Economics Assignment help
Monopolistic Competition Characteristics:
● Many producers ● Differentiated Products ● Market Power ● Free Entry and Exit
Examples Fast Food
● Many Firms competing, but no one is selling the exact same thing. ● Anyone can join.
Examples ● Hotels ● Hotels usually have
50 to 300 rooms… ● IHG & Wyndham
Seem to be the biggest… ○ But together might have a ¼ of the market.
Other Examples:
● Car Washes, Repair shops ● Restaurants in general
Characteristics ● Not Price-Takers — they can credibly raise prices. ● They have a unique product. ● But still have competitors — competitors have imperfect substitutes
Comparisons Different than perfect competition because…
● Their product is differentiated ● Consequently, they don’t lose all their customers when they raise prices
Similar to perfect competition because…
● There are many competing firms ● Anyone can enter or exit
Comparisons Similar to Monopoly because…
● Firms have market power — they can raise their prices ● They face a downward sloping demand curve
○ If they raise prices, quantity demanded decreases only a little
Different than Monopoly because…
● There are many firms ● Anyone can enter or exit
Comparisons Similar to Oligopoly because…
● Firms have market power ● There is imperfect competition
Different than Oligopoly because…
● There is free entry and exit ● There are many firms, not just a few ● Collusion is not reasonable
Product Differentiation & Market Power Product differentiation is what gives firms market power here
● Monopoly — market power driven by no close substitutes ● Oligopoly — market power because there were only a few close substitutes ● Monopolistic Competition — market power because companies sell imperfect substitutes (i.e.
substitutes that are not equivalent)
Monopoly: People still buy the good when prices go up because there are no other options.
Oligopoly: People still buy the good when prices go up because there are few other options
Monopolistic Competition: People still buy the good when prices go up because the product is different
Product Differentiation & Market Power Product differentiation is what gives firms market power here
● Perfect Competition– no market power, because firms are selling a standardized product ○ All producer’s products are equivalent in the eyes of the consumer. If one person charges a
higher price for the same item, you don’t buy from them. ● Here, when one person raises their price, people might substitute away from them, but not entirely.
How do firms differentiate? ● By style or type
○ Taco Bell ■ Constantly offering new items
● New Menu every 6 weeks (supposedly) ● Cheetos Quesadilla
○ Popeyes ■ Seems to really emphasize their “southern” style
○ Wendy’s ■ Frosty’s seem somewhat unique ■ Set of sides (i.e. Chili) seem unique
○ Chick-Fil-A ■ Markets to Christians disproportionately (I think)
By style or type ● Clothing store brands
○ Business vs. Casual ○ Men’s vs. Women’s ○ Trendy vs. ClassiC
● Car companies ○ SUVs ○ Sports Cars ○ Minivans ○ Outdoor
By Location: ● 7-11: Expensive and small — but very conveniently located ● CVS: large, but harder to find
By Location: ● Starbucks: more of a study spot ● Dunkin Donuts: come & go
By Location: ● Subway: Small but everywhere– gas stations specifically ● Sonic: Bigger, but have a classy drive-in vibe
By Quality Taco Bell vs. Chipotle
By Quality McDonalds vs. Shake Shack
How to Model Monopolistic Competition Our models include: “Cost curves” and “revenue curves” and firms maximize profits
We assume all firms have the same sort of costs. → Nothing new when it comes to costs
When it comes to revenue… Firms have market power, so their demand is downward sloping.
Because of the “price effect”, the marginal revenue of a unit is less than the price of the unit.
The change in total revenue from selling the unit is less than the price, because they also have to lower the price of all previous units.
Monopolistic Competition and Monopoly are extremely similar — in the short-run
● Everything is the same as Monopoly. ● Demand (AR here) is probably more elastic
○ More substitutes→ more elastic
● Produce Q at MC = MR ● Charge P from Demand Curve at Q ● Profit = Q(P-ATC)
But in the Long Run, Competition becomes relevant ● Monopolistic Competition includes Free Entry and Exit
○ If firms are making profit, firms enter. ○ If firms are making losses, firms leave
● In the Long Run, firms can enter or exit. ● What happens when firms enter?
○ Demand and Marginal Revenue shift left.
● What happens when firms leave? ○ Demand and Marginal Revenue shift right.
A way to think about this… Demand for Industry Firm Demand with 3 Firms Firm Demand with 4 Firms
● There is demand for the goods in an industry, that are split up between firms ● When more firms enter, the demand for each individual firm goes down. ● More firms enter → the customers are spread across more firms
● Because firms choose their prices and quantity together, there is no “supply” here. ○ The firm’s quantity supplied depends upon demand.
Price Quantity
4 48
3 36
2 24
Price Quantity
4 12
3 8
2 6
Price Quantity
4 16
3 12
2 8
An Example ● Suppose McDonald’s, Wendy’s, & Burger King are the 3 restaurants on
Burger Island. ● They’re making profit. ● Shake Shack sees the $$$ being made → opens up shop. ● Burger Island has the same amount of people. ● McDonald’s, Wendy’s & Burger King lose customers
○ → demand for the firms will shift left
Short Run vs. Long Run
● Firms sell Q at MC = MR ● Charge P based upon Demand
Long Run Characteristics
● Long Run → Firms enter or exit until Profit = 0
● Profit = Q(P-ATC) ○ P = ATC
● At Q where MC = MR, the ATC curve is Tangent to the curve Demand curve.
● At Q where MC = MR, P = ATC
Long Run Characteristics
● Firms make no profit → seems nice ○ If firms are making profit, other firms enter and the
Price gets lower.
● But firm’s won’t minimize costs ○ Unlike in perfect competition
Why is that the case?
● Two approaches: ○ MC = MR needs to be the case at Q*
■ If MC = MR = ATC (i.e. minimum cost point) then: ● P > ATC
○ since P > MR & MR =ATC ■ But if P > ATC → there are positive profits
● Firms enter ● This is not a stable long run equilibrium
○ Suppose P = ATC = MC→ zero profits and minimum cost ■ Since MR < P, MR < MC. ■ Firms will want to produce less.
Product Differentiation and Advertising ● Firms advertise to increase demand or make demand less elastic ● They can influence consumers — because they have a differentiated product
○ Advertising seems silly in perfect competition ○ Not much of a point in advertising if a product is equivalent to a competitors. ○ If you can’t charge above the market price and you can sell as much as you want at the
market price, why spend money in hopes of selling more?
Problems with Advertising ● Often don’t convey any information
○ But can serve as signals ■ Suppose a company spends several million dollars on advertising during the Super
Bowl– and the ad is very funny, but you learn nothing about the product directly. ■ It might signal that the product is good, since companies that can spend lots on
advertising are more likely to have a good product. ● How else would they get all that money if people didn’t like the product?
● Wasting Money ○ Estimated 195 Billion dollars spent on advertising in the US in 2016 ○ Is the World better off because of that spending? ○ Does Coke and Pepsi spending over 5 Billion a year on advertising help us as a society?
Problems with Advertising ● Brand Names vs. Generic
○ Brand Names help customers feel safe and good about a purchase. ■ I feel confident taking Nyquil– not concerned about being poisoned at all. ■ A random person could probably start a company and sell the same sort of stuff for a
much lower price. But I ain’t buying.
Differentiation and Many Options: Pros and Cons
● Pro: Products that are better suited for you. ○ Ragu and Prego used to offer one kind of a very similar sauce ○ Did market analysis and found that some people really preferred chunky sauce. ○ They now have 22 kinds of sauce.
● Cons: ○ Might enjoy your choice less after spending so much time thinking about tradeoffs
■ Starbucks is tasty. ■ Consider that you could’ve fed two starving kids with that money.
● Starbucks seems less tasty.
Problem Set 5
Name: ________________________
Monopoly
1. What are the five listed barriers to entry in the Monopoly lecture? (5 pts.)
2. Draw a graph of a monopoly making positive profits. Be sure to include labeled axes, MC & ATC, MR, Demand, their price and quantity, and the profit rectangle. (3 pts.)
3. Below you have the demand schedule and the total cost information for a Monopoly.
a. Complete the table. (5 pts.)
Quantity
Price (WTP)
Total Cost
MC
MR
ATC
TR
Profit
0
16
2
—
—
—
—
1
14
3
2
12
5
3
10
8
4
8
12
5
6
17
6
4
23
b. What’s the profit maximizing price and quantity? What profit will they get? (3 pts.)
c. When lowering the price from $10 to $8, what’s the price effect and what’s the quantity effect? (2 pts.)
d. What’s the Marginal Revenue of the 4th unit? What’s the price of the 4th unit? (2 pts.)
e. Why is the Marginal Revenue of the 4th unit different than the price of the 4th unit? (Hint: This could be answered in two words.) (2 pts.)
f. Monopolies lead to inefficiency; there are missed opportunities for beneficial transactions. Why is that the case? Where do we see that on this table? (Hint: It deals with MC and WTP). (3 pts.)
g. What are the recommended government responses to Monopoly? Be sure to include at least two. (2 pts.)
h. Why is the government response to Natural Monopoly generally different than other types of Monopolies? (3 pts.)
4. Suppose the movie market has two different types of consumers: students and adults. The demand schedule for movies on a given night for both groups is below. Assume that the movie theatre has no fixed cost. They have a relatively small variable cost– $1 per person going to the theatre, in order to keep the place clean.
Price
Qd by Adults
Qd by Students
14
10
0
12
12
4
10
14
8
8
16
12
6
18
16
4
20
20
a. Based upon this information, complete the table below. (6 pts.) (Hint: Qd Market = Qd by Adults + Qd by Students & TC = FC + VC)
Price
Qd by Market
TR
MR
TC
MC
Profit
14
12
10
8
6
4
b. Suppose the movie industry successfully separates the market for movies by students and adults– possibly offering discounts if you qualify as being a student for instance. By separating the markets, they have the capacity to charge different prices to different groups. To explore why this might be helpful for the firm, complete the next two tables. (10 pts)
Price
Qd by Adults
TR
MR
TC
MC
Profit
14
10
12
12
10
14
8
16
6
18
4
20
Price
Qd by Students
TR
MR
TC
MC
Profit
14
0
12
4
10
8
8
12
6
16
4
20
c. What price and quantity will they want to charge students to maximize profits within that group? (2 pts.)
d. What price and quantity will they want to charge adults to maximize profits within that group? (2 pts.)
e. What’s the total profit in the market when the firm price discriminates between the two groups? How does this compare to when they just charge one price? (2 pts.)
Oligopoly
1. Below we the market demand for a good, and the total cost of producing various levels of quantities by the industry. This problem is a theoretical example of Cournot Competition, where firms choose quantities to produce, and end up selling at whatever price the market is willing to pay for the total industry output. For simplification purposes, firms have no fixed costs, and a constant MC and ATC.
a. Complete the table. (5 pts.)
Quantity
Price
TR
MR
TC
MC
ATC
Profit
0
$14
—
0
—
—
10
$11
10
20
$8
20
30
$5
30
40
$2
40
b. Now assume that the industry is made up of two firms– selling at the profit maximizing price you just found, and evenly splitting the quantity. Both are selling 10 units at $8. Both firms have the same Marginal Cost curves. Copy and paste the Marginal Cost values from the table above– they should all be less than $3 if you did it right. After copying and pasting the MC values, complete the rest of the table. (6 pts.)
Quantity
Price
TR
MR
TC
MC
ATC
Profit
0
$11
—
0
—
—
10
$8
20
$5
30
$2
c. Given that the other firm is selling 10 units, what’s the profit maximizing quantity? What will the market price be? What’s their profit? (3 pts.)
d. What’s the profit for the firm that is still selling 10 units? (Hint: You have their Quantity (i.e. 10), you just found the price, and they have the same constant ATC). (2 pts.)
e. What’s the total industry profit before and after the other firm decided to deviate? (2 pts.)
2. Below we have a Payoff Matrix for Camel and Marlboro for deciding whether or not to advertise.
a. If Marlboro advertises, what’s Camel’s Best Response? (2 pts.)
b. If Marlboro does not advertise, what’s Camel’s Best Response? (2 pts.)
c. Does Marlboro have a dominant strategy? What is it? (2 pts.)
d. Does Camel have a dominant strategy? What is it? (2 pts.)
e. Define a Nash Equilibrium. Does a Nash Equilibrium exist in this game? What is it? (3 pts.)
f. Are the two companies better off both advertising or both not advertising? (2 pts.)
g. Define a Prisoner’s Dilemma. Explain whether or not this is a Prisoner’s Dilemma. (3 pts.)
h. Suppose Congress developed a bill banning cigarette companies from advertising. Based upon this problem, why might a cigarette company benefit from a ban on advertising? (3 pts.)
Monopolistic Competition
1. What gives firms market power in an industry characterized by Monopolistic Competition? (2 pts.)
2. In Monopolistic Competition, firms differentiate their products from competitors. Provide an example of a firm differentiating their product by: (3 pts.)
a. Quality
b. Location
c. Style or Type
3. Draw a graph of a firm making positive profits in an industry of Monopolistic Competition.
a. Be sure to include labeled axes, MC, MR, Demand, ATC and the profit rectangle. (3 pts.)
4. Draw a graph of a firm in an industry of Monopolistic Competition in the long run. (3 pts.)
