Chapter 24. Monopolistic Competition

Monopolistic CompetitionChapter 2424-1Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter ObjectivesThe monopolistic competitor in the short and long runsProduct differentiationThe characteristics of monopolistic competitionPrice discrimination 24-2Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.A monopolistically competitive industry has many firms selling a differentiated productDifferentiated means the buyer, for whatever reason, make a difference between one product and anotherIdentical means the buyer makes no difference between one product and anther product No one firm has any significant influence on price24-3Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Monopolistic Competition Defined24-4Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Monopolistic Competitor in the Short RunThe monopolistic competitor can make a profit or take a lossAs only one firm in a crowded industry it has a very elastic demand curveNo one firm can get too far out of line on price because buyers can always purchase a substitute from someone else24-5Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Monopolistic Competitor in the Short RunThe monopolistic competitor can make a profit or take a lossAs only one firm in a crowded industry it has a very elastic demand curveNo one firm can get too far out of line on price because buyers can always purchase a substitute from some one elseDMRMonopolistic competitorDMRMonopoly24-6Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Monopolistic Competitor Making a Profit in the Short RunOutput is 60Price is $15ATC is $12.10Total Profit=(Price-ATC) X Output =($15-$12.10) X 60 =($2.90) X 60 = $17424-7Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Monopolistic Competitor Taking a Loss in the Short RunOutput is 42Price is $11ATC is $12.80Total Profit=(Price-ATC) X Output =($11-$12.80) X 42 =(-$1.80) X 42 = -$75.6024-8Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Monopolistic Competitor Breaking Even in the Long Run Output is 40At the output level associated with MC=MR, the ATC curve is tangent to the demand curve24-9Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Monopolistic Competitor Breaking Even in the Long Run Output is 40Price is $12.10ATC is $12.10Total Profit=(Price-ATC) X Output =($12.10-$12.10) X 42 =( 0 ) X 42 = 024-10Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Monopolistic Competitor Breaking Even in the Long Run Price is $12.10ATC is $12.10Total Profit=(Price-ATC) X Output =($12.10-$12.10) X 42 =( 0 ) X 42 = 0The monopolistic competitor makes zero economic profits in the long run24-11Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Monopolistic Competitor Breaking Even in the Long Run Price is $12.10ATC is $12.10Total Profit=(Price-ATC) X Output =($12.10-$12.10) X 42 =( 0 ) X 42 = 0Because the monopolistic competitor does not produced at the minimum point of its ATC, the perfect competitor is more efficient than the monopolistic competitorProduct DifferentiationProduct differentiation is crucial to monopolistic competitionProduct differentiation takes place in the buyer’s mindIf a buyer sees no difference there is no differenceIn the real world buyers usually do differentiateAmericans are provided with a wide variety of products and servicesPeople in other countries rarely get to make all the consumer choices that Americans do and consequently do not engage in nearly as much product differentiation24-12Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Basis for Product DifferentiationPhysical differencesConvenienceAmbienceReputationsAppeals to vanityUnconscious fears and desiresSnob appealCustomized products24-13Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Typical Monopolistic CompetitorThe monopolistic competitor tries to set his or her product apart from the competitionThe main way of doing this is through advertisingWhen this is done successfully, the demand curve becomes more vertical or inelasticBuyers are willing to pay more for a product or service because they believe it is much better than their other choices 24-14Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Why Do People Shop at One Store Rather than Another?AmbiencePersonal attentionConvenienceEasy creditFree deliveryGood service24-15Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Product DifferencesProduct differentiation does not necessarily mean there are any physical differences among productsThey might all be the same, but how they are sold may make all the differenceThere are, of course, some very real physical product differences.Buyers often differentiate based on real physical differences, but differentiation is still taking place in the buyers mind, and it may or may not be based on real physical differences24-16Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Price Discrimination24-17Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Price discrimination occurs when a seller charges two or more prices for the same good or serviceSometimes it’s bad and sometimes it’s not bad at allPrice discrimination is often disguised as a subsidy to the poorSome Examples of Price DiscriminationDoctors often charge rich patients more than poor patientsThey may have one price for those with insurance and another price for those without insuranceMovies in the evening cost more than those in the early afternoonSenior citizen, youth, and student discountsNew and used carsYouth fairs on airlinesEvening meals in restaurants often cost more than the same meal at lunch24-18Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Practicing Price DiscriminationThe firm that practices price discrimination must be able to distinguish between two or more separate groups of buyersPrice discriminators must also be able to prevent buyers from reselling the product or serviceFor example, if a fifteen-year-old could resell his youth fare seat to an adult who could then use it, the price discrimination effort would fail24-19Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Motives for Price DiscriminationIn most cases, price discrimination is basically a mechanism for rationing goods and servicesThe main motivation for price discrimination is to raise profitsThe greater the price discrimination, the greater the profits because buyers lose some of their “consumer surplus”If price discrimination were carried to its logical conclusion, we would have perfect price discriminationThe buyers would lose all of their “consumer surplus”24-20Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.A&P’s Price Discrimination Scheme in the 1940s24-21Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Price QD TR TC Total Profit$.50 100 $50 $20 $30.00 .40 140 56 28 28.00 .30 170 51 34 17.00 Hypothetical Demand Schedule for Canned PeasA&P had an ATC of $.20 a canIf A&P could charge only one price it would be $.50 a canA&P’s Price Discrimination Scheme in the 1940s24-22Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Demand Schedule for Canned Peas by GradeGrade Price QD TR TC Total Profit A $.50 100 $50 $20 $30.00 B .40 40 16 8 8.00 C .30 30 9 6 3.00 Total Profit ------------------------------------------------------$ 41.00By keeping its markets separate rather than charging a single price, A&P was able to make much larger profitsA&P still has an ATC of $.20 a can24-23Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Is the Monopolistic Competitor Inefficient?From a purely economic standpoint . . .Yes!The firms do not produce at the minimum point on the ATCThere may be too many firms in most industriesAre there too many beauty parlors? Not if you want to get your hair done on Friday afternoon or Saturday morningAre there too many restaurants? Not on SundayThere may be overdifferentiationWould Americans want the drab businesses that characterize eastern Europe and the old soviet union?Would Americans want only one brand of toothpaste or one brand and model of a car?In America, it would be hard to imagine a no-frills worldClosing ThoughtsMore than 99% of the over 23 million business firms in the United States are monopolistic competitorsWhile monopolistic competitors do compete with respect to price, they compete still more vigorously with respect to ambience, service, and the rest of the intangibles that attract customers 24-24Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.