Module 32 krugman 1
Module 32
Monopolistic Competition
What’s New in the Fourth Edition?
• Updated business case
Module Objectives
• What is monopolistic competition and why does it occur?
• How are prices and profits determined in monopolistic competition in the short run and the long run?
• How can monopolistic competition lead to inefficiency and excess capacity, but also more product
variety?
Teaching Tips
Understanding Monopolistic Competition
Creating Student Interest
• Have students create a list of firms in the area that have recently entered or exited. Discuss what
type of products the firms sell. How many other firms sell the same product? Make sure students
understand that firms can easily enter and exit a monopolistically competitive market.
Presenting the Material
• Use Handout 32-1 to provide a concrete example of monopolistic competition. Explain that firms in
monopolistic competition have some market power because they can differentiate their product, and
also they face a downward-sloping demand curve.
• Draw a graph to illustrate the profit-maximizing output and the level of profit. Point out to the
students that in the short run this looks just like the monopoly outcome. In the long run, the
monopolistically competitive firm will earn zero economic profit just like the perfectly competitive
firm. Be sure to discuss what happens to the firm’s demand and marginal revenue curves when firms
Monopolistic Competition versus Perfect Competition
Creating Student Interest
• Ask students to name a “monopolistic” industry. See how long it takes for someone in the class to
ask whether you mean a monopoly or a monopolistically competitive industry. Use the confusion to
point out the difference between the two market structures and the importance of being clear about
Presenting the Material
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competition and monopoly (hence the hybrid name). Like perfect competition, monopolistic
competition has multiple firms and easy entry. Therefore, the long-run result is the same as perfect
competition (zero economic profit). As in monopoly, firms in monopolistic competition sell a unique
(or at least differentiated) product and have some control over price. Therefore, they can earn a profit
Module Outline
Opening Example: The fast-food industry is an example of a monopolistically competitive market in
which firms offer competing, differentiated products that are close but not perfect substitutes.
I. Understanding Monopolistic Competition
A. Monopolistic competition in the short run
1. Because there are many firms in a monopolistically competitive industry, firms cannot
collude to increase their market power.
2. A monopolistically competitive firm faces a downward-sloping demand curve and a
downward-sloping marginal revenue curve.
3. In the short run, a monopolistically competitive firm has an upward-sloping marginal
cost curve and a U-shaped average total cost curve.
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Figure 32-1
B. Monopolistic competition in the long run
1. Entry and exit affect the demand curve of every firm in the market.
2. If firms are earning economic profits, new firms will enter the market, shifting the
demand curve for the existing firms to the left.
3. If firms are incurring losses, firms exit the industry, shifting the demand curve for
existing firms to the right.
4. The market is in long-run equilibrium when there is no exit or entry.
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II. Monopolistic Competition versus Perfect Competition
A. Price, marginal cost, and average total cost
1. Monopolistically competitive firms and perfectly competitive firms are similar in that
in the long run both receive a price that is equal to their average total cost. This is
illustrated in text Figure 32-4, shown next.
Figure 32-4
2. They differ in the following ways:
a. The price a perfectly competitive firm earns is equal to its marginal cost. A
monopolistically competitive firm earns a price that is above its marginal cost. For
this reason, monopolistically competitive firms are willing to sell more than they are
currently selling at the going price.
B. Is monopolistic competition inefficient?
1. Some mutually beneficial trades go unrealized.
2. The excess capacity leads to wasteful duplication: There are too many varieties of
products.
3. Consumers, however, do benefit from the diversity of products in monopolistic
competition.
Case Studies in the Text
Economics in Action
Hits and Flops in the App Store—This EIA explains how the download of apps has fallen due to customer
fatigue.
Ask students the following questions:
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Handout 32-1
Date_________ Name____________________________ Class________ Professor________________
Monopolistic Competition
Complete the following table.
(1)
Quantity
(2)
Price
(3)
Total
revenue
(4)
Marginal
revenue
(5)
Total
cost
(7)
Marginal
cost
(8)
Profit
0
$17
—
$10
—
1
16
18
2
15
23
3
14
25
4
13
27
5
12
30
6
11
32
7
10
38
8
9
48
9
8
62
1. Which columns are this firm’s demand curve?
2. What is the profit-maximizing price and output for this monopolistic competitor?
3. What is profit for this firm at the profit-maximizing level of output?
4. What is likely to happen in the long-run in this industry?
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Answers
(1)
Quantity
(2)
Price
(3)
Total
revenue
(4)
Marginal
revenue
(5)
Total
cost
(7)
Marginal
cost
(8)
ProfitS
0
$17
$0
—
$10
—
–$10
1. Which columns are this firm’s demand curve?
2. What is the profit-maximizing price and output for this monopolistic competitor?
3. What is profit for this firm at the profit-maximizing level of output?
4. What is likely to happen in the long-run in this industry?
1
16
2
30
3
42
4
52
5
60
6
66
7
70
8
72