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1、16MONOPOLISTIC COMPETITIONstic CompetitionWHATS NEW IN THE SEVENTH EDITION:There are no major changes to this chapter.LEARNING OBJECTIVES:By the end of this chapter, students should understand:what market structures lie between monopoly and petition among firms that sell differentiated products.how
2、the outcomes under monopolistic competition and under perfect competition compare.the desirability of outcomes in monopolistically competitive markets.the debate over the effects of advertising.the debate over the role of brand names.CONTEXT AND PURPOSE:Chapter 16 is the fourth chapter in a five-cha
3、pter sequence dealing with firm behavior and the organization of industry. The previous two chapters developed the two extreme forms of market structurecompetition and monopoly. The market structure that lies between competition and monopoly is known as imperfect competition. There are two types of
4、imperfect competitionmonopolistic competition and oligopoly. This chapter addresses monopolistic competition while the final chapter in the sequence addresses oligopoly. The analysis in this chapter is again based on the cost curves developed in Chapter 13.The purpose of Chapter 16 is to address mon
5、opolistic competitiona market structure in which many firms sell products that are similar but not identical. Monopolistic competition differs from perfect competition because each of the many sellers offers a somewhat different product. As a result, monopolistically competitive firms face a downwar
6、d-sloping demand curve while competitive firms face a horizontal demand curve at the market price. Monopolistic competition is extremely common.KEY POINTS:A monopolistically competitive market is characterized by three attributes: many firms, differentiated products, and free entry.The long-run equi
7、librium in a monopolistically competitive market differs from that in a perfectly competitive market in two related ways. First, each firm in a monopolistically competitive market has excess capacity. That is, it chooses a quantity that puts it on the downward-sloping portion of the average-total-co
8、st curve. Second, each firm charges a price above marginal cost.Monopolistic competition does not have all of the desirable properties of perfect competition. There is the standard deadweight loss of monopoly caused by the markup of price over marginal cost. In addition, the number of firms (and thu
9、s the variety of products) can be too large or too small. In practice, the ability of policymakers to correct these inefficiencies is limited.The product differentiation inherent in monopolistic competition leads to the use of advertising and brand names. Critics of advertising and brand names argue
10、 that firms use them to manipulate consumers tastes and to reduce competition. Defenders of advertising and brand names argue that firms use them to inform consumers and to compete more vigorously on price and product quality.CHAPTER OUTLINE:I.Between Monopoly and Perfect CompetitionA.The typical fi
11、rm has some market power, but its market power is not as great as that described by monopoly.B.Firms in imperfect competition lie somewhere between the competitive model and the monopoly model.C.Definition of oligopoly: a market structure in which only a few sellers offer similar or identical produc
12、ts.1.Economists measure a markets domination by a small number of firms with a statistic called a concentration ratio.2.The concentration ratio is the percentage of total output in the market supplied by the four largest firms.3.In the U.S. economy, most industries have a four-firm concentration rat
13、io under 50%.D.Definition of monopolistic competition: a market structure in which many firms sell products that are similar but not identical.1.Characteristics of Monopolistic Competitiona.Many Sellersb.Product Differentiationc.Free EntryFigure 1E.Figure 1 summarizes the four types of market struct
14、ure. Note that it is the number of firms and the type of product sold that distinguishes one market structure from another.Draw a table with the four types of markets across the top. Create rows for various market characteristics such as type of product sold, number of firms, control over price, fre
15、edom of entry and exit, and ability to earn profit in the long run. Students will then be able to see how these characteristics relate to one another.Activity 1Think of a FirmType:In-class assignmentTopics: Market structureMaterials needed: NoneTime: 15 minutesClass limitations: Works in any size cl
16、assPurpose This assignment helps students relate the concept of market structure to the real world.Instructions Ask the class to answer the following questions. After they have answered all of them, ask the students to share their answers with a neighbor. Ask the neighboring student to evaluate the
17、answer to the last question. List the four market structures on the board and ask for examples that fit each category1.Write the name of a specific firm. It should be a real company, not hypothetical. 2.What products or services does this firm sell If the firm sells a wide variety of goods, choose a
18、 single item to answer the following questions.3.What other firms compete with this company Are there many competitors, only a few, or none4.Do the competing firms sell exactly the same product or does each company produce goods with special characteristics5.Categorize the industry as one of the fol
19、lowing market structures:a. Perfect competition many firms identical productsb. Monopoly one firm unique productc. Oligopoly a few firms standard or differentiated productd. Monopolistic competition many firms differentiated productsCommon Answers and Points for DiscussionMany students will choose c
20、ompanies that produce consumer goods, where product differentiation is the most important characteristic. Most of these industries are either oligopolies or monopolistically competitive. A few students may have examples of monopoly, particularly utilities or patented medicines. Almost no one will gi
21、ve an example of perfect competition.Perfect competition, while an economic ideal, does not accurately describe all sectors of the economy. Explaining that perfect competition is a special case (and adding some examples of competitive industries) will help students understand why competitive firms f
22、ace a horizontal demand curve and have no control over the prices of their products.Some students may have questions about the differences between oligopoly and monopolistic competition. Differentiating between a “few” and “many” is not always easy. Measures of market concentration can be used to ex
23、plain the difference between these two imperfectly competitive market structures.II.Competition with Differentiated ProductsA.The Monopolistically Competitive Firm in the Short Run1.Each firm in monopolistic competition faces a downward-sloping demand curve because its product is different from thos
24、e offered by other firms.2.The monopolistically competitive firm follows a monopolists rule for maximizing profit.Explain to students that product differentiation gives the seller in a monopolistically competitive market some ability to control the price of its product. In a sense, each firm is a mo
25、nopoly in the production of its particular version of the product. This is reflected by the fact that these firms face a downward-sloping demand curve. Point out that the graph looks something like a monopoly, but that the demand the firm faces will likely be much flatter (because it will be more el
26、astic).a.It chooses the output level where marginal revenue is equal to marginal cost.b.It sets the price using the demand curve to ensure that consumers will demand exactly the amount produced.Figure 23.We can determine whether or not the monopolistically competitive firm is earning a profit or los
27、s by comparing price and average total cost.a.If P ATC, the firm is earning a profit.b.If P ATC, the firm is earning a loss.c.If P = ATC, the firm is earning zero economic profit.B.The Long-Run Equilibrium1.When firms in monopolistic competition are making profit, new firms have an incentive to ente
28、r the market.a.This increases the number of products from which consumers can choose.b.Thus, the demand curve faced by each firm shifts to the left.c.As the demand falls, these firms experience declining profit.2.When firms in monopolistic competition are incurring losses, firms in the market will h
29、ave an incentive to exit.a.Consumers will have fewer products from which to choose.b.Thus, the demand curve for each firm shifts to the right.c.The losses of the remaining firms will fall.3.The process of exit and entry continues until the firms in the market are earning zero profit.a.This means tha
30、t the demand curve and the average-total-cost curve are tangent to each other.b.At this point, price is equal to average total cost and the firm is earning zero economic profit.Figure 3Remember that students have a hard time understanding why a firm will continue to operate if it is earning “only” z
31、ero economic profit. Remind them that zero economic profit means that firms are earning an accounting profit equal to their implicit costs.Point out to students that, just like firms in perfect competition, firms in monopolistic competition also earn zero economic profit in the long run. Show them t
32、hat this result occurs because firms can freely enter the market when profits occur, driving the level of profits to zero. Any market with no barriers to entry will see zero economic profit in the long run. 4.There are two characteristics that describe the long-run equilibrium in a monopolistically
33、competitive market.a.Price exceeds marginal cost (due to the fact that each firm faces a downward-sloping demand curve).b.Price equals average total cost (due to the freedom of entry and exit).C.Monopolistic versus Perfect CompetitionFigure 41.Excess Capacitya.The quantity of output produced by a mo
34、nopolistically competitive firm is smaller than the quantity that minimizes average total cost (the efficient scale).b.This implies that firms in monopolistic competition have excess capacity, because the firm could increase its output and lower its average total cost of production.c.Because firms i
35、n perfect competition produce where price is equal to the minimum average total cost, firms in perfect competition produce at their efficient scale.2.Markup over Marginal Costa.In monopolistic competition, price is greater than marginal cost because the firm has some market power.b.In perfect compet
36、ition, price is equal to marginal cost.D.Monopolistic Competition and the Welfare of Society1.One source of inefficiency is the markup over marginal cost. This implies a deadweight loss (similar to that caused by monopolies).2.Because there are so many firms in this type of market structure, regulat
37、ing these firms would be difficult.3.Also, forcing these firms to set price equal to marginal cost would force them out of business (because they are already earning zero economic profit).4.There are also externalities associated with entry.a.The product-variety externality occurs because as new fir
38、ms enter, consumers get some consumer surplus from the introduction of a new product. Note that this is a positive externality.b.The business-stealing externality occurs because as new firms enter, other firms lose customers and profit. Note that this is a negative externality.c.Depending on which e
39、xternality is larger, a monopolistically competitive market could have too few or too many products.5.In the News: Insufficient Variety as a Market Failurea.Firms may insufficiently service consumers with unusual preferences in markets with large fixed costsb.This article from Slate describes how so
40、me consumers get left out of the market because of the high fixed costs associated with creating additional varieties of a product.III.AdvertisingA.The Debate over Advertising1.The Critique of Advertisinga.Firms advertise to manipulate peoples tastes.b.Advertising impedes competition because it incr
41、eases the perception of product differentiation and fosters brand loyalty. This means that consumers will be less concerned with price differences among similar goods.2.The Defense of Advertisinga.Firms use advertising to provide information to consumers.b.Advertising fosters competition because it
42、allows consumers to be better informed about all of the firms in the market.3.Case Study: Advertising and the Price of Eyeglassesa.In the United States during the 1960s, states differed on whether or not they allowed advertising for optometrists.b.In the states that prohibited advertising, the avera
43、ge price paid for a pair of eyeglasses in 1963 was $33; in states that allowed advertising, the average price was $26 (a difference of more than 20%).B.Advertising as a Signal of Quality1.The willingness of a firm to spend a large amount of money on advertising may be a signal to consumers about the
44、 quality of the product being offered.2.Example: Kellogg and Post have each developed a new cereal that would sell for $3 per box. (Assume that the marginal cost of producing the cereal is zero.) Each company knows that if it spends $10 million on advertising, it will get one million new consumers t
45、o try the product. If consumers like the product, they will buy it again.a.Post has discovered through market research that its new cereal is not very good. After buying it once, consumers would not likely buy it again. Thus, it will only earn $3 million in revenue, which would not be enough to pay
46、for the advertising. Therefore, it does not advertise.b.Kellogg knows that its cereal is great. Each person that buys it will likely buy one box per month for the next year. Therefore, its sales would be $36 million, which is more than enough to justify the advertisement.c.By its willingness to spen
47、d money on advertising, Kellogg signals to consumers the quality of its cereal.3.Note that the content of the advertisement is unimportant; what is important is that consumers know that the advertisements are expensive.C.Brand Names1.In many markets there are two types of firms; some firms sell prod
48、ucts with widely recognized brand names while others sell generic substitutes.2.Critics of brand names argue that they cause consumers to perceive differences that do not really exist.3.Economists have defended brand names as a useful way to ensure that goods are of high quality.a.Brand names provide consumers with information about quality when quality cannot be judged easily in advance