Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
Chapter 13. Monopolistic Competition
Instructor: JINKOOK LEE
Department of Economics / Texas A&M University
ECON 202 504
Principles of Microeconomics
Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
Monopolistic Competitive Market
Monopolistic competitive market
there are many buyers and sellers.
the barriers to entry are low.
the goods and services are differentiated rather than identical.
e.g. coffee houses, restaurants, movie theaters, and supermarkets.
In the real world, monopolistically competitive markets are common.
Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
Demand Curve for a Firm
A monopolistically competitive firm faces a downward-sloping demand
curve.
raising the price from $3.00 to $3.25 reduces the quantity of caffe
lattes sold from 3,000 to 2,400.
it will lose some, but not all, of its customers.
Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
Marginal Revenue for a Firm
In a perfectly competitive market, the demand curve and the marginal
revenue curve are the same (P = MR).
However, a monopolistically competitive firm must cut the price to sell more.
a firm’s marginal revenue (MR) curve will slope downward.
MR will be below its demand curve.
MR can be even negative.
Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
Marginal Revenue for a Firm
In a perfectly competitive market, the demand curve and the marginal
revenue curve are the same (P = MR).
However, a monopolistically competitive firm must cut the price to sell more.
MR will be below its demand curve.
a firm’s marginal revenue (MR) curve will slope downward.
MR can be even negative.
Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
How to maximize profit in the short run
All firms use the same approach to maximize profits
They produce where marginal revenue (MR) equals marginal cost (MC).
profit-maximizing quantity: 5 caffe lattes
profit-maximizing price: $3.50
Profit = TR − TC = (P − ATC ) × Q = ($3.50 − $2.50) × 5 = $5.00
a firm will maximize profits where P > MC .
Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
How to maximize profit in the short run
All firms use the same approach to maximize profits
They produce where marginal revenue (MR) equals marginal cost (MC).
profit-maximizing quantity: 5 caffe lattes
profit-maximizing price: $3.50
Profit = TR − TC = (P − ATC ) × Q = ($3.50 − $2.50) × 5 = $5.00
a firm will maximize profits where P > MC .
Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
Entry of New Firms in the Long Run
If a firm (a Starbucks) is earning an economic profit selling caffe lattes,
new coffeehouses are likely to open in the same area.
How new entries will affect the firm’s demand curve?
the firm’s demand curve will shift to the left
:selling fewer caffe lattes at each price
the demand curve will become more elastic
:losing more sales if it raises its prices
Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
Entry of New Firms in the Long Run
existing firm’s demand curve shift to the left.
demand curve also become more elastic.
demand curve is tangent to the ATC.
P = ATC , the firm is breaking even in the long run.
Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
Is Zero Economic Profit Inevitable in the Long Run?
If a firm introduces new technology that allows it to sell a good at a lower
cost, competing firms will eventually duplicate that technology.
⇒ eliminating the firm’s profits in the long run.
But this result holds only if the firm fails to find new ways of lowering cost
(or differentiating its product).
Eg. The Rise and Decline and Rise of Starbucks
Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
Monopolistic Competition and Perfect 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.
Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
Comparing Mono. and Perf. Competition
The perfectly competitive firm is both allocatively efficient and
productively efficient.
A perfectly competitive firm in long-run equilibrium produces at QPC .
P = MC : allocatively efficient.
ATC is at a minimum: productively efficient.
Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
Comparing Mono. and Perf. Competition
the monopolistically competitive firm is neither allocatively efficient nor
productively efficient.
A monopolistically competitive firm produces at produces at QMC .
P > MC : not allocatively efficient.
ATC is not at a minimum: not productively efficient.
Excess capacity: the difference between its profit-maximizing level of
output and the productively efficient level of output.
Demand/Marginal Revenue
Profit in Short Run
Profit in Long Run
Comparing Mono. and Perf. Competition
How Consumers Benefit from Monopolistic Competition
Firms differentiate their products to appeal to consumers.
The success of these product differentiation strategies indicates that some
consumers find these products preferable to the alternatives.
Consumers, therefore, are better off than they would have been had these
companies not differentiated their products.