21April, 2006
Reading: Finish Chapter 8
Start Chapter 11
HW 14 Due Monday
Lecture 35
REVIEW______:
VII. Chapter 8. Managing in Competitive, Monopolistic and Monopolistically Competitive Markets.
B. Monopoly
3. Optimizing decisions.
a. Graphically
b. Analytically
4. Observations: Social Costs of Monopoly
The monopolist posts a higher price, produces a smaller quantity and earning economic profits.
Example:
P = 124 – 2Q and TC = 625 + 4Q + Q2
=TR-TC
=(124 – 2Q)Q-(625 + 4Q + Q2)
MR=124 – 4Q
MC=4 + 2Q
Optimum: 120 = 6Q
Q = 20
P = 84
= 84(20) – [625 + 4(20) + 202]
= 1680 – 1115
= 565
Compare to a Competitor, who will produce where MC=ATC
4+2Q =625/Q + 4 + Q
625 = Q2
25 = Q
P = 4 + 2(25)=54
But notice that at this price, the market would produce 124-2(25) = 76 units, or roughly 3 firms would compete.
Preview______
C. Monopolistic Competition
.1. Assumptions
2. Characterization:
3. Optimizing decisions.
4. Observations.
Lecture______
C. Monopolistic Competition. The third structural model we consider combines important components of the preceding two models.
1. Assumptions
(c) Products are differentiated.
As indicated at the beginning of class, examples of monopolistic competition include restaurants and beer, soft drinks, and many food products.
2. Characterization. Due to product differentiation monopolistic competitors face downsloping demand curves. Thus in the optimum, monopolistically competitive firms will not produce at the point where ATC = MC, as in the competitive case. However, due to entry and exit, all profits will be driven to zero.
a. Short Run Decisions. In the short run, the decision-calculus is exactly as the monopolist.
P
MC
...... AC
. Profits . .
......
D = AR = P
Q
Q* MR
Optimal quantity Q* is determined by the intersection of Marginal Revenue and Marginal cost curves. The optimal price is the intersection of the vertical extending from Q* and the demand curve. Profits are the difference between AR and ATC multiplied by the number of units produced.
b. Long Run Decisions. Due to free entry and exit, however, profits in a monopolistically competitive firm are driven to zero. The dynamic motivating this outcome involves shifts in the firm’s demand curve. As new competitors enter the market, the monopolistic competitor still has his or her “following”, however, some consumers will switch to one of the entrants, shift the demand curve for the firm inward. Inward shifts of this nature will persist until the demand curve is just tangent to the ATC curve at the optimum.
P
MC
. . . AC
. .
D’ = AR = P
Q
Q* MR’
3. Implications of Product Differentiation.
a. Product Differentiation and Social Welfare. Notice that although monopolistically competitive firms earn zero economic profits, MC does not equal ATC in the long run. Some would argue that this is a social cost associated with this industry structure. Others, however, would (I think quite reasonably) contend that the welfare loss is the cost of product differentiation. Consumers value differentiation, and if they did not, homogenous product competitive industries would prevail.
b. The nature of Managerial Decisions and the Industry Structure. Note the difference in managerial decisions in each industry structure. In the competitive industry, the primary focus of managerial decisions will be on reducing costs. Monopolists, on the other hand, are frequently regulated. Even if not, they are concerned with pricing as well as output level decisions. Finally, the monopolistic competitor will typically engage in considerable advertising, and new product development in order to make demand more inelastic, and to capture short term profits.