Economics book slide Case and Fair a good path to learn basics of economics

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PowerPoint Lectures for
Principles of Economics,
9e
By
Karl E. Case,
Ray C. Fair &
Sharon M. Oster
; ;

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15Monopolistic
Competition
Fernando & Yvonn Quijano
Prepared by:
PART III MARKET IMPERFECTIONS AND
THE ROLE OF GOVERNMENT

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15
CHAPTER OUTLINE
Monopolistic
Competition
Industry Characteristics
Product Differentiation and
Advertising
How Many Varieties?
How Do Firms Differentiate Products?
Advertising
Price and Output Determination in
Monopolistic Competition
Product Differentiation and Demand
Elasticity
Price/Output
Determination in the Short Run
Price/Output Determination in the Long
Run
Economic Efficiency and Resource
Allocation
PART III MARKET IMPERFECTIONS AND
THE ROLE OF GOVERNMENT

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Monopolistic Competition
 FIGURE 13.2 Characteristics of Different Market Organizations

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Industry Characteristics
monopolistic competition A common form of
industry (market) structure in the United States,
characterized by a large number of firms, no barriers
to entry, and product differentiation.
TABLE 15.1 Percentage of Value of Shipments Accounted for by the Largest Firms in
Selected Industries, 2002
Industry Designation Four Largest
Firms
Eight Largest
Firms
Twenty
Largest Firms
Number of
Firms
Travel trailers and campers 38 45 58 733
Games, toys 39 48 63 732
Wood office furniture 34 43 56 546
Book printing 33 54 68 560
Curtains and draperies 17 25 38 1,778
Fresh or frozen seafood 14 24 48 529
Women’s dresses 18 23 48 528
Miscellaneous plastic products 6 10 18 6,775
Source: U.S. Department of Commerce, Bureau of the Census, 1997 Census of Manufacturers, Concentration Ratios in Manufacturing. Subject Series EC92m315, June, 2001.

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Product Differentiation and Advertising
How Many Varieties?
product differentiation A strategy that
firms use to achieve market power.
Accomplished by producing products that
have distinct positive identities in
consumers’ minds.

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Product Differentiation and Advertising
How Do Firms Differentiate Products?
horizontal differentiation Products differ
in ways that make them better for some
people and worse for others.
behavioral economics A branch of
economics that uses the insights of
psychology and economics to investigate
decision making.

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Product Differentiation and Advertising
How Do Firms Differentiate Products?
commitment device Actions that
individuals take in one period to try to
control their behavior in a future period.
vertical differentiation A product
difference that, from everyone’s
perspective, makes a product better than
rival products.

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An Economist Makes Tea
Bottled iced tea is a classic example of a monopolistically
competitive market. None of the brands are exactly alike.
Nor are the teas priced the same.
Goldman and Nalebuff
discovered that sugar
beyond some point adds
little taste, yet comes at a
health cost—more calories.
Given consumers’ new
awareness of healthy and
natural foods, Honest Tea
became an overnight
success.
Product Differentiation and Advertising
How Do Firms Differentiate Products?

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Product Differentiation and Advertising
Advertising
TABLE 15.2 Total Advertising
Expenditures in 2006
Billions of Dollars
Newspapers $49.0
Television 66.8
Direct mail 59.6
Yellow pages 14.4
Internet 15.0
Radio 19.1
Magazines 24.0
Total 247.9

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TABLE 15.3 Domestic Advertising Spending by Category
in 2006 in Billions of Dollars
Rank Category 2006
1 Automotive $19.8
2 Retail 19.1
3 Telecommunications 11.0
4 Medicine & remedies 9.2
5 General services 8.7
6 Financial services 8.7
7 Food, beverages, & candy 7.2
8 Personal care 5.7
9 Airlines, hotels, car rental, travel 5.4
10 Movies, recorded video, & music 5.4
11 Restaurants 5.3
12 Media 5.1
13 Government, politics, religion 3.5
14 Insurance 3.5
15 Real estate 3.1
16 Apparel 2.9
17 Computers, software 2.5
18 Home furnishings 2.2
19 Beer, wine, & liquor 2.1
20 Education 1.9
Product Differentiation and Advertising
Advertising

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Product Differentiation and Advertising
The advocates of spirited competition believe that differentiated
products and advertising give the market system its vitality and
are the basis of its power. They are the only ways to begin to
satisfy the enormous range of tastes and preferences in a modern
economy. Product differentiation also helps to ensure high quality
and efficient production, and advertising provides consumers with
the valuable information on product availability, quality, and price
that they need to make efficient choices in the marketplace.
The Case for Advertising
Advertising

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Product Differentiation and Advertising
The bottom line, critics of product differentiation and advertising
argue, is waste and inefficiency. Enormous sums are spent to
create minute, meaningless, and possibly nonexistent differences
among products. Advertising raises the cost of products and
frequently contains very little information. Often, it is merely an
annoyance. Product differentiation and advertising have turned
the system upside down: People exist to satisfy the needs of the
economy, not vice versa. Advertising can lead to unproductive
warfare and may serve as a barrier to entry, thus reducing real
competition.
The Case Against Product Differentiation and Advertising
Advertising
Open Questions
There are strong arguments on both sides of the advertising
debate, and even the empirical evidence yields to conflicting
conclusions.

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Can Information Reduce Obesity?
Policy makers have been working to
increase the level of information that
consumers have about products. In the
early 1990s, the Food and Drug
Administration passed rules requiring
most processed foods sold in grocery
stores to carry nutrition labels. The
current hot topic in the labeling area
involves restaurant meals. With growing
obesity in the United States, many policy
makers think that one way to fight the
problem is to require calorie and fat
labeling in restaurants.
Product Differentiation and Advertising
Advertising

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Price and Output Determination in Monopolistic Competition
Product Differentiation and Demand Elasticity
 FIGURE 15.2 Product Differentiation Reduces the Elasticity of Demand Facing a Firm
The demand curve that a monopolistic competitor faces is likely to be less elastic
than the demand curve that a perfectly competitive firm faces. Demand is more
elastic than the demand curve that a monopolist faces because close substitutes for
the products of a monopolistic competitor are available.

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Price and Output Determination in Monopolistic Competition
Price/Output Determination in the Short Run
 FIGURE 15.3 Monopolistic Competition in the Short Run
In the short run, a monopolistically competitive firm will produce up to the point MR = MC.
At q0 = 2,000 in panel a, the firm is earning short-run profits equal to P0ABC = $2,000.
In panel b, another monopolistically competitive firm with a similar cost structure is shown
facing a weaker demand and suffering short-run losses at q1 = 1,000, equal to CABP1 =
$1,000.

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Price and Output Determination in Monopolistic Competition
Price/Output Determination in the Long Run
 FIGURE 15.4 Monopolistically Competitive Firm at Long-Run Equilibrium
As new firms enter a monopolistically competitive industry in search of profits, the
demand curves of profit-making existing firms begin to shift to the left, pushing marginal
revenue with them as consumers switch to the new close substitutes. This process
continues until profits are eliminated, which occurs for a firm when its demand curve is
just tangent to its average total cost curve.

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Economic Efficiency and Resource Allocation
Because entry is easy and economic profits are
eliminated in the long run, we might conclude that
the result of monopolistic competition is efficient.
There are two problems, however.
First, once a firm achieves any degree of market
power by differentiating its product (as is the case in
monopolistic competition), its profit-maximizing
strategy is to hold down production and charge a
price above marginal cost.
Second, the final equilibrium in a monopolistically
competitive firm is necessarily to the left of the low
point on its average total cost curve.

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REVIEW TERMS AND CONCEPTS
monopolistic competition
product differentiation
vertical differentiation
behavioral economics
commitment device
horizontal differentiation