Monopolistic Competition
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Characteristics
• Firms face low entry barriers• Differentiated Products
-they face a downward sloping demand curve-no Long Run Profits-Non-price Competition
• Price Taker• Many Small Firms
Product Differentiation• Price-searchers produce
differentiated products – products that differ in design, dependability, location, ease of purchase, etc.• Rival firms produce similar products
(good substitutes) and therefore each firm confronts a highly elastic demand curve.
McHits or McMisses?Hulaburger - 1962
Filet o Fish - 1963Strawberry shortcake - 1966Big Mac - 1968Hot Apple Pie - 1968Egg McMuffin - 1975Drive Thru - 1975Chicken McNuggets -
1983Extra Value Meal - 1991McLean Deluxe - 1991Arch Deluxe - 199655-cent Special - 1997Big Xtra - 1999
McRib, Sundaes and others ??
Big MacBig N TastyBig N Tasty w/ CheeseQuarter Pounder w/ CheeseDouble Quarter Pounder w/ CheeseCrispy ChickenChicken McGrillFilet-O-FishDouble CheeseburgerCheeseburgerHamburgerChicken McNuggets (4)Chicken McNuggets (6)Chicken McNuggets (9)McSalad Shaker Chef SaladMcSalad Shaker Garden SaladMcSalad Shaker Grilled Chicken Caeser Salad
Fish Supreme Chicken Parmesan Sandwich 2/3 lb. Monster Thickburger® 1/3 lb. Low Carb Thickburger®
Little Thick Cheeseburger 1/4 lb. Little Thickburger®
1/3 lb. Cheeseburger Chili Cheese Thickburger®
1/3 lb. Original Thickburger® 1/3 lb. Mushroom 'N' Swiss Thickburger®
1/3 lb. Bacon Cheese Thickburger®
Big Chicken Fillet Sandwich Charbroiled Chicken Club Sandwich Charbroiled BBQ Chicken Sandwich
Big Hot Ham 'N' Cheese™ Regular Hamburger
Regular Cheeseburger Double Cheeseburger
5-Piece Chicken Breast Strips 7-Piece Chicken Breast Strips
Big Shef
Double Jr. Cheeseburger Deluxe
1/4 lb.* Single
1/2 lb.* Double with Cheese
3/4 lb.* Triple with Cheese
Baconator®
Jr. Hamburger
Jr. Bacon Cheeseburger
Jr. Cheeseburger Deluxe
Jr. Cheeseburger
Double Stack
Deluxe Double Stack
Triple Stack
Homestyle Chicken Go Wrap
Grilled Chicken Go Wrap
Spicy Chicken Go Wrap
Crispy Chicken Deluxe
Chicken Club
Ultimate Chicken Grill
Spicy Chicken Sandwich
Homestyle Chicken Fillet
10-piece Chicken Nuggets
Premium Fish Fillet Sandwich
Crispy Chicken Sandwich
Double Jr. Cheeseburger Deluxe
1/4 lb.* Single 1/2 lb.* Double with Cheese
3/4 lb.* Triple with Cheese
Baconator® Jr. Hamburger Jr. Bacon Cheeseburger
Jr. Cheeseburger Deluxe
Jr. Cheeseburger Double Stack Deluxe Double Stack
Triple Stack Homestyle Chicken Go Wrap
Grilled Chicken Go Wrap
Spicy Chicken Go Wrap
Crispy Chicken Deluxe
Chicken Club Ultimate Chicken Grill
Spicy Chicken Sandwich
Homestyle Chicken Fillet
10-piece Chicken Nuggets
Premium Fish Fillet Sandwich
Crispy Chicken Sandwich
Price and Output• A profit-maximizing price searcher
will expand output as long as marginal revenue exceeds marginal cost.• Price will be lowered and output
expanded until MR = MC
• The price charged by a price searcher will be greater than its marginal cost.
d
Price
Quantity/time
P2
P1
MRq1 q2
Increase inTotal Revenue
Reduction inTotal Revenue
Marginal Revenue of a Price Searcher
• Initial price P1 & output q1. Total revenue (TR) = P1 * q1.1. As price falls from P1 to P2, output increases from q1 to q2,
two conflicting influences on TR.1. TR will rise because of an increase in the number of units sold (q2 - q1) * P2.
2. TR will decline [(P1 - P2) * q1] as q1 units once sold at the higher price (P1) are now sold at the lower price (P2). • Depending on the size of the shaded regions, total revenue may increase or decrease.
______
___
___
___
___
____________
0
1
2
3
4
5
6
7
8
9
10
Output
Total
Cost
Marginal Cost
Price
(AR)Quantity
Marginal Revenue
50
80
90
110
140
180
230
290
360
440
530
0
1
2
3
4
5
6
7
8
9
10
120
110
100
90
80
70
60
50
40
30
20___
______
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_________
0
110
200
270
320
350
360
350
320
270
200
30
10
20
30
40
50
60
70
80
90
Total Revenue
110
90
70
50
30
10
-10
-30
-50
-70___
______
___
___
___
___
_________
___
80
45
37
35
36
38
41
45
49
53
ATC
___
___
___
___
___
_________
___
Marginal Cost
Price
(AR)Quantity
Marginal Revenue
0
1
2
3
4
5
6
7
8
9
10
120
110
100
90
80
70
60
50
40
30
20
30
10
20
30
40
50
60
70
80
90
110
90
70
50
30
10
-10
-30
-50
-70
80
45
37
35
36
38
41
45
49
53
ATC
Cost
Output
60
50
40
30
20
10
1 2 3 4 5 60 7 8 9 10
70
80
90
100
110
120
Cost
Output
60
50
40
30
20
10
1 2 3 4 5 60 7 8 9 10
70
80
90
100
110
120
Price
Quantity
108
30 45
500
24
MC
ATC
MR D = AR
1. Firm’s profit maximizing output?2. What price will they charge?3. Firm’s revenue? Total Cost? Total Profit?4. How will things change in time?
d
MR
MC
ATC
Price and Output: Short Run Profit
Quantity/timeq
C
EconomicProfits
• A monopolistic competitor maximizes profits by producing where MR = MC, at output level q and charges a price P along the demand curve for that output level.• At q the average total cost is C.
• Because the price is greater than the average total cost per unit (P > C) the firm is making economic profits equal to the area ( [ P - C ] * q )
• What impact will economic profits have if this is a typical firm?
Price
P
Profits and Losses in the Long Run• Economic profits attract competition.
• New firms will expand supply and lower price.
• Individual demand curves will shift inward until the economic profits are eliminated.
• Economic losses cause firms to leave the market.• Demand for the remaining firms’ output
will rise until the losses have been eliminated, ending the incentive to exit.
• Firms can make either profits or losses in the short run, but only zero economic profit in the long run.
• Because entry and exit are free, competition will eventually drive prices down to the level of ATC.
Quantity/timeq
P
d
MR
MC
ATC
Price and Output: Long Run
• When profits (losses) are present, the demand curve will shift inward (outward) until the zero profit equilibrium is restored.• The price searcher establishes its output level where MC = MR.• At q the average total cost is equal to the market price. Zero economic profit is present. No incentive for firms to either enter or exit the market is present.
C = P
Price
Entry or Exit?
Supply
Profits
Case 1: Prices rise
Price
Quantity
$6
$5
$4
$3
$2
$1
10 20 30 40 50 600
Demand
SR Profits
1. Increased Demand, Price goes up2. Firms enter, Demand
faced by each firm decreases
3. Price goes down4. No LR Profits
ATCMC
Entry or Exit?
Supply
Profits
Case 2: Prices fall
Price
Quantity
$6
$5
$4
$3
$2
$1
10 20 30 40 50 600
Demand SR
Losses
1. Demand falls, Price goes down
ATC
2. Firms leave, Demand faced by each firm increases
3. Price goes up4. No LR Losses
MC
Price
Quantity/Time
Pure Comp Mono comp
Price
Quantity/Time
d
MC
ATC
d
MR
MC
ATC
P2
q2
P1
q1
• LR equilibrium for both.• P = ATC and there are no economic profits.• In monopolistic competition, firms face a
downward-sloping demand curve, its profit-maximizing price exceeds MC.
• In Monopolistic Competition, output is too small to minimize ATC in long-run equilibrium.
Comparing Price Taker Markets
Price
Quantity/Time
Pure Comp Mono comp
Price
Quantity/Time
d
Price MC
ATC
d
MC
ATC
P2
P1
Price
MR
q2q1
• Even though the two markets have the same cost structure, the price in the monopolistic competitor’s market is higher than that in the price-taker’s market ( P2 > P1 ).
• Some consider this price discrepancy a sign of inefficiency; others perceive it as a premium society pays for variety and convenience (product differentiation).
Comparing Price Taker Markets
Allocative Efficiency• Allocative efficiency is achieved when
the most desired goods are produced at the lowest possible cost.
• The Minimum point on the ATC curve:• ATC > marginal cost at the minimum
point• No allocative efficiency in Monopolistic
Competition.
Price Discrimination• Sellers may gain from price
discrimination by charging:• higher prices to groups of customers
with more inelastic demand • lower prices to groups of customers
with more elastic demand
• Price discrimination generally leads to more output and additional gains from trade.
The Economics of Price Discrimination
• If the airline charges all customers the same price, profits will be maximized where MC = MR. Here the airline charges everyone $400 and sells 100 seats.
Price
Quantity/timeSingle price
$400
$200
$300
$100
$500
$600
$700
MC
D100
MR
Net operating revenue($300*100) = $30,000
• Consider a hypothetical market for airline travel where the Marginal Cost per traveler is $100.
• This generates Net Operating Revenue of $30,000 or (total revenues) $40,000 – (operating costs) $10,000.
Price
Quantity/timeSingle price
$400
$200
$300
$100
$500
$600
$700
MC
D100
MR
Net operating revenue($300*100) = $30,000
The Economics of Price Discrimination• By charging higher prices to consumers with less elastic demand and lower prices to those with more elastic demand it will increase net operating revenue.
• If the airline charges $600 to business travelers (who have a highly inelastic demand) and $300 to other travelers (who have a more elastic demand), it can increase its Net Operating Revenue to $42,000.
Price
Quantity/timePrice Discrim.
$400
$200
$300
$100
$500
$600
$700
MC
D
Net operating revenuefrom business travelers($500*60) = $30,000
Net operating revenuefrom all others
($200*60) = $12,000
60 120
Right after you graduate, you get a job in production management and you are responsible for the entire company on weekends.Here are the costs of production for the company:
Quantity Average Total Cost 500 $200 501 $201
Your current level of production is 500 units and all 500 have been ordered by regular customers.
One weekend, the phone rings. It is a customer who wants to buy one unit of your product. This means increasing production to 501 units. The customer offers to buy it for $450.Should you accept the offer?What is the net change in the firm’s profit?
Quantity Average Total Cost 500 $200 501 $201
$100,701 - $100,000 = $701
Marginal Cost = $701
Marginal Revenue = ??
Marginal Cost = ??
Marginal Revenue = $450
Profit or Loss
L o s s
Total Cost (Q x ATC)$100,000$100,701
You’re Fired!!!
In a competitive price-searcher market, the firms willa. be able to choose their price, and the entry barriers into the market will be low.b. be able to choose their price, and the entry barriers into the market will be high.c. have to accept the market price for their product, and the entry barriers into the market will be low.d. have to accept the market price for their product, and the entry barriers into the market will be high.A profit-maximizing price searcher will expand output to the point wherea. total revenue equals total cost. b. marginal revenue equals marginal cost.c. price equals average total cost. d. price equals marginal cost.In the long run, neither competitive price takers nor competitive price searchers will be able to earn economic profits becausea. entry barriers into these markets are high, raising the costs of each firm.b. the government will dictate moderate prices for these firms.c. competition will force prices down to the level of per-unit production costs.d. marginal revenue is always less than marginal cost when barriers to entry are low.If a market is in long-run equilibrium, which of the following conditions will be present in a competitive price-taker market but absent from a competitive price-searcher market?a. P = ATC b. MR = MCc. P = MC d. MR < P
As long as a market is contestable, then even if it has only a few sellers, thea. threat of new firms will prevent the prices from rising above the competitive level.b. producers will be able to charge prices that are high enough to produce long-run economic profits.c. producers will not face new competition because the barriers to entry are high.d. market will never be expected to come close to the competitive result.
If firms in a competitive price-searcher market are currently earning economic losses, then in the long run,a. new firms will enter the market, and the current firms will experience a decrease in demand for their products until zero economic profit is again restored.b. new firms will enter the market, and the current firms will experience an increase in demand for their products until zero economic profit is again restored.c. some existing firms will exit the market, and the remaining firms will experience an increase in demand for their products until zero economic profit is again restored.d. some existing firms will exit the market, and the remaining firms will experience a decrease in demand for their products until zero economic profit is again restored.Compared to the outcome when the firms are price takers, competitive price-searcher markets will result ina. a wider variety of products and higher prices.b. less product variety and higher prices.c. a wider variety of products and lower prices.d. less product variety and lower prices.
What price should this competitive price-searcher firm charge in order to maximize profits?a. $5 b. $7 c. $8 d.
$10What is the maximum economic profit this firm depicted in Figure 2 will be able to earn?a. $0 b. $20 c. $30 d.
$100If the cost and demand conditions of this competitive price-searcher firm, what will happen in the future?a. Firms will go out of business, and the market price will rise.b. The current market price will tend to persist into the future.c. New firms will enter the market, and demand facing this firm will decline.d. The firms in this industry probably will collude in order to increase their profitability.
d. $10
b. $20
The average variable cost (AVC) and average total cost (ATC) for a firm are indicated in Figure 3. If the marginal cost curve were constructed, at what output would it cross the AVC curve?
a. 2 b 3c. 4 d. 5
At what output would a properly constructed marginal cost curve cross the ATC curve?a. 3 b 4 c. 5 d. 6
Calculate the total cost of producing four units.a. $10 b. $15 c $60 d. $75
Calculate the total variable cost of producing three units.a. $10 b. $15 c. $30 d. $45
Which output level would be most closely associated with the point where diminishing marginal returns have begun?a 4 b. 5c. 6 d. 8
Which output minimizes per-unit cost?a. 4 b. 6 c. 7 d 8
Which of the following is true?a. Firms in this industry begin to experience diminishing returns to their variable factors at output q1.b. Between q1 and q2, firms in this industry experience economies of scale.c Firms producing output rates less than q1 or more than q2 will find it difficult to survive.d. The largest firms in this industry have the lowest per-unit cost.
The graph illustrates a firma.capable of earning economic profit.b.that is only able to break even when it maximizes profit.c taking economic losses.d. that should shut down immediately.
When price rises from P2 to P3, the firm finds thata. marginal cost exceeds marginal revenue at a production level of Q2.b. if it produces at output level Q3 it will earn a positive profit.c expanding output to Q4 would leave the firm with losses.d. it could increase profits by lowering output from Q3 to Q2.When price falls from P3 to P1, the firm finds that
a.fixed cost is higher at a production level of Q1 than it is at Q3.b. it should produce Q1 units of output.c. it should produce Q3 units of output.d it should shut down immediately.