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Chapter 16: Monopolistic competition (In the long run (If firms are making…
Chapter 16: Monopolistic competition
Product differentiation
Profit maximization when Marginal Cost = Marginal Revenue
Demand curve is flatter than monopoly because have close substitutes
Characteristics
Product differentiation (i.e: books, music, films, etc)
Free entry and exit
Many sellers
In the short run
Makes profit when Price > Average Total Cost
Makes a loss when Price < Average Total Cost
graph is similar to monopoly
In the long run
If firms are making a loss => firms will exit
In the long run, Price = Average Total Cost => firms make zero economic profit
If firms are making profit => new firms will enter
This result is due to the free entry and exit of firms
Monopolistic versus perfect competition
Efficient scale: the quantity that minimizes average total cost
quantity produced < efficient scale =>
excess capacity
Mark- up over marginal cost
because Price > Marginal Cost
When new firms enter the markets => the demand curve for each single firm will shift to the left because customers now have more choices of products => reduces the opportunities of a firm to attract customers. The supply curve stays the same
Monopolistic competition and the welfare of society
The product- variety externality
: consumers get some consumer surplus from the introduction of new products => entry of new firms conveys a positive externality on customers
The business- stealing externality
: entry of new firms => causes existing firms to lose customers => negative externality
Because Price > Marginal Cost => always eager to sell additional units
Advertising
critique of advertising: much advertising is psychological rather than informational
advertising as a signal of quality: firms will spend money on advertising quality products because it is worth