Microeconomics
ECON 2302
Summer I, 2011
Marilyn Spencer, Ph.D.
Professor of Economics
Chapter 12
Announcement: 3rd Bonus Quiz
3 points possible
 View the film, “American Gangster.”
 Send an email that explains his:
1. Supply chain management through vertical integration
(CH 13)
2. Brand management (CH.12)
 You might be able to find this film online by going to:
www.projectfreetv.com.
 Email your explanation (approx. 50-100 words) to
marilyn.spencer@tamucc.edu, before class, June 28.
CHAPTER
12
Monopolistic Competition:
The Competitive Model
in a More Realistic
Setting
The coffeehouse market is competitive
because it is inexpensive to open a new store.
Hundreds of firms in the United States operate
coffeehouses.
CHAPTER
12
Monopolistic Competition: The Competitive
Model in a More Realistic Setting
Chapter Outline and Six (6) Learning Objectives
12.1 Demand and Marginal Revenue for a Firm in a
Monopolistically Competitive Market
Explain why a monopolistically competitive firm has
downward-sloping demand and marginal revenue curves.
12.2 How a Monopolistically Competitive Firm
Maximizes Profit in the Short Run
Explain how a monopolistically competitive firm
maximizes profit in the short run.
12.3 What Happens to Profits in the Long Run?
Analyze the situation of a monopolistically competitive firm
in the long run.
CHAPTER
12
Chapter Outline and Learning Objectives, cont.
12.4 Comparing Perfect Competition and Monopolistic
Competition
Compare the efficiency of monopolistic competition and
perfect competition.
12.5 How Marketing Differentiates Products
Define marketing and explain how firms use it to
differentiate their products.
12.6 What Makes a Firm Successful?
Identify the key factors that determine a firm’s success.
Monopolistic Competition:
The Competitive Model in a More Realistic Setting
Monopolistic competition A market structure in which
barriers to entry are low and many firms compete by
selling similar, but not identical, products.
12.1 LEARNING OBJECTIVE
Explain why a monopolistically competitive firm has downward-sloping
demand and marginal revenue curves.
Demand and Marginal Revenue for a Firm
in a Monopolistically Competitive Market
The Demand Curve for a Monopolistically Competitive Firm
If a Starbucks
increases the price of
caffè lattes, it will
lose some, but not all,
of its customers.
In this case, raising
the price from $3.00
to $3.25 reduces the
quantity of caffè lattes
sold from 3,000 to
2,400.
Therefore, unlike a
perfect competitor, a
Starbucks store faces
a downward-sloping
demand curve.
FIGURE 12-1
The Downward-Sloping Demand for Caffè Lattes at a Starbucks
Demand and Marginal Revenue for a Firm
in a Monopolistically Competitive Market:
MR for a Firm with a Downward-Sloping Demand Curve
Table 12-1
CAFFÈ LATTES
SOLD PER
WEEK (Q)
0
1
2
3
4
5
6
7
8
9
10
Demand and Marginal Revenue at a Starbucks
PRICE (P)
$6.00
5.50
5.00
4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
TOTAL
REVENUE
(TR = P x Q)
AVERAGE
REVENUE
(AR = TR/Q)
MARGINAL
REVENUE
(MR = ΔTR/ΔQ)
$0.00
5.50
10.00
13.50
16.00
17.50
18.00
17.50
16.00
13.50
10.00
―
$5.50
5.00
4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
―
$5.50
4.50
3.50
2.50
1.50
0.50
–0.50
–1.50
–2.50
–3.50
Demand and Marginal Revenue for a Firm
in a Monopolistically Competitive Market:
MR for a Firm with a Downward-Sloping Demand Curve
If the local Starbucks
reduces the price of a
caffè latte from $3.50 to
$3, the number of caffè
lattes it sells per week
will increase from 5 to
6.
Its MR from selling the
6th caffè latte will be
$0.50, which is equal to
the $3 additional
revenue from selling 1
more caffè latte (the
area of the green box)
minus the $2.50 loss in
revenue from selling
the first 5 caffè lattes
for $0.50 less each (the
area of the red box).
FIGURE 12-2
How a Price Cut Affects a Firm’s Revenue
Demand and Marginal Revenue for a Firm
in a Monopolistically Competitive Market:
MR for a Firm with a Downward-Sloping Demand Curve
Any firm that has the
ability to affect the price of
the product it sells will
have a MR curve that is
below its D curve.
Data from Table 12-1
create the D and MR
curves.
After the 6th caffè latte,
MR becomes negative
because the additional
revenue received from
selling 1 more caffè latte is
< the revenue lost from
receiving a lower price on
the caffè lattes that could
have been sold at the
original price.
FIGURE 12-3
The D and MR Curves for a
Monopolistically Competitive Firm
12.2 LEARNING OBJECTIVE
Explain how a monopolistically competitive firm maximizes profit in the short run.
How a Monopolistically Competitive
Firm Maximizes p in the Short Run
FIGURE 12-4
Maximizing Profit in a
Monopolistically Competitive
Market
Solved Problem
12-2
Does Minimizing Cost Maximize Profits?
Will Apple maximize
profits if it produces
800,000 iPhones per
month?
Average cost reaches a minimum at
a quantity of 800,000, but profits
are maximized at a quantity of
600,000.
12.3 LEARNING OBJECTIVE
Analyze the situation of a monopolistically competitive firm in the long run.
What Happens to Profits in the Long Run?
How Does the Entry of New Firms Affect the p of
Existing Firms?
FIGURE 12-5
How Entry of New Firms Eliminates Profits
Panel (a) shows that in the SR, Starbucks can charge a P above ATC (point A) and make a p, shown
by the green rectangle. But this p attracts new firms to enter the market, which shifts the D and MR
curves to the curves labeled “Long run” in panel (b). At point B, Starbucks breaks even.
What Happens to Profits in the Long Run?
How Does the Entry of New Firms Affect the p of Existing Firms?
Table 12-2
The Short Run and
the Long Run for a
Monopolistically
Competitive Firm
Making
the
The Rise and Decline of Starbucks
Connection
In a monopolistically
competitive industry,
maintaining profits
in the long run is
very difficult.
Starbucks: No longer
different enough?
What Happens to Profits in the Long Run?
Is Zero Economic Profit Inevitable in the Long Run?
A firm’s profits will be eliminated in the long run
only if a firm stands still and fails to find new ways
of differentiating its product or fails to find new
ways of lowering the cost of producing its product.
Don’t Let This Happen to YOU!
i
Don’t Confuse Zero Economic p with Zero Accounting p
Solved Problem
12-3
Can It Be Profitable to Be the High-Price Seller?
Because the greater demand more than offsets the higher
costs, the hhgregg store makes a larger profit.
12.4 LEARNING OBJECTIVE
Compare the efficiency of monopolistic competition and perfect competition.
Comparing Perfect Competition
and Monopolistic Competition
Monopolistic competition and perfect competition share
the characteristic that in long-run equilibrium, firms earn
zero economic profits.
However, there are two important differences between
long-run equilibrium in the two markets:
• Monopolistically competitive firms charge a price
greater than marginal cost.
• Monopolistically competitive firms do not produce at
minimum average total cost.
Comparing Perfect Competition
and Monopolistic Competition
Excess Capacity under Monopolistic Competition
FIGURE 12-6
Comparing Long-Run Equilibrium under Perfect
Competition and Monopolistic Competition
A monopolistically competitive firm has excess capacity: If it
increased its output, it could produce at a lower average cost.
Comparing Perfect Competition and Monopolistic Competition
Is Monopolistic Competition Inefficient?
Economists have debated whether monopolistically
competitive markets, being neither productively nor
allocatively efficient, results in a significant loss of well-being
to society in these markets compared with
perfectly competitive markets.
How Consumers Benefit from Monopolistic Competition:
Consumers benefit from being able to purchase a product
that is differentiated and more closely suited to their tastes.
Making
the
Connection
Abercrombie & Fitch: Can the
Product Be Too Differentiated?
A firm whose
strategy of product
differentiation
succeeds will
experience
increases in
same-store sales.
Did Abercrombie and Fitch narrow
its target market too much?
12.5 LEARNING OBJECTIVE Define marketing and explain how firms use it to differentiate their products.
How Marketing Differentiates Products
Marketing All the activities necessary for a firm to sell a
product to a consumer.
Brand Management The actions of a firm intended to
maintain the differentiation of a product over time.
How Marketing Differentiates Products
Advertising
If the increase in revenue that results from the advertising
is greater than the increase in costs, the firm’s profits will
rise.
Defending a Brand Name
A firm can apply for a trademark, which grants legal
protection against other firms using its product’s name.
Making Google Tries (and Fails) to
the
Connection
Measure the Effectiveness
of Radio Advertising
A firm’s optimal level
of advertising occurs
where the marginal
cost of advertising
equals the marginal
revenue earned from
advertising.
Does spending on radio
advertising attract
customers?
12.6 LEARNING OBJECTIVE
Identify the key factors that determine a firm’s success.
What Makes a Firm Successful?
FIGURE 12-7
What Makes a Firm Successful?
The factors under a firm’s control—the ability to differentiate its
product and the ability to produce it at lower cost—combine with
the factors beyond its control to determine the firm’s profitability.
Making
the
Connection
Is Being the First Firm in the Market
a Key to Success?
The firms that were first to
introduce a product ultimately lost
out to latecomers who did a better
job of providing consumers with
products that were more reliable,
less expensive, more convenient, or
otherwise provided greater value.
Although not first to
market, Bic ultimately
was more successful than
the firm that pioneered
ballpoint pens.
AN INSIDE
LOOK
>>
Starbucks Faces McCompetition
The effect of entry on price, quantity,
and profits at Starbucks.
KEY TERMS
Brand management
Marketing
Monopolistic competition
Assignment to prepare for Ch. 13:
 Pre-read Ch. 13, including:
 Review Questions: 3rd ed., p. 452 1.1—1.3; p 454 2.1, 2.3—2.5;
(2nd ed., p. 464, 1.1 – 1.3; p. 466, 2.1, 2.3, 2.4 & 2.5; (1st edition:
1-4, 6-8 & 10 on pp. 436-43)
 Problems and Applications: 3rd ed., p. 453 1.10; p 454, 2.6, 2.7;
p 455 2.10; p456, 2.17, 2.20; (2nd ed., p. 465, 1.10; p. 466, 2.6, 2.7
& 2.10; p. 467, 2.17; p. 468, 2.19; and:
The city is considering auctioning licenses that would allow one or
two vendors to sell ice cream on the local beach.
 If the city licenses two vendors, will it receive more in total
license fees than if it sells a license to only one vendor?
 Will people who use the beach be better off if the city licenses
two vendors or one vendor?
 Suppose the city licenses two vendors but announces that every
year it will sell licenses to two new vendors. The same vendor
may not hold a license more than once every five years. Would
this make any difference to the prices the vendors change?
(1st edition: 1, 2, 3, 4, 11, 15 & 21 on pp. 437-440).