Transcription
How's it class? So today, we are now working on chapter 25, which is monopolistic competition. So, we've covered perfect competition and monopoly. So now, we are now going into the less extreme market structures of the two. And monopolistic competition, even though it leads with the word monopolistic, it's really close to the perfect competition. Whereas a monopolistic competition here, it says a market situation in which there's a large number of firms with similar but not identical products, and entry into the industry is relatively easy. So, these are very similar, uh, to the concepts that are, uh, in perfect competition with the large number of firms, and especially this entry into the industry is relatively easy.
Now, similar but not identical products, that's a big one that separates it from, uh, perfect competition because now it creates a situation where there's a different slope to the demand curve. So, a little reminder regarding the perfect competition model, we had two different looks. We had, on the left side, we had the industry perspective, which is the upward sloping supply and downward sloping demand, which is what actually exists in the perfectly competitive model. But we also added on the right side, the firm's perspective. So, we changed notation a little bit, lowercase q and so forth. And with that, we have taken from the industry, we get the price, which happens to also equal to the demand that the firm sees, and it also happens to be the marginal revenue curve.
Now, the look of that perfectly horizontal demand curve in a perfect competitive marketplace comes from the fact that a perfectly competitive firm has no control over the price. For example, they could try to increase price, but because of the nature of the product being homogeneous, that means everybody else is selling in the industry is selling the pretty much indistinguishable, uh, different. There's no, there's no characteristic that really makes one, uh, uh, uh, distinguishes from another. Uh, they have no ability to raise the price because every, they'll lose all the buyers going to another seller. And they have no incentive to lower the price because, well, they're so small in this industry that they can sell every unit of output at that price. Usually, a firm might try to decrease the price to increase the quantity that they can sell, but in this situation, there's no reason for them to decrease the price cuz whatever they produce, they can sell at the given price. So, that gives them this perfectly horizontal demand curve. And so, essentially, that makes, uh, the perfectly competitive firm a quantity searcher, not a price and quantity searcher like a monopolist might be because the monopolist has control over price. Whereas the perfectly competitive firm only has to worry about what quantity that they're going to sell. And ultimately, they're going to end up at the quantity where the average total cost curve just touches the price, the demand, the marginal revenue curve. And of course, then we have the marginal cost curve, which is the supply curve for the firm. And then with this marginal cost equals to marginal revenue point, that gives them the profit maximizing quantity that they determined to sell.
But one of the big things here, uh, that we're taking with us with, uh, into monopolistic competition is that, uh, the firm in a monopolistic competition, they will end up at zero profits in the long run. Just zero economic profits, just like the perfectly competitive firm. Now, remember, the zero economic profits isn't a bad thing. It means that they're making a normal rate of return, what you would expect to make when you enter an industry. So, that's perfectly fine.
On the other hand, in a monopoly situation, the demand curve is the industry demand curve. So, in other words, a monopolist sees the demand curve as it is. They're large enough to see it as it is, unlike a monopolist. And that gives us now this marginal revenue curve that falls below the demand curve. And again, with marginal cost curve, then we, with that, we figure where the marginal revenue equals to marginal cost. This determines the profit maximizing quantity that the monopolist will choose. And then we have a price based on the demand curve that the monopolist will charge.
A very different outcome for a monopolist versus a perfect competitor is that in the long run, they can earn positive economic profits and maintain that. So, that's a situation where we're going to have the average total cost curve cut below. I didn't cut it too far below, but I cut it below the price that they're charging. And as you can see, the average total cost curve falls below it. So, that distance is the profit per unit that a monopolist earns, uh, in, in, in this marketplace.
And while a monopolistic competitor, the current market structure that we'll be examining in this chapter, does see a downward sloping demand curve, just like a monopolist, the monopolistic competitor will not in the long run maintain positive economic profits. In the short run, they can earn positive economic profits, just like the perfect competitor. But because of the entry and exit of firms, just like the perfect competitive situation, that will eventually in the long run erode away any economic profits and return them back to a normal rate of return, which is zero economic profits. And, uh, and so that will be one of the, the key differences from a perfect competition model that a monopolistic competitor will experience. So, the very different, uh, outcomes in the short run and long run, and of a couple of other things in terms of what, uh, what type of demand curve the monopolistic competitive firm will experience will be a little different.
So, going back to this first slide where a monopolistic competitor, there's a large number of firms, uh, it takes away a certain amount of influence or control in the marketplace that a, a firm has, uh, but there's going to be some other aspects here. Uh, the similar but not identical products, this is where it's going to cause some deviation from the perfect competitor because if they're similar but not identical, that lack of identical products, the lack of homogeneity of the products gives their product some distinction and allows them to separate themselves in perspective from the buyers and thereby allowing them to see a slightly downward sloping demand curve, uh, relative to a perfectly competitive marketplace. But the entry into the industry being relatively easy, that's the situation that returns the monopolistic competitor back to zero economic profits in the long run.
So, these characteristics of a monopolistic competition would be a significant number of sellers in a highly competitive market. They have differentiated products. There's going to be sales promotion and advertising, and then there's easy entry of new firms in the long run. So, one of the ones I like to talk about might be, uh, maybe blue jeans, uh, sellers. Uh, there are a significant number of sellers. It's a highly competitive marketplace, but there is certainly differentiated products in blue jeans. You have cheaper ones, the kind you can get from Costco, then you have the name brand ones, the type that you can get on Rodeo Drive that will cost you possibly thousands of dollars. And then so there's also, number three, sales promotion and advertising, which really makes a difference from the perfectly competitive marketplace because there's no incentive for a perfect competitor to spend money on promotion and advertising. All they got to do is produce more if they want to sell more. Um, and then the last one is the easy entry of new firms in the long run.
Now, the implication of the large number of firms is that the firm, a monopolistic competitor, will have a small market share, uh, thereby limiting their ability to influence control in the marketplace. Number two is there's lack of collusion. Collusion being coordination, uh, between different firms. And the reason why collusion exists between firms is sometimes they will try to behave, uh, in a situation where they will have monopoly type power. So, if they can coordinate to constrain, uh, quantity and increase prices to increase their profits, they will, if they have the power to collude. But because of the large number of firms, there will be a lack of collusion ability in that marketplace. And then, of course, uh, the implication of a large number of firms is that there's an independence, uh, from the marketplace, there, within the marketplace.
And then, uh, product differentiation, the distinguishing of products by brand name, color, and other minor attributes. Again, this is very different from a situation of a perfectly competitive marketplace. So, this product differentiation in price, the firm has some control over the price, and therefore they face a downward sloping demand curve. And you can consider the abundance of brand names for many products. And essentially, as you've seen, the more successful the different differentiation, the more control over price.
So, going back to revisit the idea, what are advertising incentives for a perfect competitor? There are none. There are no advertising incentives. It's just adding costs for a situation where you can still increase the amount, the quantity that you sell at the given price. So, that doesn't make sense for you to spend any money on advertising. It's a waste of, of a cost. And then, uh, for a monopolistically competitive firm, they do have an incentive to advertise because if they can advertise, then they can change the demand for their product. And that is, that is one of the things that they will be trying to do.
So, down here it says, sales promotion and advertising for a firm can increase demand. It can differentiate the product, which could, that second one, differentiating the product can, uh, change the slope of the demand curve, not just increase the demand. Increased demand is a shifted demand curve. And then the first two lead to an increase in profits if done appropriately. So, question: How much advertising should be undertaken? Well, you know, with no specific numbers, they just follow the general idea. You're going to spend on advertising up to the point where marginal revenue from the additional dollar of advertising just equals that dollar of additional dollar of marginal cost incurred. So, again, it's that same, that same outcome that you're seeking where marginal revenue equals to marginal cost.
Now, uh, the individual firm's demand and cost curves. The demand curve slopes downward for a monopolistic competitor. And again, just like the first two, uh, marketplaces where a perfect competitor and a monopoly, profit is maximized where marginal cost intersects marginal revenue from below. Now, in the short run equilibrium for a monopolistic competitor, in the short run, it is possible for a monopolistic competitor to make economic profits. So, add that word profits after the word economic. But however, losses in the short run are also clearly possible. And like I mentioned, in the long run, there's going to be zero economic profits. Economic profits will tend towards zero. Many firms produce substitutes. Any economic profits will disappear with competition.
Now, the long run economic profit is reduced to zero either via entry of new firms seeking to earn a higher rate of return or changes in product quality and advertising outlays by existing firms. All this is going to be affecting the demand curve for the product of a monopolistic competitor.
So, taking a look at the short run and long run equilibrium with monopolistic competition. So, right now, we have that downward sloping demand curve. And I want you to notice that it is a lowercase d, uh, because this is the demand curve for that monopolistic competitor's product, not for blue jeans, for example, in general, but for blue jeans from this monopolistic competitor. And then because they see a downward sloping demand curve, which is the result of some product distinction, some distinguishable characteristics of their own product, possibly either due to marketing or an actual, uh, uh, physical, uh, real component of differentiation, but they also have that downward sloping marginal revenue curve that falls below the demand curve. And then with that, now they have that marginal cost curve. And with that marginal cost equals marginal revenue, that will be establishing, of course, their profit maximizing quantity. And once you add in that average total cost curve, you can figure out based on that profit maximizing quantity, how much the, the firm, the perfect, I mean, the monopolistically competitive firm will receive per unit they sell, which is based on the price, and then how much they'll be paying per unit, which is based where that quantity established on that average total cost curve. And that's that little dash right there next to the price that establishes that. So, based on that average total cost curve, now you have that vertical distance between price and average total cost, which is the profit per unit. And, uh, and then if you multiply by the quantity, then you will get that total rectangle, rectangular area there, that blue area in terms of the total profits.
Now, another situation where you have that downward sloping demand curve and the marginal revenue curve, and then of course, the marginal cost curve. This time, it's possible for a monopolistic competitor to see average total cost curve situated like this. Now, based on where the marginal cost is equal to marginal revenue curve, uh, you're going to see again the quantity established. And then also on top of that, now what we're focusing on first is the average total cost, the cost per unit on the vertical axis, the ATC. And then of course, below that, that little dash below the ATC is going to be the price that they receive. And if the price that they receive is less than the cost per unit, then they're actually making economic losses. And then what happens, irrespective of the situation of whether or not they're making profits or losses in the short run, what's going to happen is that their demand curve is going to shift to restore zero economic profits, just like the, uh, competitive, perfectly competitive marketplace.
So, take a look now where the marginal cost is equal to marginal revenue, establishing now that, uh, profit maximizing quantity. And when, once that quantity is established, then we can go and see how much it is cost per unit based on the average total cost curve, and then based on the demand curve, we can see how much they're getting per unit. And as we can see that they're equal. So, now, now they have zero economic profits, which is again, a normal rate of return, which is what they're fine making. Of course, I'm sure they'd rather make economic profits, but they got into this industry to make a normal rate of return, and that's what they're making in the long run.
So, both a monopolistic competitor and a perfect competitor will make zero economic profits in the long run. The demand curve for the perfect competitor is perfectly elastic, so it's that horizontal one that we saw. Whereas a monopolist, downward sloping. Now, we're looking at perfect competition as well as monopolistic competition. So, the two, uh, market structures, uh, that are relatively close to each other in terms of, uh, well, the spectrum of, of, uh, marketplaces. So, here we have that price, that horizontal demand curve, average total cost curve just touching the demand price, marginal revenue curve. That means they're making zero economic profits. Okay.
An important aspect for a perfect competitor, they're efficient in the sense that they're operating also at the minimum of the average total cost curve. And that's just the nature of that perfectly horizontal demand curve that they perceive. And this is in a situation where they're making the zero economic profits. So, perfect competitor, it's paired, this, this minimum of the average total cost curve is also paired with the concept of making zero economic profits. Unlike the monopolistic competition situation where they have that downward sloping demand curve, the marginal revenue curve, and now we have the average total cost curve. In the long run equilibrium, you can see the minimum of the average total cost curves. And I hope you remember this from the cost curve chapter, uh, where we just learned the cost curve, that the marginal cost curve slices through the average total cost curve at the minimum of that average total cost curve. And as you can see, where the average total cost curve touches the demand curve is actually to the left of the minimum. And so, based on that parabolic type function, that's going to tell us that it is not at the minimum average total cost curve. It's going to be higher, but it's where it just touches the demand curve. So, based on that situation that you see right there, where the P2 and Q2 are established, the price per unit that they receive is going to equal to the cost per unit that they receive. Don't forget, the average total cost curve includes all the implicit costs, the opportunity cost. So, that's the zero economic profit that is acceptable. But that zero economic profit is not paired with the lowest point of the average total cost curve, like it is in the perfect competitive marketplace. So, in perfect competition, the long run equilibrium occurs where the average total cost is minimized. And that's not the same in monopolistic competition.
So, costs from product differentiation are not necessarily a waste of resources in a monopolistic competitor. It is a waste of resources in a perfect competitive marketplace, but not for a monopolistic competitor. And considering brand names and advertising, consumers value differentness. I mean, a lot of us don't like to buy from Costco because we know that when we go out, we're going to see a lot of people wearing the exact same clothes. I'm not one of those. I don't mind. I don't necessarily value much differentness, so I don't mind wearing the same clothes that most people, especially my age, tend to be okay with. Uh, but anyway, moving on from that, that second, second point is brand names. They're valuable private intellectual property. And these brand names can be reflected within the trademarks or words, symbols, and logos associated with different products. Now, a successful brand image contributes to a firm's profitability. Now, remember that advertising and this differentness that you're trying to do, that you're creating in this marketplace with sales and advertising is trying to take a demand curve that looks like that and now it's going to be adding some dimension so it looks more like that. And that's what you're trying to accomplish with the brand name and advertising. And also, you're also hoping to maybe possibly increase demand for your product as well. And so, a successful brand image does contribute, just because there's a lot of, uh, subliminal as well as direct influence that, uh, good logos and advertising and brand name awareness can give to a company that has a good product differentiation. You probably recognize the majority of these. I think the one that students might have the hardest time recognizing might be this one. This is the Yellow Pages. Nobody uses the Yellow Pages anymore for information of businesses. Everybody Googles things now. But if you were my age, you'd look at that and you'd say, oh yeah, that's the logo of, let your fingers do the walking through the Yellow Pages to find a business. But I think everything else on this screen, I think students are pretty familiar with.
So, regarding brand names and trademarks, the value in the marketplace depends on perceptions of future profitability. So, the valuation will equal to the market prices of shares of stock of a company times the number of shares traded. So, that's one way, if you're asking to, uh, to get the valuation of a company, that's what you're going to be using this equation right here. Oops. To figure out the valuation, the market prices of the shares of stock of a company times the number of shares traded. So, taking a look at the values of firms with the top 10 brands, you can kind of see this is, uh, not too long ago. This is based in 2019. So, you can see the Amazon estimated value, Apple, you know, what Apple just changes so much. The valuation of that company just keeps going up and up and up. So, it might be different. But actually, Amazon, I think Amazon is, uh, is a giant. And of course, you can see all the other Google, Microsoft, and so forth.
Okay, so, uh, some concepts also brought into this, uh, chapter is the concept of the types of marketing. And so, understanding what direct marketing is, it's advertising targeted at special consumers, uh, via things like postal mailings, telephone calls, or email messages. That's going direct to the consumer. And then there's mass marketing, uh, where you just throw out a really wide shotgun type of, uh, approach advertising in it, intended to reach as many customers as possible via TV, newspaper, radio, or magazine ads. And then finally, interactive marketing, it's advertising that permits a consumer to follow up directly by searching for more information.
And then of course, there's different types of goods to be aware of. And also, we can discuss the type of goods, uh, that a monopolistic competitor might be, uh, considering, uh, or their product might be falling into. Things like search goods, a product with characteristics that enable an individual to evaluate the product's quality in advance of a purchase. So, that would be things like for clothing and music, evaluated prior to your purchase. And then there's experience goods, a product that an individual must consume before the product's quality can be established. Things like soft drinks, restaurants, and movies. And then a credence good, which is a product that with qualities that consumers lack the expertise to assess without assistance. Things like healthcare and legal advice.
Now, in terms of the distribution of, uh, advertising expenses, you can see that the lion's share goes to direct marketing, then you have the internet advertising, followed by television ads, radio ads, magazine, newspaper, and then other. And in terms of the advertising, uh, methods, there's informational advertising. That's advertising that emphasizes transmitting knowledge about the features of a product. And then there's persuasive advertising, which is advertising that is intended to induce a consumer to purchase a particular product and discover a previously unknown taste for an item.
Now, one of the things I wanted to get back to really quickly is the concept of, in the long run, a monopolistic competitor, unlike a monopolist, will be back to zero economic profits. Now, the reason being is different from how, for example, a perfect competitor would be restoring to zero economic profits. So, taking a look at a monopolistic competitor here. So, we have our demand, we have our marginal revenue curve. And let's consider a situation where they are making, let's see, once we have our marginal cost curve here. So, we have our quantity established. And then we have our, our price established. And that means that if they're making positive economic profits relative to the price, then we know where the average total cost curve falls. The average total cost curve, with the minimum of that ATC where being where the marginal cost curve is, we'll see that the ATC will fall below that point. Okay. And so, now we have economic profits being made between that price and the average total cost situation here, established here. Now, that vertical distance right here, that's the, uh, profit per unit.
Now, consider a situation for a perfect competitor. Let's just say that instead of this average total cost curve, they're experiencing this average total cost curve. Now, in this situation, they're going to have economic profits. Now, I want you to consider how, in the long run, we get back to zero economic profits. Remember, the profits are signals. They're signals for firms to enter the industry because now in this industry, greater than normal rate of returns are being earned. So, those greater profits are now a signal for firms to enter this marketplace because there is easy entry and exit into a perfectly competitive marketplace, just like a monopolistic competitive marketplace. Therefore, when firms see these profits, they enter the marketplace, supply curve shifts in the industry, new equilibrium, lowering the price, establishing a new price, demand, marginal revenue curve, bringing us back down to zero economic profits. But it's this change here, this change in supply in the industry in the perfect competitive marketplace, that is different in a monopolistic. So, here supply changes. And if it was a different situation, if losses were being made, then firms would exit the marketplace, again, reestablishing a new price, reestablishing zero economic profits.
Now, that's a different situation when you have positive profits. So, positive profits being earned. Instead of supply shifting to restore zero economic profits, this time demand curve changes. But in a sense, it's a very similar thought process. When you have positive economic profits, it's a signal for firms to enter this industry for blue jeans. Remember, this is the demand for that firm's blue jeans. So, when firms enter this marketplace, what they're doing is they're going to take away demand. They might not take all a lot of demand, but as firms enter and offer new alternatives to consumers in this marketplace, it will take away demand from this blue jean manufacturer, for example, thereby shifting the demand, taking away demand for the product because it's going to go to the some new producers. Demand shifts to the left. Now, giving us that tangency point left of the minimum of the average total cost curve, but right where the ATC just touches at tangency point to that new demand curve, thereby establishing zero profits. So, in the perfect competitive marketplace, supply changed to get us to zero economic profits. But here, we're going to see demand change in a monopolistic competitor to restore zero economic profits in the long run. So, there's that, that different aspect there.
And then finally, in this monopolistic competitive marketplace chapter, we're going to be adding one additional, uh, wrinkle. I wouldn't say wrinkle, maybe a dimension to understanding a different market, uh, I'm sorry, different type of, uh, uh, firm in a monopolistic competition, and that's information products. And information product is produced using information-intensive inputs at a relatively high fixed cost, and it is distributed for sale at a relatively low marginal cost. So, examples of informational product would be things like the, the operating system Windows 10 operating system, or something that you can, uh, purchase and then, or utilize on your, uh, or on your laptop or whatever. And there's also examples of PS5 games or Xbox games, and generally just software applications in general.
So, a good friend of mine is a software developer, and often times he has to start, whenever he starts a new company, before he sells it for millions of dollars, often times he has to go get a government grant because they happen to deem his product a worthy product to society, just not really profitable in its viability for him. So, what they do is, for the benefit of society, they give him money because there's a lot of cost he has to put in, a lot of hours, he has to hire various programmers under him, uh, to assist in building his software. And before, before he can earn a single dollar on it, he spends close to couple, $2, $3 million on developing this before he can earn a cent. And that's the nature of these types of information products. Now, they have a high fixed cost because those are all costs that were incurred before he even sells a single unit. So, it doesn't come into the variable cost component. And once he comes up with it, it's really cheap to distribute it. Often, I mean, for some of you who are gamers, you might decide to purchase a game product, and you don't even have to necessarily go out to get it. All you have to do is go online and pay for it, and then with your internet, you will download it onto your computer. So, in that case, the firm selling it does not have to even often times press out a, a DVD ROM or whatever, a CD, whatever you want to label it, to get it out to consumers. With that extra cost, they don't even have to incur that. They just have to have the infrastructure to accommodate the downloads. So, to sell 10 on that infrastructure versus a thousand, it's not much change in the marginal cost.
So, this is what it looks like in terms of cost curves. If you notice that we're operating all on cost curves that are pretty much still in that downward slope. We don't even see that upward slope. And it has to do with that very high cost up front, the very high fixed cost. And so, it gives us a look such as the, these, in terms of the cost curves. Now, in for information products, there's something called the short-run economies of operation. And it's a distinguishing characteristic, and it's where declining short-run average total costs as more units of the product are sold. So, providing an information product entails incurring relatively high fixed cost, like I mentioned, but a relatively low per-unit cost for additional units of output, like I mentioned. And then the average total cost for a firm that sells an information product slopes downward, and the firm experiences short-run economies of operation.
Now, for information products, in the long run, monopolistically competitive equilibrium price adjusts to equal the average total cost curve, just like it did for non-information monopolistic competition product. And for the second point, the firm earns sufficient revenues to cover total costs, including the opportunity cost of capital, which means that they're earning a normal rate of return, which means they're earning zero economic profit. And then, final point, consumers thereby pay the lowest price necessary to induce sellers to provide the item.
So, taking a look at these different curves. So, taking a look at this slide here and the diagram here, especially on the right, right here. The main idea here is that the price is going to be established where the demand curve, which is going to be the price that the consumers are willing to pay, is going to be just tangent to the average total cost. So, in that case, the firm is covering all their costs, and therefore they will be making zero economic profits, a normal rate of return. And in that case, I guess the point is, uh, in comparative to the, in comparison to the left side, any lower price will result in a situation where economic, here they have a point here chosen, but any lower price will be a situation where a firm is going to be making economic losses based on the positioning of the average total cost curve relative to the demand curve, which is, of course, what the consumers are willing to pay. So, for informational products, you're going to see again the outcome B, where the demand curve is just tangent to the average total cost curve.
Now, one thing to note here is that the marginal cost curve is horizontal. Why is that? Because that's capturing the idea that to sell more and more units, the marginal cost curve, for example, is not going to really be changing because again, the, the very low cost, or almost zero cost, additional to sell additional units because of the nature of information products. Anyway, I hope this was helpful for the monopolistic competition. A lot of this material underlying it, you've covered already. So, this chapter, and we should have actually gone relatively fast. Just got to cover some new information, some new definitions, and so forth. I hope everyone's doing well. Uh, stay healthy, and I look forward to talking to you guys soon. Aloha.