Monopolistic Competition
aka
P rice
S eekers
W ith
L ow
B arriers
to
E ntry
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 - 1963
Strawberry shortcake - 1966
Big Mac - 1968
Big Mac
Hot Apple Pie - 1968
Big N Tasty
Egg McMuffin - 1975
Big N Tasty w/ Cheese
Quarter Pounder w/ Cheese
Drive Thru - 1975
Double Quarter Pounder w/ Cheese
Chicken
Chicken McNuggets - 1983Crispy
McGrill
Extra Value Meal - 1991 Chicken
Filet-O-Fish
Double Cheeseburger
McLean Deluxe - 1991
Cheeseburger
Arch Deluxe - 1996
Hamburger
McNuggets (4)
55-cent Special - 1997 Chicken
Chicken McNuggets (6)
Chicken McNuggets (9)
Big Xtra - 1999
Shaker Chef Salad
McRib, Sundaes and others McSalad
McSalad Shaker Garden Salad
??
McSalad Shaker Grilled Chicken
Caeser Salad
Double Jr.
Cheesebur 1/4 lb.*
ger
Single
Deluxe
Baconator
®
1/2 lb.*
Double
with
Cheese
Jr.
Jr. Bacon
Hamburge Cheesebur
r
ger
Jr.
Double
Cheesebur
Stack
ger
Homestyle Grilled
Chicken
Chicken
Go Wrap
Go Wrap
Deluxe
Double
Stack
Spicy
Chicken
Go Wrap
Chicken
Club
Ultimate
Chicken
Grill
Spicy
Chicken
Sandwich
10-piece
Chicken
Nuggets
Premium
Fish Fillet
Sandwich
Crispy
Chicken
Sandwich
3/4 lb.*
Triple
with
Cheese
Fish Supreme
Chicken Parmesan Sandwich
Jr.
2/3 lb. Monster Thickburger®
Cheesebur
1/3 lb. Low Carb Thickburger®
ger
Little Thick Cheeseburger
1/4 lb. Little Thickburger®
Deluxe
1/3 lb. Cheeseburger
Chili Cheese Thickburger®
Triple
1/3 lb. Original Thickburger®
Stack
1/3 lb. Mushroom 'N' Swiss Thickburger®
1/3 lb. Bacon Cheese Thickburger®
Big Chicken Fillet Sandwich
Crispy
Charbroiled Chicken Club Sandwich
Chicken
Charbroiled BBQ Chicken Sandwich
Deluxe
Big Hot Ham 'N' Cheese™
Regular Hamburger
Homestyle
Regular Cheeseburger
Chicken
Double Cheeseburger
Fillet
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
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.
Marginal Revenue of a Price Searcher
• Initial price P1 & output q1.
Total revenue (TR) = P1 * q1.
Price
1. As price falls from P1 to P2,
output increases from q1 to q2,
Reduction in
Total Revenue
two conflicting influences on TR.
1. TR will rise because of an
increase in the number of
units sold (q2 - q1) * P2.
Increase in
Total Revenue
P1
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.
d
MR
q1
q2
Quantity/time
Total
Price
Marginal
Output
Total Marginal
Quantity
Cost ATC
(AR)
Cost
RevenueRevenue
0
0
0
120
50
___
110
30
___
___
1
___
110
1
110
80
80
___
90
10
___
2
___
___
200
2
100
90
45
___
70
20
___
3 110 ___
___
270
3
90
37
___
50
30
___
4 140 ___
320
4
80
35
___
30
40
___
___
5 180 ___
350
5
70
36
___
10
50
___
___
6 230
360
6
60
38
___
___
-10
60
___
___
7 290 ___
350
7
50
41
___
-30
70
___
___
8 360 ___
320
8
40
45
___
-50
80
___
___
9 440 ___
___
270
9
30
49
___
-70
90
___
10 530 ___
200
10
20
53
___
Marginal
Quantity Marginal
Cost
ATC
Revenue
0
30
110
1
80
10
90
2
45
20
70
3
37
30
50
4
35
40
30
5
36
50
10
6
38
60
-10
7
41
70
-30
8
45
80
-50
9
49
90
-70
10
53
Price
(AR)
120
110
100
90
80
70
60
50
40
30
20
120
Cost
110
100
90
80
70
60
50
40
30
20
10
0
1
2
3
4
5
6
7
8
9
10
Output
120
Cost
110
100
90
80
70
60
50
40
30
20
10
0
1
2
3
4
5
6
7
8
9
10
Output
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?
MC
Price
24
ATC
10
8
MR
0
30
D = AR
45 50
Quantity
Price and Output: Short Run Profit
Price
• 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.
P
• What impact will economic profits
have if this is a typical firm?
C
MC
Economic
Profits
ATC
d
• 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)
MR
q
Quantity/time
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.
Price and Output: Long Run
• Because entry and exit are free,
competition will eventually drive Price
prices down to the level of ATC.
MC
• When profits (losses) are present,
the demand curve will shift inward
(outward) until the zero profit
equilibrium is restored.
C=P
ATC
• 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.
d
MR
q
Quantity/time
Case 1: Prices rise
Profits
Entry or Exit?
Supply
1. Increased Demand, Price goes up
2. Firms enter, Demand faced
Price
$6
by each firm decreases
ATC
MC
$5
$4
SR Profits
$3
$2
$1
0
3. Price goes down
4. No LR Profits
10
20
30
40
Demand
50
60
Quantity
Case 2: Prices fall
Profits
Entry or Exit?
Supply
1. Demand falls, Price goes down
Price 2. Firms leave, Demand faced
$6
by each firm increasesATC
MC
$5
$4
$3
$2
$1
0
Demand
SR Losses
3. Price goes up
4. No LR Losses
10
20
30
40
50
60
Quantity
Comparing Price Taker Markets
• LR equilibrium for both.
• P = ATC and there are no economic profits.
• In monopolistic competition, firms face a
downward-sloping demand curve, its profitmaximizing price exceeds MC.
• In Monopolistic Competition, output is too small to
minimize ATC in long-run equilibrium.
Pure Comp
Price
Mono comp
Price
MC
MC
ATC
d
P1
ATC
P2
d
q1
Quantity/Time
MR
q2
Quantity/Time
Comparing Price Taker Markets
• 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).
Pure Comp
Price
Mono comp
Price
MC
MC
ATC
d
P1
ATC
P2
d
q1
Quantity/Time
MR
q2
Quantity/Time
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
• Consider a hypothetical market for airline travel where
the Marginal Cost per traveler is $100.
• 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.
• This generates Net Operating Revenue of $30,000 or
(total revenues) $40,000 – (operating costs) $10,000.
Price
$700
Net operating revenue
($300*100) = $30,000
$600
$500
$400
$300
$200
MC
$100
Single price
MR
100
D
Quantity/time
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
Price
$700
Net operating revenue
($300*100) = $30,000
$700
$600
$600
$500
$500
$400
$400
$300
$300
$200
$200
MC
$100
Single price
MR
100
D
Quantity/time
$100
60
Price Discrim.
Net operating revenue
from business travelers
($500*60) = $30,000
Net operating revenue
from all others
($200*60) = $12,000
MC
D
120 Quantity/time
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?
Marginal Revenue = ??
Quantity
500
501
Marginal Cost = ??
Average Total Cost
$200
$201
Total Cost (Q x ATC)
$100,000
$100,701
$100,701 - $100,000 = $701
Marginal Cost = $701
Marginal Revenue = $450
Profit or Loss
L o s s
You’re Fired!!!
In a competitive price-searcher market, the firms will
a. 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 where
a. total revenue equals total cost.
c. price equals average total cost.
b. marginal revenue equals marginal 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 because
a.
b.
c.
d.
entry barriers into these markets are high, raising the costs of each firm.
the government will dictate moderate prices for these firms.
competition will force prices down to the level of per-unit production costs.
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 pricesearcher market?
a. P = ATC
b.
MR = MC
c. P = MC
d.
MR < P
As long as a market is contestable, then even if it has only a few sellers, the
a. 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 pricesearcher markets will result in
a. 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
a. $0
b. $20
c.
$30
d. $10
What is the maximum economic
profit this firm depicted in Figure 2
will be able to earn?
d. $100
If 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.
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
3
c.
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.
5
c.
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 firm
a. 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 that
a. 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.