1. Monopolistic Competition

2. Monopolistic Competition Characteristics of Different Market Organizations

3. Industry Characteristics monopolistic competition A common form of industry (market) structure, characterised by a large number of firms, no barriers to entry, and product differentiation.

4. Product Differentiation and Advertising How Many Varieties? product differentiation A strategy of producing products that have distinct favourable identities in consumers’ minds.

5. Product Differentiation and Advertising How Do Firms Differentiate Products? There are three types of product differentiation: • Simple: the products are differentiated based on a variety of characteristics; • Horizontal: the products are differentiated based on a single characteristic, but consumers are not clear on which product is of higher quality; and • Vertical: the products are differentiated based on a single characteristic and consumers are clear on which product is of higher quality. Differentiation occurs because buyers perceive a difference, eg due to design, performance, or how it is distributed and marketed, and who buys it.

6. Product Differentiation and Advertising Sources of product differentiation • Differences in quality, usually accompanied by differences in price • Differences in functional features or design • Ignorance of buyers regarding the essential characteristics and qualities of goods they are purchasing • Sales promotion activities of sellers, particularly advertising • Differences in availability (e.g. timing and location).

7. Product Differentiation and Advertising How Do Firms Differentiate Products? An Economist Makes TeaBottled iced tea in the US is a classic example of a monopolistically competitive market. None of the brands are exactly alike. Nor are the teas priced the same.

8. Goldman and Nalebuff discovered that sugar in iced tea beyond some point adds little taste, yet comes at a health cost—more calories. Given consumers’ new awareness of healthy and natural foods, Honest Tea became an overnight success. Product differentiation had worked. Product Differentiation and Advertising

9. Product Differentiation and Advertising Advertising

10. Product Differentiation and Advertising Advertising

11. Product Differentiation and Advertising Arguments for product differentiation • Product differentiation extends the life cycle of declining products • It satisfies the range of tastes and preferences in a modern economy. • It ensures high quality and efficient production • Advertising provides consumers with the information on product availability, quality, and price

12. Product Differentiation and Advertising The Case against product differentiation • It produces waste and inefficiency. Enormous sums are spent to create minute, meaningless differences among products. • Advertising raises the cost of products. • Comsumers are exploited as people exist to satisfy the needs of the economy, not vice versa. • Advertising serves as a barrier to entry, thus reducing real competition.

13. Price and Output Determination The demand curve that a monopolistic competitor faces is likely to be less elastic than the demand curve of a perfectly competitive firm because close substitutes for the products of a monopolistic competitor are available. Product Differentiation and Demand Elasticity Product Differentiation Reduces the Elasticity of Demand Facing a Firm P Q

14. Price and Output Determination – Short Run In the short run, a monopolistically competitive firm will produce up to the point MR = MC. At q0 = 2,000 in panel a, the firm is earning short-run profits equal to P0ABC = £2,000. In panel b, another monopolistically competitive firm with a similar cost structure is shown facing a weaker demand and suffering short-run losses at q1 = 1,000, equal to CABP1 = £1,000.

15. Price and Output Determination in Long Run As new firms enter a monopolistically competitive industry in search of profits, the demand curves of existing firms begin to shift to the left, pushing marginal revenue with them as consumers switch to the new close substitutes. This process continues until profits are eliminated, which occurs for a firm when its demand curve is just tangent to its average total cost curve (ATC). Monopolistically Competitive Firm at Long- Run Equilibrium

16. Economic Efficiency and Resource Allocation Because entry is easy in monopolistic competition, supernormal profits are eliminated in the long run. Once a firm achieves any degree of market power by differentiating its product (as is the case in monopolistic competition), its profit-maximizing strategy is to hold down production and charge a price above marginal cost. The final equilibrium in a monopolistically competitive firm is to the left of the lowest point on its average total cost curve.

17. Conclusion 1. P is greater than MC – the firm is not allocatively efficient. 2. MC does not equal AC – the firm is not productively efficient as it is not operating at least-cost output per unit. 3. Consumers are not as sovereign as in perfect competition. Advertising distorts their choices. Branding creates artificial desires.

18. Key terms • Horizontal differentiation • Allocative efficiency • Productive efficiency • Consumer sovereignty • Barriers to entry • Product differentiation