22/09/2023

Principles of Economics, Ninth Edition

N. Gregory Mankiw
Chapter 16

Monopolistic Competition

PowerPoint Slides prepared by:

V. Andreea CHIRITESCU
Eastern Illinois University

N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 2
N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 1 posted to a publicly accessible website, in whole or in part.
posted to a publicly accessible website, in whole or in part.

Monopolistic Competition, Part 1 Monopolistic Competition, Part 2

• Imperfect competition • Concentration ratio
– Between perfect competition and – Percentage of total output in the market
monopoly supplied by the four largest firms
– Oligopoly • Oligopolies, highly-concentrated
– Monopolistic competition industries (concentration ratio %)
• Oligopoly – Major household appliances (90%)
– Few sellers – Tires (91%), Light bulbs (92%)
– Offer similar or identical products – Soda (94%)
– Wireless telecommunications (95%)
N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 3 N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 4
posted to a publicly accessible website, in whole or in part. posted to a publicly accessible website, in whole or in part.
 22/09/2023

Figure 1 The Four Types of Market Structure

Monopolistic Competition, Part 3
• Monopolistic competition
– Many sellers
– Product differentiation
• Not price takers
• Downward sloping demand curve
– Free entry and exit
• Zero economic profit in the long run

Economists who study industrial organization divide markets into four types—monopoly,
oligopoly, monopolistic competition, and perfect competition.

N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 5 N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole or in part. posted to a publicly accessible website, in whole or in part. 6

Figure 2 Monopolistic Competitors in the Short Run

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

N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 7 N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole or in part. posted to a publicly accessible website, in whole or in part. 8
 22/09/2023

Figure 3 A Monopolistic Competitor in Long Run

Long Run Equilibrium, Part 1
• 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

N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 9 N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole or in part. posted to a publicly accessible website, in whole or in part. 10

Long Run Equilibrium, Part 2 Long Run Equilibrium, Part 3

• Zero economic profit • Monopolistic versus perfect competition
– Demand curve – Monopolistic competition
• Tangent to average total cost curve • Quantity: not at minimum ATC (excess
• At quantity where marginal revenue = capacity)
marginal cost • P > MC, markup over marginal cost
– Price = average total cost – Perfect competition
– Price exceeds marginal cost • Quantity: at minimum ATC (efficient scale)
• P = MC

N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 11 N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 12
posted to a publicly accessible website, in whole or in part. posted to a publicly accessible website, in whole or in part.
 22/09/2023

Figure 4 Monopolistic versus Perfect Competition

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)

N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 14
posted to a publicly accessible website, in whole or in part. 13 posted to a publicly accessible website, in whole or in part.

Advertising, Part 1 Advertising, Part 2

• Incentive to advertise • Debate over advertising
– When firms sell differentiated products – Wasting resources?
and charge prices above marginal cost – Valuable purpose?
– Advertise to attract more buyers • The critique of advertising
• Advertising spending – Firms advertise to manipulate people’s
– Highly differentiated goods: 10-20% of tastes
revenue • Psychological rather than informational
– Industrial products: Little advertising • Creates a desire that otherwise might not
exist
– Homogenous products: No advertising
N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 15 N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 16
posted to a publicly accessible website, in whole or in part. posted to a publicly accessible website, in whole or in part.
 22/09/2023

Advertising, Part 3 Advertising, Part 4

• The critique of advertising • The defense of advertising
– Impedes competition – Provide information to customers
– Increase perception of product • Customers - make better choices
differentiation • Enhances the ability of markets to allocate
• Foster brand loyalty resources efficiently
– Makes buyers less concerned with price – Fosters competition
differences among similar goods • Customers - take advantage of price
differences
– Allows new firms to enter more easily

N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 17 N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 18
posted to a publicly accessible website, in whole or in part. posted to a publicly accessible website, in whole or in part.

Advertising and the Price of Eyeglasses, Advertising and the Price of Eyeglasses,
Part 1 Part 2
• What effect does advertising have on the • What effect does advertising have on the
price of a good? price of a good?
– Consumers – view products as being – Consumers – easier to find firms with the
more different than they otherwise would best prices
• Markets less competitive • Markets – more competitive
• Firms’ demand curves less elastic • Firms’ demand curves more elastic
• Higher prices • Lower prices

N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole or in part. 19 posted to a publicly accessible website, in whole or in part. 20
 22/09/2023

Advertising and the Price of Eyeglasses, Advertising, Part 5

Part 3
• 1972, economist Lee Benham • Advertising as a signal of
• States that prohibited advertising quality
– Average price = $33 ($272 in 2018 – Little apparent information
dollars) – Real information offered – a
signal
• States that did not restrict advertising • Willingness to spend large
– Average price = $26 ($214 in 2018 amount of money
dollars) • = signal about quality of the Is it rational for
consumers to be
product
• Advertising impressed that
– Content of advertising = George Clooney is
– Reduced average prices irrelevant endorsing this
product?
– Fosters competition
N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 22
posted to a publicly accessible website, in whole or in part. 21 posted to a publicly accessible website, in whole or in part.

Advertising, Part 6 Advertising, Part 7

• Brand names • Critics of brand names
– Spend more on advertising and charge – Products – not differentiated
higher prices than generic substitutes – Irrationality: consumers are willing to pay
more for brand names
• Defenders of brand names
– Consumers – information about quality
– Firms – incentive to maintain high quality

N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 23 N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 24
posted to a publicly accessible website, in whole or in part. posted to a publicly accessible website, in whole or in part.
 22/09/2023

Table 1 Monopolistic Competition: Between

Perfect Competition and Monopoly

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posted to a publicly accessible website, in whole or in part. 25