Lecture 17: Monopolistic competition

Market structure Price formation Entry barriers

Competition Price takers Free entry  exit
Monopoly Price setter Entry barriers
Monopolistic competition Strategic pricing Free entry  exit

Market structure Firms Goods Pricing Profit

Competition Many Identical P = MR = MC 0 ⟹ P = AC
Monopoly One Identical P > MR = MC ≥ 0 ⟹ P ≥ AC
Monopolistic Several Differentiated P > MR = MC 0 ⟹ P = AC
competition

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2 Lecture17.nb

Monopolistic competition

Product differentiation

Characteristics - fast food - pizza, burger, sandwiches

Location - gas stations, supermarkets, convenience stores
Quality - restaurants, coffee
Advertising
Reputation

Assumptions

(1) Pricing - firm demand = market demand for the variety; varieties are close but imperfect
substitutes
(2) Free entry and exit

(1) Profit maximization - each firm maximizes the profit from its variety

MC = MR => Q
Q => P, P > MR so P > MC

(2) Free entry and exit => long run profit = 0

Profit = 0 <=> P = AC

Efficiency is subtle

MB = P > MR = MC

fewer varieties, each with a larger production, could sell at lower prices

Q < MES and P > Min AC is the "price of variety"

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 Lecture17.nb 3

Cost
Monopolistic competition
TC = 81 + 6Q
Cost $

140

120

100

80

60

40

20

Quantity Q
2 4 6 8 10 12

Monopolistic competition
MC = 6 and AC = 81/Q + 6
Price P

50

40

30

20
AC

10
MC

Quantity Q

◀ ▶
2 4 6 8 10 12

|
4 Lecture17.nb

Revenue
Demand Q = 24 - P
TR = (24 - Q)Q
Price P

140

120

100

80

60

40

20

Quantity Q
5 10 15 20

Demand P = 24 - Q
MR = 24 - 2Q
Price P

20

10

Quantity Q
5 10 15 20

-10

MR
-20

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 Lecture17.nb 5

Profit maximization
Profit maximization in monopolistic competition
Price P

20

15
D

10

MC

Profit maximizing Q = 9
MR

Quantity Q

◀ ▶
2 4 6 8 10 12

|
6 Lecture17.nb

Monopolistic competition equilibrium

Equilibrium in monopolistic competition

Price P

40
Equilibrium
Profit Maximum: MC = MR
Free entry and exit: AC = P
30 AC

D
20

MR

10
MC

Quantity Q

◀ ▶
2 4 6 8 10 12

|
 Lecture17.nb 7

Monopolistic competition equilibrium using TC, TR

Monopolistic competition equilibrium
TR = (24 - Q)Q
TC = 81 + 6Q
Price P

140 MR(Q* ) = MC(Q* ) TC

120 TR

100

TR(Q* )
80
AR(Q* ) =
Q*
TC(Q* )
60
AC(Q* ) =
Q*
40

20 Q* = 9

Quantity Q
2 4 6 8 10 12

Monopolistic competition equilibrium

Profit = TR - TC
Price P
Quantity Q
2 4 6 8 10 12

Profit

Profit maximum at Q = 9
*

-20

-40

-60

-80

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8 Lecture17.nb

Code

In[* ]:= ClearAll[p0, k, c, p, tr, mr, tc, ac, mc]

p0 = 24; k = 81; c = 6;

p[q_] = p0 - q;
tr[q_] = p[q] q;
mr[q_] = p0 - 2 q;
tc[q_] = k + c q;
ac[q_] = tc[q] / q;
mc[q_] = D[tc[q], q];

In[* ]:= GraphicsGrid[{

{Graphics[
Plot[tc[q], {q, 0, 12}, AxesOrigin → {0, 0}, AxesLabel → {"Quantity Q", "Cost $"},
PlotStyle → Thick, PlotLabel → "Monopolistic competition \n TC = 81 + 6Q"]
]},
{Show[
Plot[{mc[q], ac[q]}, {q, 0, 12}, AxesOrigin → {0, 0},
AxesLabel → {"Quantity Q", "Price P"}, PlotStyle → Thick,
PlotLabel → "Monopolistic competition \nMC = 6 and AC = 81/Q + 6"],
Graphics[{
Text["MC", {11, 7}],
Text["AC", {11, 15}]
}]
]}
}]
 Lecture17.nb 9

Monopolistic competition
TC = 81 + 6Q

Cost $

150

100

50

Quantity Q
2 4 6 8 10 12

Out[* ]=

Monopolistic competition
MC = 6 and AC = 81/Q + 6

Price P

50

40

30

20

AC

10
MC

Quantity Q
2 4 6 8 10 12
10 Lecture17.nb

In[* ]:= GraphicsGrid[{

{Graphics[
Plot[p[q] q, {q, 0, 24}, AxesOrigin → {0, 0}, AxesLabel → {"Quantity Q", "TR, TC"},
PlotStyle → Thick, PlotLabel → "Demand Q = 24 - P \n TR = (24 - Q)Q"]
]},
{Show[
Plot[{p[q], mr[q]}, {q, 0, 24}, AxesOrigin → {0, 0},
AxesLabel → {"Quantity Q", "Price P"}, PlotStyle → Thick,
PlotLabel → "Demand P = 24 - Q \nMR = 24 - 2Q"],
Graphics[{
Text["D", {20, 6}],
Text["MR", {20, - 12}]
}]
]}
}]
 Lecture17.nb 11

Demand Q = 24 - P
TR = (24 - Q)Q

TR, TC

140

120

100

80

60

40

20

Quantity Q
5 10 15 20

Out[* ]=

Demand P = 24 - Q
MR = 24 - 2Q

Price P

20

10

Quantity Q
5 10 15 20

-10
MR

-20
12 Lecture17.nb

In[* ]:= Show[

Plot[{p[q], mr[q], mc[q]}, {q, 0, 12}, AxesOrigin → {0, 0},
AxesLabel → {"Quantity Q", "Price P"}, PlotStyle → {{Thick, Dashed}, Thick, Thick},
PlotLabel → "Profit maximization in monopolistic competition"],
Graphics[{
Text["D", {11, 14}],
Text["MR", {11, 3}],
Text["MC", {11, 7}]
}]
]
Profit maximization in monopolistic competition
Price P
25

20

15
Out[* ]=
D

10

MC

MR

Quantity Q
2 4 6 8 10 12
 Lecture17.nb 13

In[* ]:= Show[

Plot[{p[q], mr[q], ac[q], mc[q]}, {q, 0, 12},
AxesOrigin → {0, 0}, AxesLabel → {"Quantity Q", "Price P"},
PlotLabel → "Equilibrium in monopolistic competition", PlotStyle → Thick],
Graphics[{
Text["D", {3, 23}],
Text["MR", {4, 14}],
Text["MC", {4, 7}],
Text["AC", {3, 30}],
Text["Equilibrium \n Profit Maximum: MC = MR \n Free entry and exit: AC = P",
{7, 35}]
}]
]
Equilibrium in monopolistic competition
Price P

40

Equilibrium
Profit Maximum: MC = MR
Free entry and exit: AC = P

30 AC

Out[* ]=
D

20

MR

10

MC

Quanti
2 4 6 8 10 12
14 Lecture17.nb

In[* ]:=

GraphicsGrid[{
{Graphics[Plot[{tr[q], tc[q]}, {q, 0, 12}, AxesOrigin → {0, 0},
AxesLabel → {"Quantity Q", "TR, TC"}, PlotStyle → Thick, PlotLabel →
"Monopolistic competition equilibrium \n TR = (24 - Q)Q \n TC = 81 + 6Q"],
Graphics[{Text["TR", {8, 120}]}]
]},
{
Show[
Plot[{tr[q] - tc[q]}, {q, 0, 12}, AxesOrigin → {0, 0},
AxesLabel → {"Quantity Q", "Profit"}, PlotStyle → Thick, PlotLabel → "Profit"],
Graphics[{
Text["TR(Q) - TC(Q)", {5, - 40}]
}]
]}
}]

Show[
Plot[{tr[q], tc[q]}, {q, 0, 12}, AxesOrigin → {0, 0},
AxesLabel → {"Quantity Q", "TR, TC"}, PlotStyle → Thick, PlotLabel →
"Monopolistic competition equilibrium \n TR = (24 - Q)Q \n TC = 81 + 6Q"],
Graphics[{
Text["TR", {11, 120}],
Text["TC", {11, 140}]
}]
]
 Lecture17.nb 15

Monopolistic competition equilibrium

TR = (24 - Q)Q
TC = 81 + 6Q

TR, TC
150

100

50

Quantity Q

Out[* ]=
2 4 6 8 10 12

Profit

Profit
Quantity Q
2 4 6 8 10 12

-20

-40 TR(Q) - TC(Q)

-60

-80

Monopolistic competition equilibrium

TR = (24 - Q)Q
TC = 81 + 6Q
TR, TC

150
TC

TR
Out[* ]=
100

50

Quantity Q
2 4 6 8 10 12

Show[
Plot[{p[q] q - tc[q]}, {q, 0, 12}, AxesOrigin → {0, 0},
AxesLabel → {"Quantity Q", "Profit"}, PlotStyle → Thick,
PlotLabel → "Monopolistic competition equilibrium \n Profit = TR - TC"],
Graphics[{
Text["TR", {11, 120}],
Text["TC", {11, 140}]
}]
]
16 Lecture17.nb