Principles of

Economics, 10e
Chapter 17: Monopolistic
Competition

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or duplicated, or posted to a publicly accessible website, in whole or in part. 1
 Chapter Objectives (1 of 2)

By the end of this chapter, you should be able to:

• Describe the characteristics of a monopolistically competitive market.
• Explain the impact of product differentiation on monopolistically
competitive markets.
• Determine the profit-maximizing quantity and price for a
monopolistically competitive firm.
• Compare the demand and marginal revenue curves of
monopolistically competitive firms in the short run versus the long
run.
• Explain the differences between a monopolistically competitive firm
and a perfectly competitive firm.
Mankiw, Principles of Economics, Tenth Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part. 2
 Chapter Objectives (2 of 2)

• Identify the area on a graph that represents a monopolistically

competitive firm's profit or loss.
• Explain the adjustment process in a monopolistically competitive
market if a firm in that market is not making zero profit.
• Given a scenario about goods operating in a monopolistically
competitive market, determine if it is a critique of advertising or a
defense of advertising.

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or duplicated, or posted to a publicly accessible website, in whole or in part. 3
 17-1
Between Monopoly and Perfect Competition

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or duplicated, or posted to a publicly accessible website, in whole or in part. 4
 Oligopoly

• Oligopoly*
• A market structure in which only a few sellers offer similar or
identical products
• When deciding how much to produce and what price to charge, each
firm in an oligopoly is concerned with
• What its competitors are doing
• How its competitors would react to what it might do

*Words accompanied by an asterisk are key terms from the chapter.

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 Concentration Ratio

• Concentration ratio
• Percentage of total output in the market supplied by the four
largest firms
• Industries with four-firm concentration ratios of 90 percent or more
• Aircraft manufacturing
• Tobacco
• Passenger car rentals
• Express delivery services

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or duplicated, or posted to a publicly accessible website, in whole or in part. 6
 Monopolistic Competition

• Monopolistic competition*
• A market structure in which many firms sell products that are
similar but not identical
• Attributes
• Many sellers
• Product differentiation
• Free entry and exit

*Words accompanied by an asterisk are key terms from the chapter.

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 Figure 1 The Four Types of Market
Structure
• Economists who study
industrial organization
divide markets into four
types: monopoly, oligopoly,
monopolistic competition,
and perfect competition.

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 17-2
Competition with Differentiated Products

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The Monopolistically Competitive Firm
in the Short Run
• Profit Maximization
• Produce the quantity where MR = MC
• Uses demand curve to find price
• If P > ATC: Profit
• If P < ATC: Loss
• Similar to monopoly

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 Figure 2 Monopolistic Competitors in
the Short Run
Monopolistic competitors, like monopolists, maximize profit by producing the quantity
at which marginal revenue equals marginal cost. The firm in panel (a) makes a profit
because, at this quantity, price is greater than average total cost. The firm in panel
(b) makes losses because, at this quantity, price is less than average total cost.

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or duplicated, or posted to a publicly accessible website, in whole or in part. 11
 Active Learning 1: Profit or Loss in
SR?
• Identify the firm’s profit or loss

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or duplicated, or posted to a publicly accessible website, in whole or in part. 12
 Active Learning 1: Answers

• For this firm, P < ATC at the

output where MR = MC
• The best this firm can do is to
minimize its losses

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 The Long-Run Equilibrium (1 of 3)

• When firms are making profits, new firms have incentive to enter the
market
• Demand curve shifts left
• Firms experience declining profits
• When firms are making losses, firms have incentive to exit
• Demand curve shifts right
• Firms experience greater profits
• Process of entry and exit continues until the firms in the market make
zero economic profit

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 The Long-Run Equilibrium (2 of 3)

• Once entry and exit have driven profit to zero

• Demand curve is tangent to average total cost curve
• At quantity where MR = MC
• P = ATC

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 The Long-Run Equilibrium (3 of 3)

• As in a monopoly market, price exceeds marginal cost (P > MC)

• Profit maximization requires marginal revenue to equal marginal
cost (MR = MC) and downward-sloping demand curve makes
marginal revenue less than the price (MR < P)
• As in a perfectly competitive market, price equals average total cost
(P = ATC)
• Free entry and exit drive economic profit to zero in the long run

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Figure 3 A Monopolistic Competitor in
the Long Run
• In a monopolistically competitive market, if
firms are making profits, new ones enter,
causing the demand curves for the
incumbent firms to shift to the left.
• Similarly, if firms are making losses, some
of the firms in the market exit, causing the
demand curves of the remaining firms to
shift to the right.
• Because of these shifts in demand,
monopolistically competitive firms
eventually find themselves in the long-run
equilibrium shown here.
• In this long-run equilibrium, price equals
average total cost, and each firm earns
zero profit.
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 Monopolistic versus Perfect
Competition
• Monopolistic competition
• Quantity: not at minimum ATC (excess capacity)
• P > MC, markup over marginal cost
• Perfect competition
• Quantity: at minimum ATC (efficient scale)
• P = MC

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 Figure 4 Monopolistic versus Perfect
Competition
Panel (a) shows the long-run equilibrium in a monopolistically competitive market, and panel
(b) shows the long-run equilibrium in a perfectly competitive market. Two differences are
notable. (1) The perfectly competitive firm produces at the efficient scale, where average total
cost is minimized. By contrast, the monopolistically competitive firm produces at less than the
efficient scale. (2) Price equals marginal cost under perfect competition, but price is above
marginal cost under monopolistic competition.

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 Monopolistic Competition and the
Welfare of Society
• Inefficiency of markup of price over marginal cost
• Deadweight loss of monopoly pricing
• Inefficiency of number of firms
• Product-variety externality (positive externality on consumers)
• Business-stealing externality (negative externality on existing
firms)

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 17-3
Advertising

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 Amount of Advertising

• When firms sell differentiated products and charge prices above

marginal cost, each firm has an incentive to advertise to attract more
buyers
• Advertising spending
• Differentiated consumer goods: 10-20% of revenue
• Industrial products: Little advertising
• Homogenous products: No advertising

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 The Debate over Advertising

• The critique of advertising

• Firms advertise to manipulate people’s tastes
• Psychological rather than informational
• Creates a desire that otherwise might not exist
• Impedes competition
• Makes buyers less concerned with price differences
• Makes demand less elastic
• Firm can increase profits by charging a larger markup
• over marginal cost.
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 The Defense of Advertising

• Provide information to customers

• Customers - make better choices
• Enhances the ability of markets to allocate resources efficiently
• Fosters competition
• Customers - take advantage of price differences
• Allows new firms to enter more easily

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 Advertising as a Signal of Quality

• Large amount of money on advertising can itself be a signal to

consumers about quality
• Little apparent information
• Content of advertising is irrelevant

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 Brand Names

• Spend more on advertising and charge higher prices than generic

substitutes
• Critics of brand names
• Products are not differentiated
• Defenders of brand names
• Consumers – information about quality
• Firms – incentive to maintain high quality

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 17-4
Conclusion

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 Table 1 Monopolistic Competition:
Between Perfect Competition and
Monopoly
Perfect Competition
(1 of 3)
Monopolistic Monopoly
Competition

Features that all

three market
structures share
Goal of firms Maximize profits Maximize profits Maximize profits
Rule for maximizing MR = MC MR = MC MR = MC
Can earn economic Yes Yes Yes
profits in the short run?

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 Table 1 Monopolistic Competition:
Between Perfect Competition and
Monopoly
Perfect Competition
(2 of 3)
Monopolistic Monopoly
Competition
Features that
monopolistic
competition shares
with monopoly
Price taker? Yes No No
Price P = MC P > MC P > MC

Produces welfare- Yes No No

maximizing level of
output?

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 Table 1 Monopolistic Competition:
Between Perfect Competition and
Monopoly (3 of 3)
Perfect Competition Monopolistic Monopoly
Competition
Features that
monopolistic
competition shares
with perfect
competition
Number of firms Many Many One
Entry in the long run? Yes Yes No

Can earn economic No No No

profits in the long run?

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or duplicated, or posted to a publicly accessible website, in whole or in part. 30
 Think-Pair-Share Activity (1 of 2)

You are watching the Super Bowl and during a commercial break you
see an ad featuring LeBron James. In the ad, LeBron James does
nothing but shoot basketballs. He never speaks. There is no written
copy. At the end of the advertisement, the Nike “swoosh” appears on
the screen along with the words “Nike” and “LeBron James Signature
Basketball Shoes.” You read in a newspaper that LeBron James received
$40 million to be the spokesperson for Nike basketball shoes.

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 Think-Pair-Share Activity (2 of 2)

A. While watching, a friend says, “What a waste of society’s resources.

I didn’t learn anything about Nike basketball shoes from that ad. I
think there should be government regulations requiring ads to be
informative in some way.” What have you learned from this ad?
B. Did the use of the Nike name and the Nike “swoosh” provide any
information? Explain.
C. In general, does advertising tend to decrease competition and raise
prices to consumers or increase competition and reduce prices to
consumers? Why?

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 Self-Assessment

• How might advertising reduce economic well-being?

• How might advertising increase economic well-being?

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 Summary

Click the link to review the objectives for this presentation.

Link to Objectives

Mankiw, Principles of Economics, Tenth Edition. © 2024 Cengage. All Rights Reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part. 34