Monopolistic Competition in Advertising Discussion

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I’m studying for my Economics class and don’t understand how to answer this. Can you help me study?

Critics of advertising argue that firms advertise to manipulate people’s tastes and that advertising impedes competition. Identify a product in a monopolistically competitive market. Conduct research to find an advertisement for the product. Provide a link to the ad and answer the following questions:

What does the ad convey regarding the product’s price or quality?
How does the ad increase or promote the perception of product differentiation?

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N. GREGORY MANKIW
PRINCIPLES OF
MICROECONOMICS
Eight Edition
CHAPTER
16
Monopolistic
Competition
PowerPoint Slides prepared by:
V. Andreea CHIRITESCU
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
Monopolistic Competition
• Imperfect competition
– Between perfect competition and
monopoly
– Oligopoly
– Monopolistic competition
• Oligopoly
– Few sellers
– Offer similar or 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
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.
2
Monopolistic Competition
• Concentration ratio
– Percentage of total output in the market
supplied by the four largest firms
• Oligopolies, highly-concentrated
industries (concentration ratio %)
– Major household appliances (90%)
– Tires (91%), Light bulbs (92%)
– Soda (94%)
– Wireless telecommunications (95%)
© 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
Monopolistic Competition
• Monopolistic competition
– Many sellers
– Product differentiation
• Not price takers
• Downward sloping demand curve
– Free entry and exit
• Zero economic profit in the long run
© 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.
4
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.
© 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
Short Run Equilibrium
• Profit maximization
– Produce the quantity where marginal
revenue = marginal cost
– Price: on the demand curve
– If P > ATC: profit
– If P < ATC: loss – Similar to monopoly © 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. 6 Figure 2 Monopolistic Competitors in the Short Run (a) Firm makes profit (b) Firm makes losses Price Price MC ATC Price MC ATC ATC Price ATC Profit Demand Losses Demand MR 0 Profit-maximizing quantity MR Quantity 0 Loss-minimizing quantity Quantity 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. © 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. 7 Long Run Equilibrium • If firms are making profit in short run – New firms - incentive to enter the market – Increase number of products – Reduces demand faced by each firm • Demand curve shifts left – Each firm’s profit declines until: zero economic profit © 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. 8 Figure 3 A Monopolistic Competitor in Long Run Price MC ATC Price = ATC MR 0 Profit- maximizing quantity Demand Quantity In a monopolistically competitive market, if firms are making profits, new firms 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. © 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. 9 Long Run Equilibrium • Zero economic profit – Demand curve • Tangent to average total cost curve • At quantity where marginal revenue = marginal cost – Price = average total cost – Price exceeds marginal cost © 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. 10 Long Run Equilibrium • 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
© 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.
11
Figure 4 Monopolistic versus Perfect Competition
(a) Monopolistically Competitive Firm
Price
(b) Perfectly Competitive Firm
Price
MC
MC
ATC
ATC
Price
P=MC
Markup
MC
P=MR
(demand curve)
Demand
MR
0
Quantity Efficient
produced scale
Quantity
0
Quantity produced
= Efficient scale
Quantity
Excess capacity
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.
© 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.
12
Welfare of Society
• Sources of inefficiency
– Markup of price over marginal cost
• Deadweight loss of monopoly pricing
– Too much or too little entry
• Product-variety externality (positive
externality on consumers)
• Business-stealing externality (negative
externality on existing firms)
© 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.
13
Advertising
• Incentive to advertise
– When firms sell differentiated products
and charge prices above marginal cost
– Advertise to attract more buyers
• Advertising spending
– Highly differentiated goods: 10-20% of
revenue
– 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
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.
14
Advertising
• Debate over advertising
– Wasting resources?
– Valuable purpose?
• The critique of advertising
– Firms advertise to manipulate people’s
tastes
• Psychological rather than informational
• Creates a desire that otherwise might not
exist
© 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.
15
Advertising
• The critique of advertising
– Impedes competition
– Increase perception of product
differentiation
• Foster brand loyalty
– Makes buyers less concerned with price
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
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.
16
Advertising
• 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
© 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.
17
Advertising and the price of eyeglasses
• What effect does advertising have on the
price of a good?
– Consumers – view products as being
more different than they otherwise would
• Markets less competitive
• Firms’ demand curves less elastic
• Higher 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 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.
18
Advertising and the price of eyeglasses
• What effect does advertising have on the
price of a good?
– Consumers – easier to find firms with the
best prices
• Markets – more competitive
• Firms’ demand curves more elastic
• Lower 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 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.
19
Advertising and the price of eyeglasses
• 1972, economist Lee Benham
• States that prohibited advertising
– Average price = $33 ($248 in 2012
dollars)
• States that did not restrict advertising
– Average price = $26 ($196 in 2012
dollars)
• Advertising
– Reduced average prices
– Fosters competition
© 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.
20
Advertising
• Advertising as a signal of quality
– Little apparent information
– Real information offered – a
signal
• Willingness to spend large
amount of money
• = signal about quality of the
product
– Content of advertising =
irrelevant
Is it rational for
consumers to be
impressed that Jennifer
Aniston is endorsing
this product?
© 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.
21
Advertising
• Brand names
– Spend more on advertising and charge
higher prices than generic substitutes
© 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.
22
Advertising
• Critics of brand names
– Products – not differentiated
– Irrationality: consumers are willing to pay
more for brand names
• Defenders of brand names
– Consumers – information about quality
– Firms – incentive to maintain high quality
© 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.
23
Table 1
Monopolistic Competition: Between
Perfect Competition and Monopoly
© 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.
24

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