Microeconomics II

Bedele Campus
Economics Department

2022/23
Bedele Ethiopia
Chapter One
Monopolistic
Competition
Department of Economics,2021/22
Chapter Objectives
After completing this chapter, students would be
able to:
§ Describe the monopolistically competitive market
structure, and compare and contrast it with perfect
competition and pure monopoly.
§ Explain the short run and long run equilibrium of a
firm in monopolistic competition.
§ Discuss the costs and benefits of advertising.
§ Discuss the existence of excess capacity and the
social welfare aspects of monopolistic competition.
§ Comment on Chamberlin’s model of monopolistic
competition and appreciate its contributions.
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 Introduction
§In general, both perfect competition and
pure monopoly are useful tools of analysis;
but neither of the two depicts the common
phenomena of the real world.
§ These real world phenomena are best
analyzed using the market structures that
fall between the two extremes, namely,
monopolistic competition and oligopoly.

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 Definition
 This market model can be defined as the
market organization in which there are
relatively many firms selling differentiated
products.
 Monopolistic competition is a blend of
competition and monopoly.

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Con’t………………………………………….

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 Characteristics of McM
§ Many number of buyers & sellers(Firms)
§ Differentiated products
§ Limited control over price
§ Relatively any condition of entry and exit
Eg: Clothes & Shoes soap (B-29, Wabel,
777 …), toothpaste (Aquafresh, Colgate,
CloseUp …), stationeries (SinarLine, MAMCO
…), cigarettes (Rothmans, Marlboro, Nyala,
Dunhill …), etc.

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 Product Differentiation
 Product differentiation is generally
intended to distinguish the product of one
producer from that of the others in the
‘industry’.
 Product differentiation can be real or
fancied.

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 Real product differentiation
Exists when there are differences in:
§the specification of the products
(chemical composition/ingredients), or
§differences in the factor inputs, or
§the location of the firm
Eg.: Body soap & Cloth soap

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 Fancied (spurious/imaginary) product
differentiation
Exists when the products are basically the
same but the consumer is persuaded, via:
§advertising or other selling activities
§difference in packaging,
§difference in design, or
§simply by brand name.
Eg.: body soap

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 Demand Curve
§Monopolistic has negatively slope demand
curve
§More elastic than PM demand curve
§Less elastic than PCM demand curve

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Types of Demand Curves in McM
1. The planned sales curve and
2. The actual sales curve

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 The planned sales curve(dd)
§This is a demand curve that shows how much
the firm will sell if it varies its price from
the ongoing level under the assumption that
other firms maintain their existing prices.
Case 1:If the firm reduces its price and other
firms maintain their prices, the firm can
expect a considerable increase in sales since it
will be able to attract buyers away from other
firms in the group (‘industry’) and increase
sales to existing customers.
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 Con’t……………………………………….
Case 2:
If the firm increases its price and other firms
maintain their prices, the firm can expect a
considerable decrease in sales since it will lose
business to other firms in the group.

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 The actual sales curve(DD)
§ This is the demand curve based on the
supposition that all firms raise or lower their
prices by the same amount as this firm under
consideration.
§ Thus, if firms follow both price- rises and
price-cuts of a firm, no shift of customers is
expected to result from a price change.
§ If this is the case, then the position of the
DD curve will be affected only by the entry
into or exit out of the particular market where
the market share of each firm is affected.
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Graphically

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Note
§The actual sales curve (DD) is less elastic
than the planned sales curve (dd).

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 Costs under McM
§The average variable cost (AVC), marginal
cost (MC) and average total cost (ATC)
curves are all U- shaped implying that there
is only a single level of output which
corresponds to optimal production.

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 Con’t……………………………………….
§ Nevertheless, there are some new concepts
that Chamberlin added to the traditional
theory of costs. He introduced the selling
costs to the theory of the firm for the first
time.
§ The recognition of product differentiation
provides the rationale for the selling
expenses incurred by a firm. He also argued
that the selling-costs curve is U-shaped,

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 Industry Vs Product Group
§ Industry is a group of firms producing
identical product
§Where as product group is a group of firms
who produces differentiate product

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 Equilibrium of the firm
§Choice related variable for PCM is quantity
§But for PM are price or quantity
§Where as for McM the choice related
variables are:
(i) price (or quantity),
(ii) product variation, and
(iii) selling expenses.

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 Con’t…………….………………………
In the short run,
§The firm maximizes its profit at a point
where MR = MC provided that price is at
least as high as the average variable cost
(i.e., as long as P AVC).
§ In the McM may entertain Normal, excess
and Loss profit.

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 Excess/Abnormal/positive profit
§ If the price the firm charges per unit of
output (P) exceeds the average cost (ATC)

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 Normal/zero/break even profit
§ If P = ATC the demand curve is tangent to
the ATC curve).

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 Loss
§If P < ATC at equilibrium

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 Con’t……………………………………….
§Even if the firm incurs a loss, it will continue
to be in business as long as the total revenue
generated from the sale of the product, at
least, covers the total variable cost (i.e., as
long as TR > TVC or P > AVC).

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Numerical Example
§Assume a firm engaging in selling its product
and promotional activities in monopolistic
competition face short run demand and cost
functions as and , respectively. Having this
information, find
A. Determine the optimal level of output and price in the short run.
B. Calculate the economic profit (loss) the firm will obtain (incur).
C. the economic profit (loss) of the firm.

Answer: Q=2 , P=20 Profit = 16

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 Long run
§In the long run monopolistic firms entertain
zero profit because:
i. Free entry into and exit out of the product group,
ii. Price competition of the existing firms.

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 Con’t……………………………………….
 How this long run equilibrium is achieved
through the price adjustments of the
existing firms and through the entry and
exit of firms into and out of the product
group?
 Price adjustments of the existing firms are
shown by shift in the planned sales (dd)
curve,
 while entry (or exit) cause shifts in the
actual sales (DD) curve.
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 Con’t……………………………………….
§Equilibrium attains if the actual sales (DD)
curve cuts the planned sales (dd) curve at
the point of tangency of the later (dd) with
the LAC curve

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Con’t……………………………………….

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 Excess Capacity and Welfare Loss
§ Excess capacity is the difference between
the ideal output corresponding to the
minimum LAC and the output actually
attained in the long run equilibrium.
§

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Con’t……………………………………….

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 Con’t……………………………………….
In general, the social welfare aspects of
monopolistic competition are ambiguous.

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End of Chapter One
Chapter Two
Oligopoly

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Con’t……………………………………….

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