Monopolistic Competition

Introduction

• Lecture by Jacob from reviewecon.com
• For more help, visit reviewecon.com and pick up the Total Review Booklet

Monopolistic Competition Characteristics

• Many sellers within the market → High competition
• Low barriers to entry:
  • Examples: High startup costs, customer loyalty, government regulations
• Zero economic profit in the long run (firms break even or earn normal profit)
• Goods are differentiated but substitutable
  • Leads to a downward sloping demand curve due to the substitution effect

Demand and Marginal Revenue

• Graph setup: Price (Y-axis), Quantity (X-axis)
• Each firm has its own downward-sloping demand curve (portion of market demand)
• Increase in price → Consumers buy substitutes
• Increase in output → Price falls
• Marginal Revenue (MR) differs from Demand (D)
  • MR is less than price
  • Illustrated with a table example
• Graphing Demand and MR:
  • Demand (D) curve
  • MR curve below D
• Elasticity:
  • Positive MR → Elastic demand
  • MR = 0 → Unit elastic point
  • Negative MR → Inelastic demand

Short Run Graphs

• Economic profits:
  • Axis: Price (Y-axis), Quantity (X-axis)
  • Demand curve, MR curve, Marginal Cost (MC) curve
  • Profit-maximizing quantity: MR = MC
  • Profit-maximizing price: At demand curve above MR=MC
  • Economic profit: ATC is lower than demand at profit-maximizing quantity
  • Rectangular area between ATC and demand at profit-maximizing quantity = Economic profit
• Economic losses:
  • Setup similar to profit graph
  • Economic loss: ATC is above demand at profit-maximizing quantity
  • Firm continues operating if Price > Average Variable Cost (AVC)
  • Loss minimization due to covering AVC, losing less than fixed costs if shut down

Long Run Equilibrium

• Firms break even due to low barriers to entry
• Zero economic profit graph setup:
  • Demand curve, MR curve, MC curve
  • ATC tangent to demand curve at profit-maximizing quantity
  • Firm breaks even: ATC = Demand

Transition to Long Run Equilibrium

• From economic profits to long run:
  • Firms enter market → Demand and MR shift left
  • Decreased market share for each firm → More substitutes
  • Elasticity increases
• From economic losses to long run:
  • Firms exit market → Demand and MR shift right
  • Increased market share for remaining firms → Fewer substitutes
  • Demand becomes less elastic

Efficiency in Monopolistic Competition

• Not productively efficient (produces on downward sloping part of ATC curve)
  • Termed excess capacity
  • Unlike monopoly's economies of scale
• Not allocatively efficient (price above MC)
  • Markup between price and MC
  • Deadweight loss present due to inefficiency

Benefits of Monopolistic Competition

• Variety due to product differentiation
• Variety adds real value to consumers

Changes in Costs Impact

• Fixed cost changes (e.g., lump-sum tax, rent, advertising):
  • Shifts ATC, not quantity or price
  • Creates short-run economic losses or profits
  • Long run: Firms break even
• Variable cost changes (e.g., per unit tax, input price changes):
  • Shifts ATC and MC
  • New MR = MC → New quantity and price
  • Economic losses/profits in short run

Conclusion

• Practice drawing graphs at reviewecon.com
• Total Review Booklet for further help
• Importance of understanding graphs for exams.