Monopolistic Competition

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.title[
# Monopolistic Competition
]
.subtitle[
## Chapter 16
]
.author[
### Hussain Hadah
]
.date[
### University of Houston | 20 April 2022
]

---

# Table of contents

1. [Introduction](#intro)

2. [Between Monopoly and Perfect Competition](#sec1)

3. [Competition with Differentiated Products](#sec2)

4. [Advertising](#sec3)

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# Introduction

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# Monopolistic Competition Example

- You walk into a bookstore

- There are many books by many authors

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- At first glance, the market for books seems competitive

- There are many authors and publishers

- There are also many buyers

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- At second glance, the market for books could be monopolistic

- Each book is unique, publishers have some latitude in choosing what price to charge

- The sellers in this market are price makers rather than price takers

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- The market for novels fits neither the competitive nor the monopoly model

- It is best described by the model of _monopolistic competition_
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# Between Monopoly and Perfect Competition

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# What is a Monopolistic Competition?

- We saw examples of perfectly competitive markets and monopolistic markets

- Competition and monopoly are two extreme forms of market structure

- Most markets in the economy include elements of both these cases

- Economists call this _imperfect competition_

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- <span style="color:red;"> _Oligopoly_</span> is an example of an imperfectly competitive market with only a few sellers that offer a similar or identical product in a market

- Economists often measure a market’s domination by a small number of firms with a statistic called the _concentration ratio_, which is the percentage of total output in the market supplied by the four largest firms

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- <span style="color:red;"> _Monopolistic competition_</span> is another example of an imperfectly competitive market structure in which there are many firms selling similar but not identical products

- Each firm has a monopoly over its product, but many other firms are competing for the same customers

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<h1 style="font-size:32px">Attributes of a monopolistic competition</h1>

</br>

### 1. Many sellers: Many firms are competing for the same group of customers

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### 2. Product differentiation: Each firm produces a product that is at least slightly different from those of other firms. Thus, rather than being a price taker, each firm faces a downward-sloping demand curve

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### 3. Free entry and exit: Firms can enter or exit the market without restriction. Thus, the number of firms in the market adjusts until economic profits are driven to zero

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#### Examples:  books, computer games, restaurants, piano lessons, cookies, clothing, and so on

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# Monopolistic competition vs Oligopoly

- Both lie between the extreme cases of perfect competition and monopoly

- Oligopoly departs from the perfectly competitive ideal of Chapter 14 because there are only a few sellers in the market

- The small number of sellers makes rigorous competition less likely and strategic interactions among them are vitally important

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- A monopolistically competitive market has many sellers, each of which is small compared to the market

- It departs from the perfectly competitive ideal because each of the sellers offers a somewhat different product

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# 4 types of markets

<img src="images/image1.png" width="80%" height="80%" style="display: block; margin: auto;" />
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# Competition with Differentiated Products

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# Monopolistically Competitive Firm:
## In the short run
<img src="images/image2.png" width="80%" height="80%" style="display: block; margin: auto;" />

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# The LR Equilibrium

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# Monopolistic vs. Perfect Competition

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# Monopolistic Competition and Welfare

### Sources of inefficiency in a monopolistically competitive market:

#### 1. Markup: it causes the same DWL caused by a monopolistic pricing

#### 2. The number of firms in the market: There may be too much or too little entry. One way to think about this problem is in terms of the externalities associated with the entry. Whenever a new firm considers entering the market with a new product, it takes into account only the profit it would make. Yet its entry would also have the following two effects that are external to the firm:

- The _product-variety externality_: Because consumers get some consumer surplus from the introduction of a new product, the entry of a new firm confers a positive externality on consumers
  - The _business-stealing externality_: Because other firms lose customers and profits when faced with a new competitor, the entry of a new firm imposes a negative externality on existing firms
  
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# Monopolistic Competition and Welfare (cont.)

### - Monopolistically competitive markets do not have all the desirable welfare properties of perfectly competitive markets

### - Inefficiencies are subtle, hard to measure, and hard to fix, there is no easy way for public policy to improve the market outcome

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# Advertising

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# The Debate over Advertising

### Is society wasting the resources it devotes to advertising? Or does advertising serve a valuable purpose?

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##### The Critique of Advertising

- Firms advertise to manipulate people’s tastes

- Advertising is psychological rather than informational

- Advertising impedes competition

- Advertising often tries to convince consumers that products are more different than they truly are

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##### The Defense of Advertising

- Advertising to provide information to customers

- Advertising fosters competition

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# Advertising (cont.)

## Advertising as a signal of quality

## Advertising and brand name