Chapter 17
Monopolistic
Competition and
Advertising
MODERN PRINCIPLES OF ECONOMICS
Third Edition
Outline
 Sources of Product Differentiation
 The Monopolistic Competition Model
 The Economics of Advertising
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Introduction
 Monopolistic competition combines some
features of competitive markets with some
features of monopoly.
 Monopolistic competition is a market with:
• Many sellers.
• Free entry and exit.
• Product differentiation.
 Monopolistic competitors face a downward
sloping demand curve.
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Definition
Monopolistic competition:
a market with a large number of firms
selling similar but not identical products.
Examples:
Restaurants
Soft drinks, beer
Many other consumer products
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Product Differentiation
COSTI IOSIF/SHUTTERSTOCK
Can you tell the difference?
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Product Differentiation
COSTI IOSIF/SHUTTERSTOCK
How about now?
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Product Differentiation
 Products can be differentiated along any
dimension that people care about, such as
taste, style, features, or location.
 Differentiated products are often highly
advertised.
 Firms want consumers to perceive their
products as different and better because that
increases their market power.
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Self-Check
Under monopolistic competition, there are/is:
a. Many firms.
b. A few firms.
c. One firm.
Answer: a – under monopolistic competition,
there are many firms.
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Monopolistic Competition
Price
Short Run
In the short run, a monopolistic
competitor can make profits like
a monopolist.
MC
P
Profit
AC
Demand
Q
MR
Quantity
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Monopolistic Competition
Price
 Firms enter → ↓market share
The firm produces QLR and
 Demand curve shifts left
makes zero profits but P > MC.
 Entry continues until P = AC
Long Run
MC
P
AC
MR
Q LR
Demand
Quantity
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Monopolistic Competition
Price
Long Run
The firm produces QLR and
makes zero profits but P > MC.
MC
P
AC
MR
Q LR
Demand
Quantity
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Monopolistic Competition
 A monopolistically competitive firm can reduce
output and raise the price without losing all of
its customers.
 Product differentiation means the firm is able to
charge P > MC. Is there DWL?
 It also means that a firm does not produce at
the minimum of its AC curve (inefficiency)
 In the longer run, consumers are better off
because of new features and products.
 Politics of choice or market failure?
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Monopolistic Competition
Price
Monopolistic
Competition
Price
P = AC
Profits = 0
MC
AC
PC
PMC
Competition
P = AC, Profits = 0
Minimum AC
MC
AC
P = MR
Demand
Quantity
QMC
QC
Quantity
MR
Comparing Monopolistic competition and Competition.
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Self-Check
Firms in which of the following markets will
produce at the minimum AC:
a. Monopoly.
b. Monopolistic competition.
c. Competition.
Answer: c – a competitive firm will produce at
the minimum average cost.
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Economics of Advertising
 Monopolies, oligopolies, and monopolistically
competitive firms use advertising to differentiate
their products and build brand identity.
 Informative advertising is about price, quality,
and availability.
 Persuasive advertising is about changing
people’s minds and moving the market towards
monopoly.
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Economics of Advertising
 There is evidence that advertising lowers prices
and improves consumer welfare.
 Advertising can also signal that the seller
expects the product to be a success.
 Persuasion can give us tastes that appear silly
or unjustified.
 Persuasion also can deepen our enjoyments
and our memories.
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Economics of Advertising
 In a blind taste test,
subjects were given
labeled and unlabeled
glasses of Coke.
 They reported greater
enjoyment from drinking
the labeled Coke.
 Brain scans showed
activity in the memory
regions of the brain.
INTERFOTO/ALAMY
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Economics of Advertising
 Persuasive advertising can create market
power by brand differentiation.
 Advertising helps people enjoy a lot of products.
 Ads make Google search, newspapers, and
cable TV cheaper.
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Takeaway
 A monopolistically competitive industry has many
sellers, free entry, and differentiated products.
 Each firm retains a downward-sloped demand
curve and Price remains above MC.
 Free entry drives price down to P = MC, where
economic profits = 0.
 Firms do not produce at the minimum AC.
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Takeaway
 Advertising can inform consumers about price,
quality, and availability.
 Advertising can also increase perceptions of
product differentiation, which allows firms to
increase prices.
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