economics for managers gtu mba sem 1 chapter 17

7/31/2019 Economics For Managers GTU MBA Sem 1 Chapter 17

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By:

Prof. Sharif Memon


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xMonopolistic Competitionx Many firms selling products that are similar

but not identical.

x Oligopoly

x Only a few sellers, each offering a similar or

identical product to the others.


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Markets that have some

features of competition and

some features of monopoly.


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x

Many sellersx Product differentiation

x Free entry and exit


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There are many firms competing for the

same group of customers.

xProduct examples include books, CDs,movies, computer games, restaurants,

piano lessons, furniture, etc.


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xEach firm produces a product that is

at least slightly different from those

of other firms.xRather than being a price taker, each

firm faces a downward-sloping

demand curve.


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x Firms can enter or exit the market

without restriction.

xThe number of firms in the marketadjusts until economic profits are zero.


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(a) Firm Makes a Profit


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Short-run economic profits encourage new

firms to enter the market. This:

x Increases the number of products offered.x Reduces demand faced by firms already in the

market.

x Incumbent firms demand curves shift to theleft.

x Demand for the incumbent firms products fall,

and their profits decline.


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Short-run economic losses encourage firms

to exit the market. This:

x Decreases the number of products offered.x Increases demand faced by the remaining

firms.

x Shifts the remaining firms demand curvesto the right.

x Increases the remaining firms profits.


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Firms will enter and exit untilthe firms are making exactly

zero economic profits.


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As in a monopoly, price exceeds marginal

cost.xProfit maximization requires marginal

revenue to equal marginal cost.

x

The downward-sloping demand curvemakes marginal revenue less than

price.


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As in a competitive market, price equals

average total cost.x Free entry and exit drive economic profit

to zero.


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x For a competitive firm, price equalsmarginal cost.

x For a monopolistically competitive firm,price exceeds marginal cost.

s Because price exceeds marginal cost, an

extra unit sold at the posted price meansmore profit for the monopolisticallycompetitive firm.


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Monopolistic competition does nothave all the desirable properties of

perfect competition.


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Monopolistic Competition and

the Welfare of Society

x There is the normal deadweight loss of

monopoly pricing in monopolistic

competition caused by the markup of

price over marginal cost.

x However, the administrative burden of

regulating the pricing of all firms that

produce differentiated products would be

overwhelming.


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Another way in which monopolistic

competition may be socially inefficient is

that the number of firms in the market may

not be the ideal one. There may be too

much or too little entry.


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Externalities of entry include:

x product-variety externalities.

x business-stealing externalities.


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The product-variety externality:Because consumers get some consumer

surplus from the introduction of a new

product, entry of a new firm conveys a

positive externality on consumers.


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The business-stealing externality:Because other firms lose customers and

profits from the entry of a new competitor,

entry of a new firm imposes a negative

externality on existing firms.


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When firms sell differentiated products

and charge prices above marginal cost,each firm has an incentive to advertise in

order to attract more buyers to its

particular product.


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x Firms that sell highly differentiatedconsumer goods typically spend between10 and 20 percent of revenue onadvertising.

x Critics of advertising argue that firmsadvertise in order to manipulate peoplestastes.

x They also argue that it impedescompetition by implying that productsare more different than they truly are.


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x Defenders argue that advertising providesinformation to consumers

x They also argue that advertising increases

competition by offering a greater varietyof products and prices.

x The willingness of a firm to spend

advertising dollars can be a signal toconsumers about the quality of the

product being offered.


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xCritics argue that brand names cause

consumers to perceive differences that do

not really exist.

economics for managers gtu mba sem 1 chapter 17

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