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MonopolisticCompetitionEconomicsPRINCIPLESOFN.GregoryMankiwPremiumPowerPointSlides
byRonCronovich16MonopolisticCompetitionEconomInthischapter,
lookfortheanswerstothesequestions:Whatmarketstructuresliebetweenperfectcompetitionandmonopoly,andwhataretheircharacteristics?Howdomonopolisticallycompetitivefirmschoosepriceandquantity?Dotheyearneconomicprofit?Inwhatwaysdoesmonopolisticcompetitionaffectsociety’swelfare?Whatarethesocialcostsandbenefitsofadvertising?11MONOPOLISTICCOMPETITIONInthischapter,
lookfortheIntroduction:
BetweenMonopolyandCompetitionTwoextremesPerfectcompetition:manyfirms,identicalproductsMonopoly:onefirmInbetweentheseextremes:imperfectcompetitionOligopoly:onlyafewsellersoffersimilaroridenticalproducts.Monopolisticcompetition:manyfirmssellsimilarbutnotidenticalproducts.02MONOPOLISTICCOMPETITIONIntroduction:
BetweenMonopoCharacteristics&Examples
ofMonopolisticCompetitionCharacteristics:ManysellersProductdifferentiationFreeentryandexitExamples:apartmentsbooksbottledwaterclothingfastfoodnightclubs03MONOPOLISTICCOMPETITIONCharacteristics&Examples
ofComparingPerfect&Monop.Competitionyesnone,price-takerfirmhasmarketpower?downward-slopinghorizontalDfitsyesyesfreeentry/exitmanymanynumberofsellersMonopolisticcompetitionPerfectcompetition04MONOPOLISTICCOMPETITIONComparingPerfect&Monop.ComComparingMonopoly&Monop.Competitionyesyesfirmhasmarketpower?downward-slopingdownward-sloping
(marketdemand)Dfitsyesnofreeentry/exitmanyonenumberofsellersMonopolisticcompetitionMonopoly05MONOPOLISTICCOMPETITIONComparingMonopoly&Monop.CoprofitATCPAMonopolisticallyCompetitiveFirmEarningProfitsintheShortRunThefirmfacesadownward-sloping
Dcurve.AteachQ,MR<P.Tomaximizeprofit,firmproducesQwhereMR=MC.Thefirmusesthe
DcurvetosetP.QuantityPriceATCDMRMCQ06MONOPOLISTICCOMPETITIONprofitATCPAMonopolisticallyClossesAMonopolisticallyCompetitiveFirm
WithLossesintheShortRunForthisfirm,
P<ATC
attheoutputwhereMR=MC.Thebestthisfirmcandoistominimizeitslosses.QuantityPriceATCQPATCMCDMR07MONOPOLISTICCOMPETITIONlossesAMonopolisticallyCompeMonopolisticCompetitionandMonopolyShortrun:Undermonopolisticcompetition,
firmbehaviorisverysimilartomonopoly.Longrun:Inmonopolisticcompetition,
entryandexitdriveeconomicprofittozero.Ifprofitsintheshortrun:
Newfirmsentermarket,
takingsomedemandawayfromexistingfirms,
pricesandprofitsfall.Iflossesintheshortrun:
Somefirmsexitthemarket,
remainingfirmsenjoyhigherdemandandprices.08MONOPOLISTICCOMPETITIONMonopolisticCompetitionandMAMonopolisticCompetitorintheLongRunEntryandexitoccursuntil
P=ATCandprofit=zero.NoticethatthefirmchargesamarkupofpriceovermarginalcostanddoesnotproduceatminimumATC.QuantityPriceATCDMRQMCMCP=ATCmarkup09MONOPOLISTICCOMPETITIONAMonopolisticCompetitorintWhyMonopolisticCompetitionIs
LessEfficientthanPerfectCompetition1.
ExcesscapacityThemonopolisticcompetitoroperatesonthedownward-slopingpartofitsATCcurve,
produceslessthanthecost-minimizingoutput.Underperfectcompetition,firmsproducethequantitythatminimizesATC.2.
MarkupovermarginalcostUndermonopolisticcompetition,P>MC.Underperfectcompetition,P=MC.010MONOPOLISTICCOMPETITIONWhyMonopolisticCompetitionIMonopolisticCompetitionandWelfareMonopolisticallycompetitivemarketsdonot
haveallthedesirablewelfarepropertiesofperfectlycompetitivemarkets.BecauseP>MC,themarketquantityisbelow
thesociallyefficientquantity.Yet,noteasyforpolicymakerstofixthisproblem:Firmsearnzeroprofits,socannotrequirethem
toreduceprices.011MONOPOLISTICCOMPETITIONMonopolisticCompetitionandWMonopolisticCompetitionandWelfareNumberoffirmsinthemarketmaynotbeoptimal,duetoexternaleffectsfromtheentryofnewfirms:Theproduct-varietyexternality:
surplusconsumersgetfromtheintroduction
ofnewproductsThebusiness-stealingexternality:
lossesincurredbyexistingfirms
whennewfirmsentermarketTheinefficienciesofmonopolisticcompetitionaresubtleandhardtomeasure.Noeasywayforpolicymakerstoimprovethemarketoutcome.012MONOPOLISTICCOMPETITIONMonopolisticCompetitionandW1. Sofar,wehavestudiedthreemarketstructures:perfectcompetition,monopoly,andmonopolisticcompetition.Ineachofthese,wouldyouexpecttoseefirmsspendingmoneytoadvertisetheirproducts?Whyorwhynot?2. Isadvertisinggoodorbadfromsociety’sviewpoint?Trytothinkofatleastone“pro”and“con.”ACTIVELEARNING1
Advertising1313MONOPOLISTICCOMPETITION1. Sofar,wehavestudiedthrAdvertisingInmonopolisticallycompetitiveindustries,productdifferentiationandmarkuppricing
leadnaturallytotheuseofadvertising.Ingeneral,themoredifferentiatedtheproducts,
themoreadvertisingfirmsbuy.Economistsdisagreeaboutthesocialvalueofadvertising.014MONOPOLISTICCOMPETITIONAdvertisingInmonopolisticallyTheCritiqueofAdvertisingCriticsofadvertisingbelieve:Societyiswastingtheresourcesitdevotestoadvertising.Firmsadvertisetomanipulatepeople’stastes.Advertisingimpedescompetition–
itcreatestheperceptionthatproductsare
moredifferentiatedthantheyreallyare,
allowinghighermarkups.015MONOPOLISTICCOMPETITIONTheCritiqueofAdvertisingCriTheDefenseofAdvertisingDefendersofadvertisingbelieve:Itprovidesusefulinformationtobuyers.Informedbuyerscanmoreeasilyfindandexploitpricedifferences.Thus,advertisingpromotescompetitionandreducesmarketpower.Resultsofaprominentstudy:
Eyeglassesweremoreexpensiveinstates
thatprohibitedadvertisingbyeyeglassmakers
thaninstatesthatdidnotrestrictsuchadvertising.016MONOPOLISTICCOMPETITIONTheDefenseofAdvertisingDefeAdvertisingasaSignalofQualityAfirm’swillingnesstospendhugeamounts
onadvertisingmaysignalthequalityofitsproduct
toconsumers,regardlessofthecontentofads.Adsmayconvincebuyerstotryaproductonce,
buttheproductmustbeofhighqualityforpeople
tobecomerepeatbuyers.Themostexpensiveadsarenotworthwhile
unlesstheyleadtorepeatbuyers.Whenconsumersseeexpensiveads,
theythinktheproductmustbegoodifthecompany
iswillingtospendsomuchonadvertising.017MONOPOLISTICCOMPETITIONAdvertisingasaSignalofQuaBrandNamesInmanymarkets,brandnameproductscoexistwithgenericones.Firmswithbrandnamesusuallyspendmoreonadvertising,chargehigherpricesfortheproducts.Aswithadvertising,thereisdisagreementabouttheeconomicsofbrandnames…018MONOPOLISTICCOMPETITIONBrandNamesInmanymarkets,brTheCritiqueofBrandNamesCriticsofbrandnamesbelieve:Brandnamescauseconsumerstoperceivedifferencesthatdonotreallyexist.Consumers’willingnesstopaymoreforbrandnamesisirrational,fosteredbyadvertising.Eliminatinggovtprotectionoftrademarks
wouldreduceinfluenceofbrandnames,
resultinlowerprices.019MONOPOLISTICCOMPETITIONTheCritiqueofBrandNamesCriTheDefenseofBrandNamesDefendersofbrandnamesbelieve:Brandnamesprovideinformationaboutqualitytoconsumers.Companieswithbrandnameshaveincentive
tomaintainquality,toprotectthereputationoftheirbrandnames.020MONOPOLISTICCOMPETITIONTheDefenseofBrandNamesDefeCONCLUSIONDifferentiatedproductsareeverywhere;examplesofmonopolisticcompetitionabound.Thetheoryofmonopolisticcompetitiondescribesmanymarketsintheeconomy,
yetofferslittleguidancetopolicymakerslookingtoimprovethemarket’sallocationofresources.021MONOPOLISTICCOMPETITIONCONCLUSIONDifferentiatedproduCHAPTERSUMMARYAmonopolisticallycompetitivemarkethas
manyfirms,differentiatedproducts,andfreeentry.Eachfirminamonopolisticallycompetitivemarkethasexcesscapacity–produceslessthanthequantitythatminimizesATC.Eachfirmchargesapriceabovemarginalcost.2222MONOPOLISTICCOMPETITIONCHAPTERSUMMARYAmonopolisticaCHAPTERSUMMARYMonopolisticcompetitiondoesnothaveallofthedesirablewelfarepropertiesofperfectcompetition.Thereisadeadweightlosscausedbythemarkupofpriceovermarginalcost.Also,thenumberoffirms(andthusvarieties)canbetoolargeortoosmall.Thereisnoclearwayforpolicymakerstoimprovethemarketoutcome.2323MONOPOLISTICCOMPETITIONCHAPTERSUMMARYMonopolisticcoCHAPTERSUMMARYProductdifferentiationandmarkuppricingleadtotheuseofadvertisingandbrandnames.Criticsofadvertisingandbrandnamesarguethatfirmsusethemtoreducecompetitionandtakeadvantageofconsumerirrationality.Defendersarguethatfirmsusethemtoinformconsumersandtocompetemorevigorouslyonpriceandproductquality.2424MONOPOLISTICCOMPETITIONCHAPTERSUMMARYProductdiffereMonopolisticCompetitionEconomicsPRINCIPLESOFN.GregoryMankiwPremiumPowerPointSlides
byRonCronovich16MonopolisticCompetitionEconomInthischapter,
lookfortheanswerstothesequestions:Whatmarketstructuresliebetweenperfectcompetitionandmonopoly,andwhataretheircharacteristics?Howdomonopolisticallycompetitivefirmschoosepriceandquantity?Dotheyearneconomicprofit?Inwhatwaysdoesmonopolisticcompetitionaffectsociety’swelfare?Whatarethesocialcostsandbenefitsofadvertising?2626MONOPOLISTICCOMPETITIONInthischapter,
lookfortheIntroduction:
BetweenMonopolyandCompetitionTwoextremesPerfectcompetition:manyfirms,identicalproductsMonopoly:onefirmInbetweentheseextremes:imperfectcompetitionOligopoly:onlyafewsellersoffersimilaroridenticalproducts.Monopolisticcompetition:manyfirmssellsimilarbutnotidenticalproducts.027MONOPOLISTICCOMPETITIONIntroduction:
BetweenMonopoCharacteristics&Examples
ofMonopolisticCompetitionCharacteristics:ManysellersProductdifferentiationFreeentryandexitExamples:apartmentsbooksbottledwaterclothingfastfoodnightclubs028MONOPOLISTICCOMPETITIONCharacteristics&Examples
ofComparingPerfect&Monop.Competitionyesnone,price-takerfirmhasmarketpower?downward-slopinghorizontalDfitsyesyesfreeentry/exitmanymanynumberofsellersMonopolisticcompetitionPerfectcompetition029MONOPOLISTICCOMPETITIONComparingPerfect&Monop.ComComparingMonopoly&Monop.Competitionyesyesfirmhasmarketpower?downward-slopingdownward-sloping
(marketdemand)Dfitsyesnofreeentry/exitmanyonenumberofsellersMonopolisticcompetitionMonopoly030MONOPOLISTICCOMPETITIONComparingMonopoly&Monop.CoprofitATCPAMonopolisticallyCompetitiveFirmEarningProfitsintheShortRunThefirmfacesadownward-sloping
Dcurve.AteachQ,MR<P.Tomaximizeprofit,firmproducesQwhereMR=MC.Thefirmusesthe
DcurvetosetP.QuantityPriceATCDMRMCQ031MONOPOLISTICCOMPETITIONprofitATCPAMonopolisticallyClossesAMonopolisticallyCompetitiveFirm
WithLossesintheShortRunForthisfirm,
P<ATC
attheoutputwhereMR=MC.Thebestthisfirmcandoistominimizeitslosses.QuantityPriceATCQPATCMCDMR032MONOPOLISTICCOMPETITIONlossesAMonopolisticallyCompeMonopolisticCompetitionandMonopolyShortrun:Undermonopolisticcompetition,
firmbehaviorisverysimilartomonopoly.Longrun:Inmonopolisticcompetition,
entryandexitdriveeconomicprofittozero.Ifprofitsintheshortrun:
Newfirmsentermarket,
takingsomedemandawayfromexistingfirms,
pricesandprofitsfall.Iflossesintheshortrun:
Somefirmsexitthemarket,
remainingfirmsenjoyhigherdemandandprices.033MONOPOLISTICCOMPETITIONMonopolisticCompetitionandMAMonopolisticCompetitorintheLongRunEntryandexitoccursuntil
P=ATCandprofit=zero.NoticethatthefirmchargesamarkupofpriceovermarginalcostanddoesnotproduceatminimumATC.QuantityPriceATCDMRQMCMCP=ATCmarkup034MONOPOLISTICCOMPETITIONAMonopolisticCompetitorintWhyMonopolisticCompetitionIs
LessEfficientthanPerfectCompetition1.
ExcesscapacityThemonopolisticcompetitoroperatesonthedownward-slopingpartofitsATCcurve,
produceslessthanthecost-minimizingoutput.Underperfectcompetition,firmsproducethequantitythatminimizesATC.2.
MarkupovermarginalcostUndermonopolisticcompetition,P>MC.Underperfectcompetition,P=MC.035MONOPOLISTICCOMPETITIONWhyMonopolisticCompetitionIMonopolisticCompetitionandWelfareMonopolisticallycompetitivemarketsdonot
haveallthedesirablewelfarepropertiesofperfectlycompetitivemarkets.BecauseP>MC,themarketquantityisbelow
thesociallyefficientquantity.Yet,noteasyforpolicymakerstofixthisproblem:Firmsearnzeroprofits,socannotrequirethem
toreduceprices.036MONOPOLISTICCOMPETITIONMonopolisticCompetitionandWMonopolisticCompetitionandWelfareNumberoffirmsinthemarketmaynotbeoptimal,duetoexternaleffectsfromtheentryofnewfirms:Theproduct-varietyexternality:
surplusconsumersgetfromtheintroduction
ofnewproductsThebusiness-stealingexternality:
lossesincurredbyexistingfirms
whennewfirmsentermarketTheinefficienciesofmonopolisticcompetitionaresubtleandhardtomeasure.Noeasywayforpolicymakerstoimprovethemarketoutcome.037MONOPOLISTICCOMPETITIONMonopolisticCompetitionandW1. Sofar,wehavestudiedthreemarketstructures:perfectcompetition,monopoly,andmonopolisticcompetition.Ineachofthese,wouldyouexpecttoseefirmsspendingmoneytoadvertisetheirproducts?Whyorwhynot?2. Isadvertisinggoodorbadfromsociety’sviewpoint?Trytothinkofatleastone“pro”and“con.”ACTIVELEARNING1
Advertising3838MONOPOLISTICCOMPETITION1. Sofar,wehavestudiedthrAdvertisingInmonopolisticallycompetitiveindustries,productdifferentiationandmarkuppricing
leadnaturallytotheuseofadvertising.Ingeneral,themoredifferentiatedtheproducts,
themoreadvertisingfirmsbuy.Economistsdisagreeaboutthesocialvalueofadvertising.039MONOPOLISTICCOMPETITIONAdvertisingInmonopolisticallyTheCritiqueofAdvertisingCriticsofadvertisingbelieve:Societyiswastingtheresourcesitdevotestoadvertising.Firmsadvertisetomanipulatepeople’stastes.Advertisingimpedescompetition–
itcreatestheperceptionthatproductsare
moredifferentiatedthantheyreallyare,
allowinghighermarkups.040MONOPOLISTICCOMPETITIONTheCritiqueofAdvertisingCriTheDefenseofAdvertisingDefendersofadvertisingbelieve:Itprovidesusefulinformationtobuyers.Informedbuyerscanmoreeasilyfindandexploitpricedifferences.Thus,advertisingpromotescompetitionandreducesmarketpower.Resultsofaprominentstudy:
Eyeglassesweremoreexpensiveinstates
thatprohibitedadvertisingbyeyeglassmakers
thaninstatesthatdidnotrestrictsuchadvertising.041MONOPOLISTICCOMPETITIONTheDefenseofAdvertisingDefeAdvertisingasaSignalofQualityAfirm’swillingnesstospendhugeamounts
onadvertisingmaysignalthequalityofitsproduct
toconsumers,regardlessofthecontentofads.Adsmayconvincebuyerstotryaproductonce,
buttheproductmustbeofhighqualityforpeople
tobecomerepeatbuyers.Themostexpensiveadsarenotworthwhile
unlesstheyleadtorepeatbuyers.Whenconsumersseeexpensiveads,
theythinktheproductmustbegoodifthecompany
iswillingtospendsomuchonadvertising.042MONOPOLISTICCOMPETITIONAdvertisingasaSignalofQuaBrandNamesInmanymarkets,brandnameproductscoexistwithgenericones.Firmswithbrandnamesusuallyspendmoreonadvertising,chargehigherpricesfortheproducts.Aswithadvertising,thereisdisagreementabouttheeconomicsofbrandnames…043MONOPOLISTICCOMPETITIONBrandNamesInmanymarkets,brTheCritiqueofBrandNamesCriticsofbrandnamesbelieve:Brandnamescauseconsumerstoperceivedifferencesthatdonotreallyexist.Consumers’willingnesstopaymoreforbrandnamesisirrational,fosteredbyadvertising.Eliminatinggovtprotectionoftrademarks
would
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