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Diploma in Management Studies Microeconomics ECO001
Diploma in Management Studies Microeconomics ECO001
Microeconomics ECO001
Lecture 10 Monopolistic Competition
Topics to be discussed:
Features of Monopolistic Competition
Short Run Equilibrium in Monopolistic Competition
Long run Equilibrium in Monopolistic Competition
Comparison Between Monopolistic Competition and
Perfect Competition
Effect of Advertising and Innovation
Ref: Parkin, Chapter 14
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Learning Outcomes
After this lecture, students should be able to:
Define and identify monopolistic competition
Explain how output and price are determined
in a monopolistically competitive industry
Compare between monopolistic competition
and perfect competition
Explain why advertising costs are high in a
monopolistically competitive industry
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Product Differentiation
Product Differentiation
Firms in monopolistic competition practice
product differentiation, which means that
each firm makes a product that is slightly
different from the products of competing
firms.
Loss Minimizing
A firm might incur an
economic loss in the
short run.
P < ATC
It will operate in the
short run if P > AVC
It will shut down in the
short run if P < AVC
10
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Excess Capacity
Firms in monopolistic
competition operate
with excess capacity
in long-run
equilibrium.
The downwardsloping demand curve
for their products
drives this result.
15
Markup
Firms in monopolistic
competition operate
with positive mark up.
Again, the downwardsloping demand curve
for their products
drives this result.
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Perfect Competition
In contrast, firms in
perfect competition
have no excess
capacity and no
markup.
The perfectly elastic
demand curve for
their products drives
this result.
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Product Innovation
Innovation is costly, but it increases total
revenue.
Profit will increase if total revenue increases
by more than total cost
Firms pursue product development until the
marginal revenue from innovation equals the
marginal cost of innovation inn order to
maximize profit.
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Effect of Advertising
Advertising costs might
lower the average total
cost by increasing
equilibrium output and
spreading their fixed
costs over the larger
quantity produced.
Here, with no
advertising, the firm
produces 25 units of
output at an average
total cost of $60.
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Effect of Advertising
The advertising
expenditure shifts the
average total cost curve
upward.
With advertising, the
firm produces 100 units
of output at an average
total cost of $40.
The firm operates at a
higher output and lower
average total cost than
it would without
advertising.
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Effect of Advertising
Selling Costs and
Demand
If other firms did not
advertise, the firm that
advertise has larger
demand and also the
demand is inelastic and
the markup is large.
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Effect of Advertising
Selling Costs and
Demand
In the long run, all firms
advertise
The firms demand
decreases and become
more elastic
lowers the price and
markup until it can only
earn normal profit
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Signal Quality
Using Advertising to Signal Quality
Firms use advertising to signal the high
quality of their products.
A signal is an action taken by an informed
person or firm to send a message to
uninformed persons.
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Exercise 10.1
Of the following characteristics, which one
applies exclusively to a monopolistic
competitive firm?
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Exercise 10.2
The similarity between monopoly and
monopolistic competition is:
(a) There are barriers to entry
(b) They sell differentiated product
(c) There is perfect information
(d) There is long run normal profit
(e) The price is higher than marginal
revenue
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Exercise 10.3
The similarity between perfect competition
and monopolistic competition in the long
run is:
(a) They both produces at the lowest point
of the ATC
(b) They both charge a price equals
marginal cost
(c) They both earn normal profit
(d) The number of firms are the same
(e) Firms demand curve is horizontal
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Exercise 10.4
(a) Consider a monopolistic competitive
firm selling shoes and make a normal
profit. How can it differentiate its product
in order to make economic profit?
(b) If the firm is able to differentiate
successfully and earns an economic profit
in the short run. What will happen to this
firm in the long run?
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Monopolistic Competition
Short Run Profit
P
MC
MC
ATC
P1
ATC
P2
D
MR
Q1
MR
D
Q
Q2
Exercise 10.5
1. What are the effects of advertising in the
monopolistic competitive market?
2. Draw the diagram of a monopolistic
competitive firm that is earning an economic
profit. Be sure to label all the curves. Indicate
the area that equals the firms economic
profit. Is this a long-run equilibrium? Why or
why not?
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