11/30/2019

N. GREGORY MANKIW
PRINCIPLES OF The Big Picture
ECONOMICS  Chapter 13: The cost of production
Eight Edition  Now, we will look at firm's revenue
 But revenue depends on market structure
1. Competitive market (chapter 14)
CHAPTER Monopoly (chapter 15)
Monopolistic
2.
3. Monopolistic Competition (this chapter)
Competition 4.

Oligopoly (chapter 17)
Are there other types of markets? Yes, not now
Premium PowerPoint Slides by:
V. Andreea CHIRITESCU
Modified by Joseph Tao-yi Wang Eastern Illinois University
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
1 2019/11/30 Perfect Competition Joseph Tao-yi Wang

N. GREGORY MANKIW
PRINCIPLES OF Chapter 14: Perfect Competition
ECONOMICS  Products are Perfect Substitutes
Eight Edition  Result: Price Taking
 P = MR = MC
 SR: Will operate if P > AVC (FC is sunk)
CHAPTER
Monopolistic
Perfect  LR: Will operate at P = ATC
 Firms enter if P > ATC; exit if P < ATC
Competition
Premium PowerPoint Slides by:
V. Andreea CHIRITESCU
Modified by Joseph Tao-yi Wang Eastern Illinois University
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
3 2019/11/30 Perfect Competition Joseph Tao-yi Wang

N. GREGORY MANKIW
PRINCIPLES OF Chapter 15: Monopoly
ECONOMICS  MR=MC to maximize profit (still true!)
Eight Edition  But, P > MR (D - downward sloping)
 Welfare Cost of a Monopoly:
 Profits (unfair?) vs. DWL (efficiency loss!)
CHAPTER
Monopoly  Cures? Do nothing?
 Auction off the market!

Premium PowerPoint Slides by:

V. Andreea CHIRITESCU
Modified by Joseph Tao-yi Wang Eastern Illinois University
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
5 2019/11/30 Monopoly Joseph Tao-yi Wang

1
 11/30/2019

Look for the answers to these questions: Introduction

• What market structures lie between perfect • Two extremes
competition and monopoly, and what are • Perfect competition: many firms, identical
their characteristics? products (perfect substitutes)
• How do monopolistically competitive firms • Monopoly: one firm (no substitutes)
choose price and quantity? Do they earn • Imperfect competition – in between the
economic profit? extremes: (partial substitutes)
• How does monopolistic competition affect – Oligopoly: only a few sellers offer similar
society’s welfare? or identical products.
• What are the social costs and benefits of – Monopolistic competition: many firms sell
advertising? similar but not identical products.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 8 as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 9
management system for classroom use. management system for classroom use.

Comparisons
Monopolistic Competition
Perfect Monopolistic
• Characteristics: Competition Competition Monopoly
Number of sellers Many Many One
– Many sellers with product differentiation
Free entry/exit Yes Yes No
 Location, location, location! (產品定位) Long-run
• Not price takers; downward sloping D curve economic profits Zero Zero Positive
– Free entry and exit The products No close
firms sell Identical Differentiated substitutes
• Zero economic profit in the long run
Firm has market None;
• Examples of monopolistic competition: power? price-taker Yes Yes

– Apartments, books, bottled water, D curve Downward- Downward

facing firm Horizontal sloping -sloping
clothing, fast food, night clubs
(market D)
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 10 as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 11
management system for classroom use. management system for classroom use.

A Monopolistically Competitive Firm Earning

Short Run Equilibrium Profits in the Short Run
• Profit maximization in the short-run for the
The firm faces a Price
monopolistically competitive firm: downward-sloping profit MC
– Produce the quantity where MR = MC D curve. P ATC

– Price: on the demand curve At each Q, MR < P. ATC

D
– If P > ATC: profit To maximize profit,
– If P < ATC: loss firm produces Q MR
where MR = MC.
– Similar to monopoly Q Quantity
The firm uses the
D curve to set P.

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 12 as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 13
management system for classroom use. management system for classroom use.

2
 11/30/2019

A Monopolistically Competitive Firm

Long Run Equilibrium
With Losses in the Short Run
• If monopolistically competitive firms are
Price
For this firm, MC making profit in short run
P < ATC losses ATC – New firms: incentive to enter the market
at the output where • Increase number of products
ATC
MR = MC.
P – Reduces demand faced by each firm
The best this firm • Demand curve shifts left; prices fall
can do is to D
– Each firm’s profit declines to zero
minimize its losses. MR
Q Quantity • If losses in the short run:
– Some firms exit the market, remaining firms
enjoy higher demand and prices
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 14 as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 15
management system for classroom use. management system for classroom use.

A Monopolistic Competitor in the Long Run Why Monopolistic Competition Is

Less Efficient than Perfect Competition
Entry and exit occurs • Monopolistic competition
until P = ATC and Price
MC – Excess capacity: quantity is not at
profit = zero.
ATC minimum ATC (it is on the downward-
Notice that the firm P = ATC sloping portion of ATC)
charges a markup of
price over marginal markup – Markup over marginal cost: P > MC
cost and does not D • Perfect competition
produce at minimum MC MR
– Quantity: at minimum ATC (efficient scale)
ATC. Q Quantity
– P = MC

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 16 as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 17
management system for classroom use. management system for classroom use.

Welfare of Society Welfare of Society

• Monopolistically competitive markets • Markup, P > MC
– Do not have all the desirable welfare – Market quantity < socially efficient quantity
properties of perfectly competitive markets • Deadweight loss of monopoly pricing
• Sources of inefficiency • The product-variety externality:
– Markup of price over marginal cost – Consumers get extra surplus from the
– Too much or too little entry (number of introduction of new products
firms in the market) • The business-stealing externality:
• Product-variety externality – Losses incurred by existing firms when
• Business-stealing externality new firms enter market
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 18 as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 19
management system for classroom use. management system for classroom use.

3
 11/30/2019

Active Learning 1 Advertising Advertising

1. So far, we have studied three market • Incentive to advertise
structures: perfect competition, monopoly,
– When firms sell differentiated products
and monopolistic competition.
and charge prices above marginal cost
– In each of these, would you expect to see firms
spending money to advertise their products? – Advertise to attract more buyers
Why or why not? • Advertising spending
2. Is advertising good or bad from society’s – Highly differentiated goods: 10-20% of
viewpoint? Try to think of at least one “pro” revenue
and “con.” – Industrial products: Little advertising
– Homogenous products: No advertising
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 20 as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 21
management system for classroom use. management system for classroom use.

Advertising The Critique of Advertising

• In monopolistically competitive industries • Firms advertise to manipulate people’s
– Product differentiation and markup pricing tastes
lead naturally to the use of advertising – Psychological rather than informational
• The more differentiated the products • Creates a desire that otherwise might not
exist
– The more advertising firms buy
• Advertising impedes competition
• Economists disagree about the social – Increase perception of product differentiation
value of advertising: • Foster brand loyalty; higher markups
– Wasting resources? • Makes buyers less concerned with price
– Valuable purpose? differences among similar goods
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 22 as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 23
management system for classroom use. management system for classroom use.

The Defense of Advertising Advertising

• The defense of advertising • Advertising as a signal of quality
– It provides useful information to buyers – Little apparent information
– Informed buyers can more easily find and – Real information offered – a signal
exploit price differences • Willingness to spend large amount of money
– Advertising promotes competition and = signal about quality of the product
reduces market power
– Content of advertising = irrelevant
• Results of a prominent study: Benham (1972)
– Eyeglasses were more expensive in states that
prohibited advertising by eyeglass makers than
in states that did not restrict such advertising
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 24 as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 25
management system for classroom use. management system for classroom use.

4
 11/30/2019

Brand Names Brand Names

• In many markets, brand name products • Critics of brand names
coexist with generic ones. – Products – not differentiated
• Brand names – Irrationality: consumers are willing to pay
– Spend more on advertising and charge more for brand names
higher prices than generic substitutes • Defenders of brand names
• As with advertising, there is disagreement – Consumers – information about quality
about the economics of brand names… – Firms – incentive to maintain high quality
to protect the reputation of their brand
name
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 26 as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 27
management system for classroom use. management system for classroom use.

Summary Summary
• A monopolistically competitive market has • Monopolistic competition does not have all
many firms, differentiated products, and free of the desirable welfare properties of perfect
entry. competition.
• Each firm in a monopolistically competitive – There is a deadweight loss caused by the
market has excess capacity—it produces markup of price over marginal cost.
less than the quantity that minimizes ATC. – Also, the number of firms (and thus
Each firm charges a price above marginal varieties) can be too large or too small.
cost. – There is no clear way for policymakers to
improve the market outcome.

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 28 as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 29
management system for classroom use. management system for classroom use.

Summary
• Product differentiation and markup pricing
Chapter 16: Monopolistic Competition
lead to the use of advertising and brand  Differentiated Products: Closest to reality!
names.  Location, location, location!
– Critics of advertising and brand names  SR: Like a monopoly (locally)
argue that firms use them to reduce  LR: Zero profits
competition and take advantage of  Homework: Mankiw, Ch.16, Problem 2, 5, 7-10
consumer irrationality.  Challenge Questions (Past Finals)
– Defenders argue that firms use them to  2007 - Part 3, 6 2014 - Essay C5-6
inform consumers and to compete more  2015 - Essay B7-12 2017 - Essay B6-8, D1
vigorously on price and product quality.  2018 - Essay C5-9
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 30
management system for classroom use. 2019/11/30 Monopolistic Competition Joseph Tao-yi Wang