210 Putting It Together: Monopolistically Competitive Industries

Summary

The goal of this module was analyze a firm’s profit maximizing strategies under conditions of monopolistic competition.  You learned how to:

• Define the characteristics of a monopolistically competitive industry
• Calculate and graph the firm’s fixed, variable, average, marginal and total costs
• Explain the difference between short run and long run equilibrium in a monopolistically competitive industry
• Understand how product differentiation works in monopolistically competitive industries and how firms use advertising to differentiate their products, understanding impact on elasticity
• Understand why monopolistically competitive markets are inefficient (including deadweight loss)

Examples

Monopolistically competitive industries consist of a significant number of firms, which each produce a differentiated (or heterogeneous) production. In other words, Colgate, AIM, and Tom’s of Maine each produce toothpaste, but they are not identical products. Like firms in any market structure, if a monopolistically competitive firm wishes to maximize profits, it will supply the quantity of output where marginal revenue equals marginal cost. Like perfectly competitive firms, competition prevents monopolistically competitive firms from earning positive economic profits in the long run, unless those firms create innovative new products and/or use advertising to convince customers they have done so.

Returning to some of the questions posed in the “Why it Matters” feature at the beginning of this module:

• Why do gas stations charge different prices for a gallon of gasoline? Some gasoline companies use different additives to make their products at least appear different.  This allows them to charge higher prices than companies that don’t make as good a case for their product.
• What determines how far apart the prices of Colgate and Crest toothpaste can be? Location also matters.  A gas station just off the highway can charge higher prices than stations further away, because travelers perceive and are willing to pay for the convenience of the former.
• Why did fast food restaurants start offering salads? Fast food restaurants added salads to their menus to differentiate their product by appealing to health conscious diners.
• Why did McDonalds come up with the Big Mac sandwich? McDonalds invented the Big Mac because its competitors offered similar enough regular burgers that McDonalds lost its monopoly profits.  The Big Mac restored those profits, at least until Burger King came up with the Whopper and other fast food restaurants developed their own special burgers.