CHAPTER 8: MONOPOLISTIC COMPETITION

Monopolist’s Profit

In a competitive market equilibrium, P = MC and total surplus is maximized.

In the monopoly eq’n, P > MR = MC
The value to buyers of an additional unit (P) exceeds the cost of the resources needed to produce that unit (MC).
The monopoly Q is too low – could increase total surplus with a larger Q.
Thus, monopoly results in a deadweight loss.

Price discrimination: selling the same good at different prices to different buyers.
The characteristic used in price discrimination is willingness to pay (WTP):
A firm can increase profit by charging a higher price to buyers with higher WTP.
Short run: Under monopolistic competition, firm behavior is very similar to monopoly.
Long run: In monopolistic competition, entry and exit drive economic profit to zero.

If there are profits generated in the short run:

New firms enter market, taking some demand away from existing firms, prices and profits fall.
If losses in the short run: Some firms exit the market, remaining firms enjoy higher demand and prices.

Why Monopolistic Competition Is Less Efficient than Perfect Competition?

1. Excess capacity
The monopolistic competitor operates on the downward-sloping part of its ATC curve,
produces less than the cost-minimizing output.
Under perfect competition, firms produce the quantity that minimizes ATC.

2. Markup over marginal cost

Under monopolistic competition, P > MC.
Under perfect competition, P = MC.

How Monopolistic Competition affects welfare?

Monopolistically competitive markets do not have all the desirable welfare properties of perfectly competitive
markets.
Because P > MC, the market quantity is below the socially efficient quantity.
Yet, not easy for policymakers to fix this problem: Firms earn zero profits, so cannot require them
to reduce prices.

The problem facing policymakers here is similar to the problem arising from natural monopoly:
With natural monopoly, ATC is always falling, so MC is below ATC. If regulators force a natural monopoly to
price at marginal cost, it will incur losses.
Ch.8 - Question 1

The following discussion describes recent changes in the strategy of Parker Pen Co. Although consumer
interest in fine writing pens in the United States may seem equivalent to consumer response to Kodak
film and cameras in the opening case of this chapter, Parker Pen Co., which is owned by Newell
Rubbermaid Co., developed a strategy to build its presence in China where there is increased income
and strong preferences for fine writing pens as part of China’s gift-giving business culture. Executives
in other parts of the world may have substituted smartphones and tablets for expensive pens, but
Chinese professionals are often willing to pay thousands of dollars for them. In response, Parker Pen
Co. has darkened its pens’ ink to appeal to writers of Chinese characters and added a special Chinese
character meaning prosperity and good luck to the pens’ heads. These changes have increased sales
from 30% to 50% in many of China’s department stores. The number of Chinese earning a household
income of more than one million yuan (approximately $156,000) increased 20% from 2010 to 2011.
Pens are an affordable luxury, but also serve as a means for people to display their new wealth.
Parker’s pens sales had been declining in North America and Europe, so the company turned to China
and adopted a higher pricing policy to emphasize the status of the pens. Parker does have competition
for its expensive pens from Montblanc, which has opened stores to sell its pens and other products.
However, Parker pens contribute “substantially” to overall sales growth for Newell Rubbermaid.

§ a. Discuss the role of consumer demand in influencing Parker Pen’s strategies.

Demand in China influenced Parker Pen Co.’s strategies through both income and consumer preferences
variables. Household income in China had increased, which gave consumers greater ability to pay for both
inexpensive and expensive pens. China’s gift-giving culture created a demand for expensive pens as a status
symbol. The latter factor, in particular, differed from consumer behavior in North America and Europe where
many persons no longer used pens of any form.

§ b. Do you think Parker will be able to maintain its market power in China? Explain.

Parker already faces competition in the expensive-pen market, which will increase if profits continue to grow.
This could erode the company’s market power and force it to develop new strategies to adapt to the Chinese
market.

Ch.8 - Question 2

Indicate and explain whether each of the following statements describe a perfectly competitive firm, a
monopolistically competitive firm, and/or a monopolist.

a. A firm is producing at the output where MR equals MC and charges the price according to the
consumers' willingness to pay 

Monopolist Firm
This statement describes the monopolist form of the market as the monopoly firm produces the output at the point
where the marginal revenue of the firm is equal to the marginal cost. Also, the monopoly firm can implement
price discrimination by charging a different price to different consumers according to their willingness to pay
and can maximize their profits.

b. In the long run, a firm is producing at the profit-maximizing level of output, where the price is $13,
and the average total cost (ATC) is $10 

Monopolistic Competitive Firm

This statement describes the monopolistic competitive firm as the firm can maximize their long firm profits by
charging the price greater than the average cost of the firm.

c. A firm is producing at the profit-maximizing level of output, where the price is $14, the ATC is $10,
and the marginal cost (MC) is $7. An increase in output will decrease both the ATC and the firm's
profit 
Perfectly Competitive Firm
This statement describes the perfectly competitive firm as the perfectly competitive firm can only maximize their
profits by increasing their production level and not by increasing their price. In this case, increasing the output
will lead to lower profits and lower average costs.

d. A firm is producing at the profit-maximizing level of output where the price is $13, and the ATC is
$15, which cause the firm to exit the market in the long run 

Perfectly Competitive Firm

This statement describes the perfectly competitive form of the market as the firms do not have the option to
increase their prices, and hence if the cost of production increases, they will start incurring losses. The firm
will be left with no option but to exit the market.