Chapter 13

Monopolistic
Competition

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 Monopolistic Competition

• Monopolistic competition
• Relatively large number of sellers
• Product differentiation
• Easy entry and exit
• Nonprice competition like advertising

LO1 13-2
 Monopolistically Competitive
Industries

• Industry concentration
• Measured by 4-firm concentration ratio
• Percentage of sales by 4 largest firms
output of four largest firms
4-firm CR =
total output in the industry
• Herfindahl index
• Sum of squared market shares
HHI = (%S1)2 + (%S2)2 + (%S3)2 + …. +
LO1 (%Sn)2 13-3
 Continue….
• Squaring is done because it gives larger firms greater weight
• Higher HHI, the more concentrated the industry.
• HHI approaches zero when a market consists of a large
number of firms of relatively equal size, and equal to 10k if
pure monopoly
• Rule of thumb:
• HHI < 1000 : not concentrated
• 1000 < HHI < 1800 : moderately concentrated
• HHI > 1800 : concentrated

13-4
 Low Concentration Industries
(2) (3) (2) (3)
(1) 4-Firm Herfindahl (1) 4-Firm Herfindahl
Concentration Concentration
Industry Ratio Index Industry Ratio Index

Textile machinery 30 360 Wood trusses 15 102

Women’s dresses 28 328 Metal stamping 14 88

Metal windows and
Textile bags 28 318 door 13 109

Plastic bags 27 299 Wood pallets 11 51

Ready-mix concrete 23 313 Sheet metal work 7 30
Jewelry 23 230 Signs 7 28
Asphalt paving 22 188 Stone products 7 23
Plastic pipe 21 187 Quick printing 4 8
Sawmills 15 98 Retail bakeries 4 7

Curtains and draperies 14 85 Bolts, nuts, and rivets 4 6

13-5
 Price and Output in Monopolistic
Competition

• Demand is highly elastic

• Short run profit or loss
• Produce where MR = MC
• Profit Maximizing Might Be Loss Minimizing
• Some firms in monopolistic competition have a
tough time making a profit.
• A burst of entry into an industry can limit the
demand for each firm’s own product.

LO2 13-6
 The Short Run: Profit or Loss

MC ATC
Price and costs

P1
A1

Economic D1
profit
MR = MC

MR

0
Q1
Quantity
LO2 13-7
 The Short Run: Profit or Loss

MC ATC

A2
Price and costs

P2

Loss
D2

MR = MC

MR

0
Q2
Quantity
LO2 13-8
 The Long Run: Only a Normal
Profit
•Long Run: Zero Economic Profit
• Economic profit induces entry and economic loss
induces exit, as in perfect competition.
• Entry decreases the demand for the product of
each firm.
• Exit increases the demand for the product of each
firm.
• In the long run, economic profit is competed away
and firms make zero economic profit.

13-9
 The Long Run: Only a Normal Profit

MC
ATC
P3= A3
Price and costs

D3

MR = MC

MR

0
Q3
Quantity
LO2 13-10
 Monopolistic Competition and
Efficiency

• Monopolistic competition inefficient

• Productive inefficiency because P > min ATC
• Allocative inefficiency because P > MC
• Excess capacity
• A markup of price over marginal cost

LO3 13-11
 Monopolistic Competition and
Efficiency

• Excess capacity
• A firm has excess capacity if the quantity it
produces is less that the quantity at which
average total cost is a minimum.
• A firm’s efficient scale is the quantity of
production at which average total cost is a
minimum.
• Markup
• A firm’s markup is the amount by which price
exceeds marginal cost.
LO3 13-12
 Monopolistic Competition and
Efficiency

P4

Price is lower

Excess capacity at
minimum ATC
Q4

LO3 13-13
 Product Variety

• The firm constantly manages price, product,

and advertising
• Better product differentiation
• Better advertising
• The consumer benefits by greater array of
choices and better products
• Types and styles
• Brands and quality
LO4 13-14