Market Structures: Monopolistic Competition Imperfect Competition • The spectrum of competition: Perfect Comp. ------------- Monopoly Monop. Comp.-- Oligopoly • Assumptions underlying Monopolistic Competition – Differentiated products • Differentiated products leads to some market power over price or a downward slping demand curve – Many buyers and sellers – Free entry and exit – Perfect knowledge Short-run Vs. Long-run Supply Decisions • In the short-run, the firm is able to set prices like a monopolistic. P>MR so MR=MC implies that P>MC. A firm can make profits, breakeven or make losses. • In the long-run, free entry and exit will eliminate economic profits or losses. • In either case, the monopolistically competitive firm produces a level of output where LRAC are greater than LRAC minimum or the efficient scale and sets price above MC. Monopoly Competition and Economic Welfare • Compared to competitive markets, monopolistic competition results in an output level where there is – Excess capacity – LRAC >LRAC min – P>MC - or MB>MC – So, Deadweight Welfare Loss exists • Welfare loss is due to product differentiation – If differentiation is real, the welfare is small – If differentiation is the result of advertising which does not contribute anything to consumer satisfaction, it represents welfare loss Advertising • Advertising is costly, the question is - does it add anything of value to the consumer? – informative advertising which contributes to competition – Advertising aimed at creating perceived differences or brand loyalty – Breakfast cereals and kids versus supermarket ads • Advertising and the prisoner’s dilemma – selfcanceling ads.