DRAW BEFORE PRESENTATION

Profit= price- ATC

0= price must be equal to ATC

During Paulo’s report:
Chapter 14: analyzed how some firms in the
economy face competition but fails at
succeeding at it so they become price takers
instead of price makers.
Chapter 15: Analyzed about how a typical firm
has some degree of market power but does not
have that much of an effect in the economy so
they become monopolistic
1st
Now, to further understand Monopolistic
Competition, we should understand the
decisions facing an individual firm.
How a Monopolistically Competitive Firm earn
Profits and incur losses in the Short Run
The graphical analysis of the monopolistically
competitive firm-> is very similar to that of the
monopoly firm.
A) First case is when firm makes profit
1. Demand curve:
Each firm in a monopolistically
competitive market, like monopoly, has
a downward sloping demand curve
since their products are differentiated
from those of the other firms
2. Draw MC and MR: Also,
monopolistically competitive firms
follow a monopolist rule for profit
maximization (ASK): the Q is produced
wherein marginal revenue is equal to
the marginal cost and then uses the
demand curve to find the price at which
it can sell this quantity.
3. ATC & Y labels (price and ATC): now if
the average total cost of a firm is
below the price, this means that the
firm will make profit because at this Q
(point), the price is above ATC.
2nd
B) Another case is when the firm incur losses.
1. Compare the first graph to the second
a. Price and average total cost is
reversed
b. Demand curve changes since
price is below ATC now
2. And when price is below ATC, the firm
makes losses (show in the graph)
3. When this happens that the firm is
unable to make profit, what it can only
do is minimize its losses by producing
that quantity where marginal revenue
equals marginal cost still
3rd
The situations that I just explained which were
short run profit and short run loss do not last
long.
Eventually, the firms making and losing profit
will have to either enter or exit market to have
positive effects in the long run.
If the competitive firms in an industry earn an
economic profit (like in the short run firms
earning profit), then other firms will be
encouraged to enter the same industry, which
will reduce the profits of the existing firms.
Price is equal to Average total cost (thus the
tangency)
Profit= price- ATC
0= price must be equal to ATC ->>>>> P=ATC

More firms will continue to enter the industry

until the firms are earning only a normal profit.
However, if there are too many firms, then
firms will start to incur losses. This will cause
them to leave the industry.
Entry and exit: Consequently, the remaining
firms will return to normal profitability as the
exit of the firms will shift the demand curves of
the remaining firms to the right, therefore
declining losses.
4th
The process of entry and exit continues until
the firms in the market are making exactly zero
economic profit.
This therefore leads to long-run equilibrium
Once the zero economic profit is achieved, new
firms have no incentive to enter and existing
firms have no incentive to exit since they are
neither gaining profit nor having losses.
Moreover, this point of tangency occurs at the
same quantity wherein MR=MC
- The firms in a monopolistic competition
will still produce at the quantity
wherein MR=MC since they follow the
monopolist rule of profit maximization
Monopoly market: P> MC
Competitive market: P= ATC -> free entry and
exit drive economic profit to zero
Conclude: graph of all four types
 The theory of monopolistic competition
describes many markets in the
economy,
yet offers little guidance to
policymakers looking to improve the
market’s allocation of resources.

Refer to drawing:

Graph: Demand curve is barely touching the

ATC curve-> mathematically, we say that these
two curves are tangent to each other

Explanation:

Since in a long-run equilibrium, the markets are

making zero economic profit, the difference
between price and Average total cost must be
zero and we can see this from the graph with
 Monopolistic competition does not
have all of the desirable welfare
properties of perfect competition.
There is a deadweight loss caused by
the markup of price over marginal cost.

 a loss of economic efficiency

that can occur when
equilibrium for a good or
service is not achieved or is not
achievable

 Also, the number of firms can be too

large or too small. There is no clear way
for policymakers to improve the market
outcome.

 Product differentiation and markup

pricing lead to the use of advertising
and brand names. Critics of advertising
and brand names argue that firms use
them to reduce competition and take
advantage of consumer irrationality.
Defenders argue that firms use them to
inform consumers and to compete
more vigorously on price and product
quality.

 Critique other products

 Differences don’t really exist

 Irrationality: consumers buying

bc of brand names