Introduction. Learning Objectives. Learning Objectives. Economics Today Twelfth Edition. Chapter 25 Monopolistic Competition

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1 Roger LeRoy Miller Economics Today Twelfth Edition Chapter 25 Copyright 2004 Pearson Addison Wesley. All rights reserved. Introduction Thomas Jefferson extolled the virtues of allowing individuals to pursue religion within their own denomination, rather than urging everyone to participate in a one-size-fits-all theology. In economics, the model of monopolistic competition is based on reasoning that parallels the thinking of Thomas Jefferson with regard to churches. Slide 25-2 Learning Objectives Learning Objectives Discuss the key characteristics of a monopolistically competitive industry Contrast the output and pricing decisions of monopolistically competitive firms with those of perfectly competitive firms Explain why brand names and advertising are important features of monopolistically competitive industries Describe the fundamental properties of information products and evaluate how the prices of these products are determined under monopolistic competition Slide 25-3 Slide

2 Chapter Outline Did You Know That... Price and Output in Monopolistic Competition Comparing Perfect Competition with Brand Names and Advertising Information Products and Monopolistic Competition Elementary school students are the age group of Internet users most likely to click on banner ads? Internet advertisers are trying to determine how to increase the click ratio for everyone using the Web? Slide 25-5 Slide 25-6 A market situation in which a large number of firms produce similar but not identical products Entry into the industry is relatively easy Characteristics of monopolistic competition Significant number of sellers in a highly competitive market Differentiated products Sales promotion and advertising Easy entry of new firms in the long run Slide 25-7 Slide

3 Implications of the large number of firms Small market share Lack of collusion Independence Product Differentiation The distinguishing of products by brand name, color, and other minor attributes Slide 25-9 Slide Product differentiation and price Differentiate perfectly Producer is a monopoly Significant influence on price Differentiation is not perfect Producer is a monopolistic competitor The more successful it is at differentiation, the more control it has over price Ease of entry Threat of a more efficient competitor is always present Slide Slide

4 Sales promotion and advertising Can increase demand for a firm Can differentiate a firm s product Should be continued to the point at which the additional revenue from one more dollar of advertising just equals that one dollar of marginal cost Advertising as signaling behavior Advertising over a long period of time is a signal that a firm wants repeat business Slide Slide Short-Run and Long-Run Equilibrium with Monopolistic Competition What do you think? Would a perfect competitor have any incentive to advertise? Why would a monopolistically competitive firm advertise? Can advertising lead to efficiency? Dollars per Unit P Profits Panel (a) A MC d MR Price (P 1 ) > Economic profit q Quantity Slide Figure 25-1, Panel (a) Slide

5 Price and Output in Short-Run and Long-Run Equilibrium with Panel (b) MC Panel (c) MC Dollars per Unit P Losses A d -Price (P 1 ) < -Economic loss Dollars per Unit P = T A MR d -Price (P 1 ) = -Normal rate of return MR q Quantity q Quantity Figure 25-1, Panel (b) Slide Figure 25-1, Panel (c) Slide Comparing Perfect Competition with Comparison of the Perfect Competitor with the Monopolistic Competitor Perfect competitors and monopolistic competitors earn zero economic profit. Panel (a) Perfect Competition MC Minimum Panel (b) Minimum MC How are they different? Dollars per Unit P 1 d MR = P Dollars per Unit P 2 d MR q 1 q 2 Quantity per Time Period Quantity per Time Period Slide Figure 25-2, Panels (a) and (b) Slide

6 Comparing Perfect Competition with What do you think? Would you want to live in a perfectly competitive world with homogenous products? Brand Names Firms use trademarks, words, symbols, and logos to distinguish their product brands from goods or services sold by other firms A successful brand image contributes to a firm s profitability Slide Slide Advertising Advertising Forms of advertising Direct marketing Mass marketing Interactive marketing Search goods have characteristics that can be evaluated prior to purchase Experience goods, such as movies and haircuts, don t fully reveal their value until they have been consumed Advertising for experience goods is more likely to be persuasive rather than informational Slide Slide

7 Information Products and Cost Curves for Information Products Information products, such as computer operating systems, software, and digital music and videos, have a unique cost structure Product development entails high fixed costs, but the marginal cost of producing a copy for one more customer is low Slide Slide Cost Curves for Information Products Sellers of information products experience short-run economies of scale. The average total cost continually declines as quantity increases. and Information Products Computer game manufacturers operate in a monopolistically competitive market In monopolistic competition, marginal cost pricing results in losses for the firm Slide Slide

8 Infeasibility of Marginal Cost Pricing of an Information Product Pricing for Information Products In the long-run, price will equal average total cost. This yields the long-run equilibrium condition of zero economic profit. Firms selling information products in a monopolistically competitive industry will recover all their production costs. Customers will pay more than marginal cost, but they will pay the minimum price necessary to call forth the product to market. Slide Slide Issues and Applications: U.S. Churches Differentiate Their Products Membership in mainline Protestant denominations has declined as distinctions between denominations have blurred. Denominations are now trying to highlight their unique characteristics in promotional campaigns, thereby achieving some degree of product differentiation. Web Links The following Web link appears in the margin of this chapter in the textbook: Slide Slide

9 Summary Discussion of Learning Objectives Key characteristics of monopolistic competition Large number of small firms Differentiated products Easy entry and exit Advertising and sales promotion Summary Discussion of Learning Objectives Contrasting the output and pricing decisions of monopolistically competitive firms with those of perfectly competitive firms Monopolistically competitive firm MR = MC determines output Price set on demand curve P > MC P = in the long run Slide Slide Summary Discussion of Learning Objectives Monopolistically competitive firms attempt to boost demand for their products through product differentiation Providing an information product entails incurring relatively high fixed costs but low marginal costs Summary Discussion of Learning Objectives In long-run equilibrium, the provider of an information product in a monopolistically competitive industry will sell the product for a price equal to average total cost Slide Slide

2007 Thomson South-Western

2007 Thomson South-Western Monopolistic Competition Characteristics: Many sellers Product differentiation Free entry and exit In the long run, profits are driven to zero Firms have some control over price What does the costs graph