Chapter 17 - Monopolistic competition

Economics 200 with Kirk at University of Washington - Seattle Campus

About this deck

By: Alyssa Hunt
Textbook:

Study Guide for Mankiw's Principles of Microeconomics, 4th

Study Guide for Mankiw's Principles of Microeconomics, 5th
Created: 2009-03-10
Size: 23 flashcards
Views: 26

About StudyBlue

STUDYBLUE makes things that make you better at school. Things like online flashcards with photos and audio. Things like personalized quizzes and friendly reminders about when (and what) to study next. Think of it as a digital backpack™: access to all of your study materials online and on your phone. STUDYBLUE exists to make studying efficient and effective for every student, for free. Join us.

“I have used this website for three exams, and I see a huge difference in my test results.”
Naj

Sign up (free) to study this.

monopolistic competition

a market structure in which many firms sell products that are similar but not identical

characteristics:

- many sellers
- product differentiation
- free entry

characteristic:
many sellers

there are many firms competing for the same group of customers

characteristic:
product differentiation

each firm produces a product that is at least slightly different from those of other firms. thus rather than being a price-taker, each firm faces a downward-sloping demand curve

characteristic:
free entry

firms can enter/exit the market without restriction. thus, the number of firms in the market adjusts until economic profits are driven to zero

how is monopolistic competition like a monopoly?

- downward sloping demand curve
- chooses the quantity to produce where marginal revenue equals marginal cost
- chooses the price based on where MC = MR

when firms are making profits --

new firms have incentive to enter the market

what is the effect of new firms entering the market?

- increases the # of products to choose from
- demand for firms' products fall -- declining profit
- some firms leave the market, driving the price back up again

examples of monopolistic competition:

- books
- brands of cereal
- brands of peanut butter

characteristics of a long-run equilibrium:

- price exceeds marginal cost because profit maximization requires MC = MR
- price = ATC because free entry/exit drives economic profit to zero

difference to monopoly:

economic profit equals zero in the long-run

efficient scale

the quantity that minimizes ATC

excess capacity

when a firm could increase the quantity and lower the ATC of production

differences between monopolistic competition and perfect competition

1. excess capacity
2. markup over marginal cost

what does the zero-profit condition ensure?

that price equals average total cost, but not that price equals marginal cost

the product-variety externality

because consumers get some consumer surplus from the introduction of a new product, entry of a new firm conveys a positive externality on consumers

the business-stealing externality

because other firms lose customers and profits from the entry of a new competitor, entry of a new firm imposes a negative externality on existing firms

firms that sell highly-differentiated consumer goods (soft drinks, dogfood, makeup...) spend what percentage of their revenue on advertising?

between 10 and 20%

cons of advertising:

- manipulates people's tastes
- creates a desire that wouldn't exist otherwise
- impedes competition
- firms can then charge a higher markup

pros of advertising:

- give information to customers
- tells of the existence of new products
- fosters competition -- each firm has less market power

signal of quality

the willingness of the firm to spend a large amount of money on advertising sends a signal about the quality of the product

cons of brand names:

- cause consumers to see differences where there aren't any
- WTP is deceived
-

pros of brand names:

- useful way to ensure consumers the goods are of high quality
- provide information about quality
- give firms incentive to uphold good quality