,aperfectlycompetitivefirmfacesahorizontaldemandcurveatthemarketprice.)Thus,themonopolisticallycom-petitivefirmfollowsamonopolist’sruleforprofitmaximization:
Itchoosesthequantityatwhichmarginalrevenueequalsmarginalcostandthenusesitsde-mandcurvetofindthepriceconsistentwiththatquantity.
Figure17-1showsthecost,demand,andmarginal-revenuecurvesfortwotypicalfirms,eachinadifferentmonopolisticallycompetitiveindustry.Inbothpanelsofthisfigure,theprofit-maximizingquantityisfoundattheintersectionofthemarginal-revenueandmarginal-costcurves.Thetwopanelsinthisfigureshowdifferentoutcomesforthefirm’sprofit.Inpanel(a),priceexceedsaveragetotalcost,sothefirmmakesaprofit.Inpanel(b),priceisbelowaveragetotalcost.Inthiscase,thefirmisunabletomakeapositiveprofit,sothebestthefirmcandoistominimizeitslosses.
Allthisshouldseemfamiliar.Amonopolisticallycompetitivefirmchoosesitsquantityandpricejustasamonopolydoes.Intheshortrun,thesetwotypesofmarketstructurearesimilar.
THELONG-RUNEQUILIBRIUM
ThesituationsdepictedinFigure17-1donotlastlong.Whenfirmsaremak-ingprofits,asinpanel(a),newfirmshaveanincentivetoenterthemarket.This
entryincreasesthenumberofproductsfromwhichcustomerscanchooseand,therefore,reducesthedemandfacedbyeachfirmalreadyinthemarket.Inotherwords,profitencouragesentry,andentryshiftsthedemandcurvesfacedbytheincumbentfirmstotheleft.Asthedemandforincumbentfirms’productsfalls,thesefirmsexperiencedecliningprofit.
Conversely,whenfirmsaremakinglosses,asinpanel(b),firmsinthemarkethaveanincentivetoexit.Asfirmsexit,customershavefewerproductsfromwhichtochoose.Thisdecreaseinthenumberoffirmsexpandsthedemandfacedbythosefirmsthatstayinthemarket.Inotherwords,lossesencourageexit,andexitshiftsthedemandcurvesoftheremainingfirmstotheright.Asthedemandfortheremainingfirms’productsrises,thesefirmsexperiencerisingprofit(thatis,de-clininglosses).
Thisprocessofentryandexitcontinuesuntilthefirmsinthemarketaremak-ingexactlyzeroeconomicprofit.Figure17-2depictsthelong-runequilibrium.Oncethemarketreachesthisequilibrium,newfirmshavenoincentivetoenter,andexistingfirmshavenoincentivetoexit.
Noticethatthedemandcurveinthisfigurejustbarelytouchestheaverage-total-costcurve.Mathematically,wesaythetwocurvesaretangenttoeachother.Thesetwocurvesmustbetangentonceentryandexithavedrivenprofittozero.Becauseprofitperunitsoldisthedifferencebetweenprice(foundonthedemandcurve)andaveragetotalcost,themaximumprofitiszeroonlyifthesetwocurvestoucheachotherwithoutcrossing.
Figure17-2
Price
P=ATC
0
MR
Profit-maximizingquantity
MC
Demand
ATC
Quantity
AMONOPOLISTICCOMPETITORINTHELONGRUN.Inamonopolisticallycompetitivemarket,iffirmsaremakingprofit,newfirmsenter,andthe
demandcurvesfortheincumbentfirmsshifttotheleft.Similarly,iffirmsaremakinglosses,oldfirmsexit,andthedemandcurvesof
theremainingfirmsshifttotheright.Becauseoftheseshiftsindemand,amonopolisticallycompetitivefirmeventuallyfindsitselfinthelong-runequilibriumshownhere.Inthislong-runequilibrium,priceequalsaveragetotalcost,andthefirmearnszeroprofit.
Tosumup,twocharacteristicsdescribethelong-runequilibriuminamonop-olisticallycompetitivemarket:
◆Asinamonopolymarket,priceexceedsmarginalcost.Thisconclusionarisesbecauseprofitmaximizationrequiresmarginalrevenuetoequalmarginal
costandbecausethedownwardslopingdemandcurvemakesmarginalrevenuelessthantheprice.
◆Asinacompetitivemarket,priceequalsaveragetotalcost.Thisconclusionarisesbecausefreeentryandexitdriveeconomicprofittozero.
Thesecondcharacteristicshowshowmonopolisticcompetitiondiffersfrommo-nopoly.Becauseamonopolyisthesolesellerofaproductwithoutclosesubsti-tutes,itcanearnpositiveeconomicprofit,eveninthelongrun.Bycontrast,becausethereisfreeentryintoamonopolisticallycompetitivemarket,theeco-nomicprofitofafirminthistypeofmarketisdriventozero.
MONOPOLISTICVERSUSPERFECTCOMPETITION
Figure17-3comparesthelong-runequilibriumundermonopolisticcompetitiontothelong-runequilibriumunderperfectcompetition.(Chapter14discussedtheequilibriumwithperfectcompetition.)Therearetwonoteworthydifferencesbe-tweenmonopolisticandperfectcompetition:
excesscapacityandthemarkup.
ExcessCapacityAswehavejustseen,entryandexitdriveeachfirminamonopolisticallycompetitivemarkettoapointoftangencybetweenitsdemand
(a)
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