Monopolistic Competition

17 Monopolistic Competition CHECKPOINTS

Checkpoint 17.1 Checkpoint 17.2 Checkpoint 17.3 Problem 1 Problem 1 Problem 1 Clickerversion Problem 2 Clicker version Problem 2 Problem 2 Clicker version Problem 3 Problem 3 Clicker version Problem 3 Clickerversion Clickerversion Problem 4 In the news Clickerversion In the news In the news

Practice Problem 1 The table shows the total revenue of the 50 firms in the tattoo industry. Calculate the four-firm concentration ratio and the HHI. What is the market structure of the tattoo industry? CHECKPOINT 17.1

Solution The four-firm concentration ratio is 46.6. The market shares of the four largest firms are 17.1, 12.4, 9.5, and 7.6. CHECKPOINT 17.1

The market shares from the largest to the smallest are 17.1, 12.4, 9.5, 7.6, 1.9, and 0.8 percent. HHI is the sum of the square of the shares of 50 largest firms. HHI = 292.41 + 153.76 + 90.25 + 57.76 + (3.61 x 16) + (0.64 x 30) The HH1 is 671.14. CHECKPOINT 17.1

The four-firm concentration ratio and the HH1 suggest that the tattoo industry is an example of monopolistic competition unless there are other reasons that would make the concentration measures unreliable guides. CHECKPOINT 17.1

Practice Problem 2 The table shows the total revenue of the 50 firms in the tattoo industry. What would be the market structure of the tattoo industry if each of the 50 firms operated in a different city and the cities are spread across the nation? CHECKPOINT 17.1

Solution If the 50 firms in the tattoo industry operate in different cities spread across the nation, each firm is effectively without competition. The market might be a series of monopolies. CHECKPOINT 17.1

Study Plan ProblemIf each firm in the tattoo industry operated in a different city and the cities are spread across the nation, the market might _______. CHECKPOINT 17.1 • be a series of monopolies • collapse because of lack of competition • be monopolistic competition • be perfect competition • Total revenue of the 50 firms in the tattoo industry.

Practice Problem 3 The table shows the total revenue of the 50 firms in the tattoo industry. What additional information would you need about the tattoo industry to be sure that it is an example of monopolistic competition? CHECKPOINT 17.1

Solution The additional information needed is information about product differentiation; competition on price, quality, and marketing; and evidence of low barriers to the entry of new firms. CHECKPOINT 17.1

Study Plan Problem What additional information would you need about the tattoo industry to be sure that it is an example of monopolistic competition? CHECKPOINT 17.1 • Barriers to entry • Competition on quality and marketing • Competition on price • Product differentiation • All of the above • Total revenue of the 50 firms in the tattoo industry.

Practice Problem 4 The table shows the total revenue of the 50 firms in the tattoo industry. Suppose that a new tattoo technology makes it easier for anyone to enter the tattoo industry. How might the market structure of the tattoo industry change? CHECKPOINT 17.1

Solution This new tattoo technology would most likely lead to the entry of more firms, greater product differentiation, and more competition. CHECKPOINT 17.1

Study Plan Problem Suppose that a new tattoo technology makes it easier for anyone to enter the tattoo industry.You would expect _______ in product differentiation and ______competition on product quality, price, and marketing. CHECKPOINT 17.1 • no change; less • an increase; more • a decrease; more • an increase; no change • a decrease; less • Total revenue of the 50 firms in the tattoo industry.

In the news Is a prepaid phone plan right for you?Cell-phone providers are offering new no-contract plans. For example, Tmobile’s “flexpay” plans allow users to buy monthly service; Boost Mobile’s no-contract plan has use; and Virgin Mobile’s plan has unlimited calling for $49.99 a month. All providers are actively marketing their no-contract plans. Source: Wall Street Journal, April 22, 2009 In what type of market are cell-phone plans sold? Explain your answer. CHECKPOINT 17.1

Solution The market structure is monopolistic competition. The number of cell-phone providers is large, and they offer differentiated services. No firm dominates the market and the firms compete on quality, price, and marketing. New cell-phone providers can enter the market with their own plan. CHECKPOINT 17.1

Practice Problem 1 Natti has a website at which people can design and buy a pair of sunglasses. Natti pays $4,000 a month for her Web server and Internet. The glasses are made by a firm, which Natti pays $50 a pair. Natti has no other costs. Calculate Natti’s profit-maximizing output, price, and economic profit. CHECKPOINT 17.2 • The demand schedule for Natti’s sunglasses.

Solution Marginal cost, MC, is $50 a pair—the price that Natti pays her supplier of glasses. The figure shows the demand, marginal revenue, and marginal cost curves. Profit is maximized when MC = MR and Natti sells 100 pairs a month. CHECKPOINT 17.2

The price is $150 a pair, and average total cost, ATC, is $90 a pair—the sum of $50 marginal (and average variable) cost and $40 average fixed cost. Economic profit is $60 a pair on 100 pairs a month, so economic profit is $6,000 a month. CHECKPOINT 17.2

Practice Problem 2 Natti has a website at which people can design and buy a pair of sunglasses. Natti pays $4,000 a month for her Web server and Internet. The glasses are made by a firm, which Natti pays $50 a pair. Natti has no other costs. Do you expect other firms to enter the industry? CHECKPOINT 17.2 • The demand schedule for Natti’s sunglasses.

Solution Natti is making an economic profit, so other firms have an incentive to enter the industry and will do so. CHECKPOINT 17.2

Study Plan Problem Natti has a website at which people can design and buy a pair of sunglasses. Natti pays $4,000 a month for her Web server and Internet. The glasses are made by a firm, which Natti pays $50 a pair. Natti has no other costs. CHECKPOINT 17.2 • The demand schedule for Natti’s sunglasses.

CHECKPOINT 17.2 Do you expect other firms to enter the Web sunglasses business? • Other firms have no incentive to enter the market. • Other firms have an incentive to enter the market and will do so. • Other firms have an incentive to enter the market but barriers prevent them. • Some firms will exit the market. • As other firms enter, Natti will exit the market. • The demand schedule for Natti’s sunglasses.

Practice Problem 3 Natti has a website at which people can design and buy a pair of sunglasses. Natti pays $4,000 a month for her Web server and Internet. The glasses are made by a firm, which Natti pays $50 a pair. Natti has no other costs. What happens to the demand for Natti’s sunglasses and Natti’s profit in the long run? CHECKPOINT 17.2 • The demand schedule for Natti’s sunglasses.

Solution Because Natti’s is making a positive economic profit, firms will enter the market and the demand for Natti’s sunglasses will decrease. The demand curve for Natti’s sunglasses will shift leftward. As the demand for Natti’s sunglasses decreases, her economic profit also decreases. In long-run equilibrium, Natti’s makes zero economic profit. CHECKPOINT 17.2

Study Plan Problem Natti has a website at which people can design and buy a pair of sunglasses. Natti pays $4,000 a month for her Web server and Internet. The glasses are made by a firm, which Natti pays $50 a pair. Natti has no other costs. CHECKPOINT 17.2 • The demand schedule for Natti’s sunglasses.

CHECKPOINT 17.2 In the long run, the demand for Natti’s sunglasses _______and in long-run equilibrium, Natti’s _______. • increases; economic profit increases • decreases; shuts down • decreases; makes zero economic profit • decreases; incurs an economic loss • The demand schedule for Natti’s sunglasses.

In the news Condé Nast shuts down Portfolio Condé Nast Publications launched its monthly business magazine Portfolio less than two years ago. In late 2008, Condé Nast cut its payroll and advertising budgets by 5 percent across all of its titles. Portfolio was hit with the biggest cuts. Recently, Condé Nast shut down Portfolio. Source: Wall Street Journal, April 28, 2009 Explain the effects of the payroll and advertising budgets cuts on Condé Nast loss in the short run. Why did Condé Nast shut down Portfolio? CHECKPOINT 17.2

Solution Payroll and advertising budgets are variable costs, so a cut in these costs shifts the ATC and MC curves downward. With no change in the prices of the magazines, Condé Nast’s economic loss decreased. Condé Nast shut down Portfolio because its loss from Portfolio exceeded its total fixed cost and the company expected the loss to continue in the coming year. CHECKPOINT 17.2

Practice Problem 1 Bianca bakes delicious cookies. Her total fixed cost is $40 a day, and her average variable cost is $1 a bag. Few people know about Bianca’s Cookies, and she maximizes profit by selling 10 bags a day for $5 a bag. Bianca thinks that if she spends $50 a day on advertising, she can increase her market share and sell 25 bags a day for $5 a bag. If Bianca’s belief about the effect of advertising is correct, can she increase her economic profit by advertising. CHECKPOINT 17.3

Solution With no advertising, Bianca’s total revenue is $50 (10 bags at $5 a bag) and her total cost is $50 (the sum of $40 total fixed cost and $10 total variable cost). So her economic profit is zero. With $50 a day advertising expenditure, Bianca has a total revenue of $125 (25 bags at $5 a bag) and total cost of $115 (total fixed cost is $90, and total variable cost is $25). Her economic profit with no price change is $10, so Bianca can increase her economic profit by advertising. CHECKPOINT 17.3

CHECKPOINT 17.3 Study Plan ProblemBianca bakes delicious cookies: TFC is $40 a day, AVC is $1 a bag and she maximizes profit by selling 10 bags a day for $5 a bag.Bianca thinks that if she spends $50 a day on advertising, she can sell 25 bags a day for $5 a bag. If Bianca’s belief about the effect of advertising is correct, she ________. • cannot increase her economic profit by advertising because advertising increases her average total cost • cannot increase her economic profit by advertising because advertising increases her total cost • can increase her economic profit by advertising only if she raises the price of her cookies • can increase her economic profit by advertising

Practice Problem 2 Bianca bakes delicious cookies. Her total fixed cost is $40 a day, and her average variable cost is $1 a bag. Few people know about Bianca’s Cookies, and she maximizes profit by selling 10 bags a day for $5 a bag. Bianca thinks that if she spends $50 a day on advertising, she can increase her market share and sell 25 bags a day for $5 a bag. If Bianca advertises, will her average total cost increase or decrease at the quantity produced? CHECKPOINT 17.3

Solution If Bianca advertises, her average total cost will decrease. With no advertising, her average total cost is $5 a bag ($50 a bag ÷ 10 bags). With advertising, her average total cost is $4.60 a bag|($115 a bag ÷ 25 bags). CHECKPOINT 17.3

Practice Problem 3 Bianca bakes delicious cookies. Her total fixed cost is $40 a day, and her average variable cost is $1 a bag. Few people know about Bianca’s Cookies, and she maximizes profit by selling 10 bags a day for $5 a bag. Bianca thinks that if she spends $50 a day on advertising, she can increase her market share and sell 25 bags a day for $5 a bag. If Bianca advertises, will she continue to sell her cookies for $5 a bag or will she raise or lower her price? CHECKPOINT 17.3

Solution We can’t say if Bianca will continue to sell her cookies for $5 a bag. Her profit-maximizing price will depend on how her demand curve shifts when she advertises. Advertising costs are fixed costs, so they don’t change marginal cost, which remains at $1 a bag. Bianca will sell the profit-maximizing quantity (the quantity at which marginal revenue equals marginal cost) for the highest price she can charge (read from the demand curve) for the quantity produced. CHECKPOINT 17.3

CHECKPOINT 17.3 Study Plan ProblemBianca bakes delicious cookies: TFC is $40 a day, AVC is $1 a bag and she maximizes profit by selling 10 bags a day for $5 a bag.Bianca thinks that if she spends $50 a day on advertising, she can sell 25 bags a day for $5 a bag. If Bianca’s advertises, at what price will she sell her cookies? • $5 a bag • a price above $5 a bag • cannot say if the price will be above, equal to, or below $5 a bag, depending on the demand for her cookies • a price below $5 a bag

In the news Purex tackles tough market, using new spin Americans like to pour their own laundry detergent, but Dial plans to launch Purex Complete, a “3-in-1” laundry sheet embedded with detergent, fabric softener, and antistatic agents and in an easy to use container. Only about 50 percent of consumers currently use softener and antistatic agents (laundry additives). Dial will spend $50 million marketing Purex Complete. Source: Wall Street Journal, April 28, 2009 Why create a new laundry detergent when there are so many? What “new spin” would you stress in the marketing campaign? CHECKPOINT 17.3

Solution A new product is developed and launched if the marginal benefit from its development exceeds the marginal cost of its development. Because many consumers seem to find separate laundry additives inconvenient, the marketing campaign should target these people and stress the convenience feature. CHECKPOINT 17.3

Monopolistic Competition