Topic 9: Monopolistic Competition Flashcards
<p>What are the characteristics of monopolisitic competitions</p>
<ol> <li>Many sellers and buyers</li> <li>Products are differentiated (but close substitutes)</li> <li>Relatively free entry and exit</li> <li>Information is imperfect (advertising).</li></ol>
<p>- monopolistically competitive industries are extremely common, examples: personal computers; televisions; most other consumer electronics; restaurants; running shoes; etc.</p>
<p>Descrbie monopolistic competition profit maximisation in the short run</p>
<ul> <li>because products are differentiated, firms face a downward-sloping demand curve (hence MR below D)</li> <li>however, it is usually quite elastic, and this elasticity depends on the number of close substitutes and how differentiated their product is</li> <li>firms still aim to maximise profit, and so will still operate where MR = MC</li> <li>in the short run the firm has the same profit possibilities as in perfect competition (positive economic profits; normal (zero) economic profits; quasi loss; shut down)</li></ul>
<p>Describe monopolisitc competition profit maximisation in the long run</p>
<ul> <li>because of the relative ease of entry and exit, firms earn normal economic profits in the long run</li> <li>because each firm produces a differentiated product, we don’t look at the ‘firm versus the market’ here – we focus solely on the individual firm</li></ul>
<p>Describe economic profit in monopolisitc competition</p>
<ul> <li>profit maximisation at MR = MC, in short run positive economic profits made</li> <li>+ive profits entice new firms to enter the market. As firms enter the market they take market share off existing firms.</li> <li>therefore demand curve (and MR curve) shifts to the left. Process continues until normal profits earned and no new firms enter.</li> <li>as firms enter, the demand curve (and MR curve) for existing firm becomes more elastic, as there are now more substitutes for their good</li> <li>new profit maximisation point where demand is at tangent to ATC, P1 = ATC1, Q1</li></ul>
<p>Describe quasi loss in monopolistic competition</p>
<ul> <li>initially quasi loss made at profit max point, MR = MC</li> <li>losses cause some firms to leave the market. As firms leave the existing firms are able to increase their market share.</li> <li>therefore demand curve (and MR curve) shifts to the right. Process continues until normal profits earned and no firms leave.</li> <li>as firms leave, the demand curve for existing firm becomes less elastic, as there are now fewer substitutes for their good, this is again where the demand curve is tangent to the ATC curve.</li></ul>
<p>Describe the efficiency of monopolisitic competitions</p>
<ul> <li>long run: monopolistically competitive firm will operate at a price of Pmc and output Qmc</li> <li>PC firm will operate at min ATC, with a price of Ppc and output Qpc in the long run</li> <li>as in monopoly, a Mon Comp firm has some market power, and so is able to reduce output and charge a (slightly) higher price</li> <li>productive efficiency: <ul> <li>In Perf. Comp, firm operates at min ATC</li> <li>In Mon Comp, firm operates to the left of min ATC, therefore not productively efficient.</li> </ul> </li> <li>allocative efficiency: <ul> <li>In Perf. Comp, P = MC</li> <li>In Mon Comp, P > MC, therefore not allocative efficient either as gap between MB and MC</li> </ul> </li> <li>excess capacity <ul> <li>in Mon Comp, firms are said to have excess capacity; excess capacity = the difference between output at min ATC and actual profit max level of output</li> <li>here, the firm has q0 – qMC amount of excess capacity.</li> <li>this means firms could ↑ output and hence ↓ average costs, but don’t have to, because of product differentiation (market power) e.g. restaurants</li> </ul> </li></ul>
<p>Reasons for continuance of monopolistic competitions</p>
<ol> <li>because monopolistically competitive markets give us choice</li></ol>
<ul> <li>in perfect competition, goods were identical which is fine for wheat, potatoes etc, but think of the consequences for most other consumer goods – only one type of car, restaurant, television, etc.</li></ul>
<ol> <li>there is more dynamic efficiency than under perfect competition</li></ol>
<ul> <li>e.g. the research and development undertaken by many of these firms</li> <li>therefore monopolistic competition involves a trade-off between a slight loss of efficiency against greater choice.</li></ul>
<p>Describe the situation of monopolistc competitive firms in the long run</p>
<ul> <li>firms will earn zero economic profit in the long run, due to the ease of entry and exit in the market</li> <li>however, this is only true if the existing firm stands still, and fails to innovate and/or continually differentiate its product</li> <li>therefore, monopolistically competitive firms are often in a ‘race to innovate and differentiate’, in order to prolong the period where they can earn positive economic profits</li></ul>
<p>Describe what occurred to Apple</p>
<p>Case study: Apple</p>
<ul> <li>Apple Mac introduced 1984: highly differentiated, highly profitable</li> <li>by mid-1990s, Windows had replicated many of the features of the Mac (mouse, icons etc) <ul> <li>this, coupled with rise of competitor PC makers, meant this differentiation was lost</li> <li>Apple lost market share (demand shifted left and more elastic)</li> </ul> </li> <li>assumption here of constant cost structure not realistic, but doesn’t change the moral of the story</li> <li>Apple has turned its fortunes around, largely through four innovations</li> <li>done through constant innovation, either through genuinely different products, or through ‘fashion’</li> <li>it is only by this constant change that they can hope to continue making positive economic profits. When they stop, so will these profits.</li></ul>
<p>How do firms use marketing to differentiate products?</p>
<ol> <li>Brand management:</li></ol>
<ul> <li>firms can try to promote product loyalty through their name, which may delay the onset of normal economic profits</li></ul>
<ol> <li>Advertising:</li></ol>
<ul> <li>an advertising campaign ultimately tries to shift the demand curve to the right</li> <li>for this to be successful, the increase in revenue from the increase in demand must be greater than the increase in costs from advertising.</li></ul>
<p>What is the impact of advertising?</p>
<ul> <li>initially, assume firm is earning zero economic profit, at (P0, q0); then implements ad campaign</li> <li>this increases its FIXED costs, not variable. Hence only AFC (not shown) and ATC affected, ATC shifts up</li> <li>if campaign NOT successful: ATC shifts, but demand remains the same; firm goes from normal economic profit to a loss (P0 – ATC1) x q0 <0</li> <li>if campaign successful: ATC still shifts up, demand (and MR) shift out to the right (D1 and MR1) and (hopefully for firm) becomes more inelastic. Positive economic profits: (P1 – ATC2) x q1</li></ul>
