]

I
t
[ [ J [ [ I :

T,' ,".* i.,-,,,*#;;: ::;'

**

"'

T;;i*;$c

.r m.n.p.,i s,i c

-\Iorl*p*i*qtic
=.". -tuence *"

#u*xeap*rit?*re {}*&re*r{
*e"fi

::;ti*:: i;i

flz:fi GF*ll.ciic

"";;;;';H',;;;.5:T;;'ffi;'#:#k*;X#:[Ji,f,,*TfffJT:; Although this is our working deflnition, monopolistic competitors do have some
over price because their products are differentiated. But it's a very small
now encounter a differentiated product for the flrst time. Note that the definition

\:r-j2"{tp':tlli{}I1

-ruence.

,, monopolistic competition differs from that of perfect competition only in the element ,: a differentiated product. You'Il remember that under perfect competition, all the sell.:= sold an identical product.
Why did we say the product was identical? Because none of the buyers dift'erentiated sale. Each was considered the same: Number 2 wheat is number - 11'heat; a large grade A egg is a large grade A egg. If the buyer doesn't differentiate among the versions of the product sold, the products T'!:* difrer*err* herr,v**ri r*e identical. If he does differentiate, the product is then differentiated. Who determines iil**liei:i *nC ,-i;ti;:rr:riii*teri ;hether the product is difierentiated or identical? The buyer-that's who.

.=ong the products for

261

262

CHAPTER

11

Like the perfect competitor, the monoporistic competitor operates with perf.ect information. And as under perfect competiiion, flrms can easity enter or leave
rnoustry.

the

The M*n*p*lisric C*rnpctit*r in rhe Shorr Run

The n:oni:pr:li s{ic cLur-?F*ti{.r

c*n *:ake a pr*tit cr tak* a lcss in the rhi;rt rtin"

Ve* *llrsiic d*manil c*rve

run is the same as that under perfect competition. In the tong run, if.firms are rosing money, many wil leave the industry, rowering industry supply and raising market prlc". eni it, in trre long run, flrms are realizing substantial profits, new firms will be attracted to the industr5f thus raising supply and lowering market price. But we're getting.ahead of ourselves. Figure 1 shows a monopolistic competitor in the short run. Notice how its demand and MR curves slope downward, rike tho.se of the monoporist. Theoretically, we may oF for a somewhat more elastic demand curve for the montpgtstic competitor than for ttre monopolist because the latter faces the demand curve for the entire iniustry. The monop olistic competitor, as onry one firm in a crowded industry, must have a very erastic demand curve because there a.re many close substitutes foi the firm,s product. In facr no one can get too far out of line with respect to price because buyers are always read-r. to purchase substitutes from a rival firm. Getting back to Figure 1, how much is the flrm's output? How much is its price? How much profit does it make? Work it out right here:

Ljkg the perfect competitor, the monopolistic competitor can make a profit or take a loss in the short run; but in the long run the flrm will break even. The reason the monopo_ listic competitor makes zero economic profits in the long

Firsf the output' when MC equars MR, output is 60. we find that at an output oif 60, the price, which we read off the demand curve, is $15, and the ATC is $12.10 or soNow we can write down our standard equation, substitute, and
solve:

Total profit

: :

(price
$2.90
$174

($15*$12.10)x60

ATC) X Outpur
60

. Now we're ready for Figure 2. which also shows the monopolistic competitor in the short run. How much is output? Is the firm making a profit o. ,'uting a io.s? How much is it?
Total profit

: (Price*ATC)xOurput
($11

-$12.80)x42 -$1.80 x 42

-$75.60
I',m not above admitting that even r cannot read my own graphs with any greater orecis]91 than rhe average reader. so, if your price, output, arclana, consequently, ross are a little different from mine-no problem. i,tt u"."pi any loss thai's within the range of $70 to $80.

Monopalis 24 rr*--**-

tic Competition
Flgaf I

263

lltii ::ii: 22 i" '

i:- li

i!4*n+pt>listir: C+mp*iit*r l-daki n* a Flclfit in the Sh*rr ltun

The monopolistic competitor makes a profit only in the short run. How much is this firm,s price and output? The price is gl5 and the output is 60.

,,

,-

|t, ti

i:r 't

e
.o
o_

i-*1

l,

i--l

rt o L -- i,-.

010

60

7A

100 120 140

]60

Output

24 22
2A

Flgxr* ?
.Man<;pc!i;tic Ct:a.rprritr:r ?r*.ing

a La*s in ihe $trr*it }tu*

The monopolistic competitor will take a loss only in the short run. How much is this monopolisric compedtor's price and output? price is $1 I and output is 42.

18
t'

',5 14

.E

a 10
10

(L

60

7A

80

90

100 12A 140

160

Output

264

CHAPTER

11

L*ng Run Th* k1*n*p*listic C*rnpetit*r in the

As I
zero economic the monopolistic competitor 't":k:t do*'n said earlier, in the long run **" n'*t *il enter the industry' driving profits. If there *"

!lrr: ir:ng rutt'

( i i16 1,r r1,t1rt'ii 'ri" r1:llftl'11'l h Ij1 ,51'-i\i r'1:' (:o1l'\llliL ':

'r'o"t'-i"'"p'ot'*' marketpriceandprohts'ffttre"rearelosses''o*"nt*'willleavetheindustry'pushing run. Note how th *J3['iin]ilil.o",,stic c.ompetiror in the rongprice' output is 40' il'ii*tly below the curves ooint ar which the MC and MR ".o$ i,.*'.fr" ,t", price is equal to AIC at that output'

;Hf.:t;t::

ffiH"" ffiri.iS.

sure you figured o.,,

Werethefirmtop;;;';"atanyothert"tp;'whatwouldhappentoitsprofits?I'm output, the demand curve *Jr*,n"y-*oiA Ue tosr"s. it any other price is less than AIC lies below the ATC curve' so point of the AIC cun-e' the pri*;;id;; 3 is higher.thanrio"tminimum it Note that the monopolistic competitiofl than price is t igt This means that in the long run "r
is

!\ht: i: rcixl

eiiir:rr:n{: th*
"

pfrl*{[ {i]!1}tr:';itOr trr. ll:* itct i1]$1]ritc'i igtie aL]tilpel

because'h" T:i:ry1*:::H::*::Suces competition' than it ii under perfect its iTC curve, output iS i"iu"t or rhe minimum point of *o."-"tn"i"ttt: the monopolistic competitor th who is Finally, we have is your AIc? Because "in"i"r"v. oj'iil." is one test ro, rrn"i"n"y: what monopolisthe perfecr "o*p*riptoao""' at the minimu* poi* oiitt efC cqle'and the perfect competitor is more efficient' the perfect competitor tic competito: ao""oi' "iuarly

underuPerrect;:ffitl',

to ttre Ieft

""o.,o*i" io*", *J nu. u

output than the perfect compt competitor' perfect cornIn"i*t p*a,rcer than is the monopolistic mooopotisic comPetitor of a ;;;il;J" Figure a provioes charges a higher 'Tu " norice, tf,e monopotistic competitor petitor in the long ;.;ffi1i

Tosumup,boththemonopoli,ti""o*p"iitirandtheperfectcompetitormakezgro p,ofit' i' tJro"g i *:T#,':'r:'ffiffiT .:,tIffi;,:1-i:":

*" f

ffi

Figa:e 3
,*t'l

Rtr* ftrreliitir,g E'"'c* ii' t!-i;: L'tng In the long run, the monoPolistic ."-o",i,oi.".t break even Notethe ii^iltt" n^rc curve is tangent to same demand cuwe and thal at that ts outout, MC MR How much outPut for this firm? Price t.iJ"

*:t+p*ii it ic {){:'it

pr*i

ir;r

""a is $12.25 and outPut is 40'

G
'=
a4D
10

Mon opo/

is

tic

Compe ti tt on

265

A. The Monopolistic Competitor 18

B.

The Perfect Competitor

16
14 12 14 12

t 58
6

r{n

to

E8
o

o o

40 s0
Output

60

4A 50 ' Output

60

Diure 4 b.\1on,;polistit

C.rmpetitor and the Pcriir'r C(),rrpetrtur irr thc Lur,g !tuo

FiE ($10) than the perfect competitor ($9). The monopolistic competitor has a lower Qut (30) than the perfect cornpetitor (45). Also, since the perfect competitor produces r the minimum poirt of her ATC curve, she is a more efficient producer than the
mopolistip competitor, who
has a higher

ATC-$10 vs.

$9.

Produet I] iff.erentiario*
Jloduct differentiation is crucial to monopolistic competition. In fact, the product diftrentiation is really what stands between perfect competition and the real world. People Ifferentiate among many similar products. What makes one good or service differ from another? We need only for the buyer D believe there's a difference, because product differentiation takes plaie in the buyer's
?'he e*rcini fa,;l*r dit,l*:*ntiatiE:a"

i:

prr:duer

rind. What's the difference between a Toyota Camry and a Corvette? There is absolutely ndifference between these two cars /the buyer sees no difference. Suppose someone fo given the choice and says, "I don't care. They're both the same to me." To this buyer,
cars are identical. One is 1onge1 maybe; one has nicer upholstery. Americans are provided with a wide array of shampoos, breakfast cereals, candy bs, facial and bath soaps, soft drinks, ballpoint pens, and thousands of other consumer tmds. Similarly, we can choose from among huge numbers of lawyers, accountants, ytysical therapists, chiropractors, advertising agencies, public relations firms, service l*ions, and restaurants. People living in most other countries don't have all the conrwner choices that'Arnericans do, so they donlt engage in nearly as much product diflrentiation as Americans. We're always differentiating, and our basis doesn't have to be taste, smell, size, or

ft

?Ve'r* ;;lways diil*r*ntiating.

rc CDs; both shops charge exactly the same prices. Both shops are conveniently hcated. But one is usually crowded and the other is always empty. Why? Ambience. Perhaps one place iets you listen to a CD before you buy it. PerLrys one store will take special orders for you. Perhaps the salesclerks and owners are ix, helpful people, while in the other store they're all grouches. Now we're dealing with a differentiated product. The CDs are the same. The prices rc the same. But one store's got ambience up to here, and the other has to send out for it.

cEn any physical differences among the products. Two music shops might carry

the

266

CHAPTER

11

$
T.

The trend toward customization is taking product differentiation one st6p furrher. When you're buying a new car. you can pick something from the lot, or. if you don't mind waiting a few weeks, you can order a car eustomized to your-specificafions. Now, however, you can configure your vehicle to your specifications on the Internet and climb behind the wheel within just a few days. More and more, manufacturers like SONY, Dell, *ndApple are allowing customers to bypass retailers and buy direct. Toyota and other carmakers have equipped their showrooms in Japan with Internet terminals. Publishers are at the forefront of product customization. Some publish books on dernand. [n other words, if there's some out-of-print book that you'd like

to buy, they can just print it up for you. Very soon you'll be able to walk into a bookstore, ask them for virtually any book, and it will be waiting for you when
you return from the coffee bar. College textbook publishers accommodate professors by custom publishing book-long collections of articles to be read by their students. And, finally, here's some news you may be able to use. If you, or anyone you know, should happen to have a novel you would like to have publishedwith an audience presumably limited to friends and

family-there are ne* digital publishing houses (for

example, iUniverse and Replica Books) that

your book into

print.

will

get
i i
J

The buyer prefers Mr. Nice Guy's store over the grouch's store, so we have a differentiated product. When sellers try to get buyers to differentiate between their products and those of competitors, the sellers.do so based on more than physical differences between their product and other versions of it. Also used are convenience, ambience, reputations of the sellers, and appeals to your vanity, unconscious fears, and desires, as well as snob appeal. To all that we can now add customizing products to suit individual tastes (see the bor on customization). Is McDonald's a monopolistic competitor? Think about it. First, does McDor.. : produce a diflerentiated product? To answer one question with another, do cusro::differentiate between a Big Mac and Burger King's Whopper? To judge from their aj ..:, tising, both companies seem to think so.

Next question: Is McDonald's one of many firms in the industry? Well, whar's ---: industry? Ready-to-eat burgers and fries? Or fast food? What do you think? Fasr fc,_,: I agree. So McDonald's 13,000 U.S. outlets compete with almost a quarter million c,---=: fast-food outlets. what percentage of fast-food outlets within five miles of your h,::t are McDonald's? So McDonald's, although a huge chain, is basically a monopcrl:.-:competitor.

on the ln,'eb

Booksellers try to get you to differentiate between the books they sell and the books ::.: by other booksellers, even though each may be selling the same books at the same pn::. See how differently rvlw.batrne$andncble.c*rn and www.amazon.com present Ra g t i r-. : by E. L. Doctorow; Time and Again, by Jack Finney; and The Age ot'Tttrbulence. :..

Alan Greenspan.

Advertising and Momopo?istic Competition

One of the most important ways that the monopolistic competitor can differentiate tL:: good or service from those of his competitors is by advertising. "Best fbod in tow'::. "Reliable Service," "No Waiting," and "Free Delivery," are all ways of letting potenrir customers know why his firm is better than the competition.

Monopolistic Competition

267

I t

recent decades law firms that specialize in personal injury claims have aggres_ advertised their expertise. Here is u ,u*ptirig of ads taken from the Brooklyn
:

YeIIow Pages:

$crious Injury? we cgme to you*horne or hospital. No fee unless successful. Get Money for your Injuries. No Fee Unless you Collect. Ge the cash that you deserve.

laident
ubile

with a truck? Make them

pay!

L:jfl,9:"'*: only provides information"about a good ;;,h"' ory. Advertising not ::,::L::.'jl:i!lj'h"r',iur,.,'oin, or service l but it helps a new firm break into tfre Uusirolft' A drugstore and stimurates might paper the prhood wifh circrrlq,c and borhood with circulars an^ advertise in the ^;..^*:^^ i-^ .r
but that's

or,n"i, m r::::i-:::l:T:T,:f T" "e[*,,, ilF services, ana tnat customers have to pav anvthing unless they win theii

these ads may seem a littre undignified for attorneys, they do get results. The

.diffi;ffiff;:,11ru:: ;;.

rhe new kid on ,n" head-to-head with his more established "nuuiing rivals. But advertising, of course, cioes have u ao*rrio". It can be quite bothersome fi.nding o,, yo* i* vvruE uwtrtuiilue(.l Dv 5::XJ:1*T:r1T_:\:e\x\ ,,ut perhaps worse walk, and being bombarded bv .miqlo ^- +L^ -^l:^ vu urs raur(' anu r v. stilr, advenising can substantia[! trre irice_--_or j=o, we might have dozens of monopolistic u eo.o or service. rn a worst case sce_ competitors ,uto.,uuiluitous ads end up r-ering each other without. boosting sares. And the consumers getting stuck ,*h the bill in the form of

:ff ::"1':, :* :"':T:::":':,:llg:T::q rl' advertising can level the playing nera,

b;';;;;il:;".ti"ffiflJi;:: ;i*y parked car in the vicinity. So

ol'j]iil

3::,-*::"::::::"-Try,

higher pri-"es.

"ni-up

Typical Monopolistic Competitor

ffi;t1p}#:;f;n#*ml:m:,.Lyffi *H,;*m I By tim"

It,s something lerse competitor can't proviie, unless, i *t*j bar.and see whether-the.barrender oi "ourr", ail barshappen to do this. walk into r$Emge puts a drink a.*, ,n ,[I"i.i*, o"r.* you,ve if.ir,s what you atways order_rhen that drink,s on me. T:r"jrj^y,f::_r"d competitor attempts to Each monopolistic set his firm apart i... ,rr" competition. f main way of doing this is through uou".tiring. a, *" ,u*"in',illio"*ura,, chapter, sen this is done successfuny, the Jemand cu*e f*"d by the monoporistic competitor h'es more verricar or inerastic sry"ir-t willing io puy ;;;]., this product Lrause

You walk into your neighbo.hood tavern. the you [h' vour drink is waiting foi you. oK, so it;, orty a Diet Coke r'uJe Lerted up to the with a rwist of lemon. lrt n" thought that counts. rG orrt"nd"i, uy ,,"nirv pracing rr.rrra in front of your ian at the bar has announced, "This ,oo-un is one of my regulars. She doesn,t even hrrc to say anything. I know what she d.i;;, and I know where she rikes to sit.,, The bartender has accorded you a certain ,,.tur, u of beronging.

The monopolistic competiror tnes lo set his or her product apan from rhe competirion.

tod emporiums' gas stations,-Lard*ur" ,rJ."., gb-""n, drugstores, restaurants and fast{Eax) accounting and Iaw firmsj doctors, aentists, a"",rl"i*J,;;;;".r, and laundries, "tor"i;;;;;"r, and all the small businesses you'd-^see arong any MJn street, use. r"Ji rr"s many competi_ -F aud each produces rc"
hershops' mom-and-pop- groceries and general stores, spoons, beauty parrors and "off"e bars, rru*Lurg", joints, and dlions of other tiny retail stores where J".pr" speno iime euiii'g,"o.rnting, getting
Think of alr the 7-Elevens, diners,
a differentiated pioAuct.

they berieve it's wonderfur. or they,[undergo acts of great physical endurance: *Td walk a mile for a Camel.', 'Typical monopolistic competitors are grocery stoies,

.topr, greasy

268

CI]APTER

11

#
q6

How many times have you called a company's ,"*i." number and gotten a prerecorded message when you needed to talk to a live person? How many times have you been put on hold for 20 minutes because "all our representatives are curently assisting other customers" Ji Why does service stink? It's sirnple, explains BttsinessWeek: Providing a live person costs a lot more than piaying a recording.
And it's
a question

)
nies have set up two-tier, three-tier, or eyen fbur-tier customer service departments. For example, one New Englanc electric utility provides its top 350 business clients with six customer-service representatives. The next tier of 700 is handle<I by six more, and the next 30,000 have just two reps to service their needs. And the rernaining 3m,000 residential customers at the lowest end? They get an 80Q number

with

a recorded message.

of who is calling. 'The top 20 peraBusinessWeek, October 23, 2000. cover story.

cent of customers at a typical commercial bank generate up to six times as much revenue as they cost, while the bottom fifth costs three to lbur times more than they make for rhe company."i So you want to keep your best customers happy while sometimes doing everything you can [o lose your least desirabie customers. To do this, many iarge compa-

rThere's a great websire which shows you how to cut through all those au{omated menus and ralk directly with a fellow hunran. Go ro :.1 .' 1....., ;!111r.,.;11 ., 'rr lrnd click on FAQ for a listing of the phone numbers of prompts of hundreds of large companies. lRusinessWeek. op. cir.. p. I 26.

groomed, or picking up a couple of everyday household items. Most of them dispensr one thing" and you won't {ind it on the menu. It's local gossip. People stop by in th: morning with last night's news, and later thai afternoon they come to pick up that da1 ': iatest scoop. If you lived in a smali town, where would .r,orz rather do business? You eat in one luncheonette rather than any of the others because the counterman talks to you while you're having lunch or the waitress keeps your coffee cup fi1led. you prefer one grocery tlecause they'Il take your order over the phone. you,d rather shop r a particular drugstore because it has a much more cheerful atmosphere than all the othei
drugstores in town.

Small businesses often provide better service than lar-eer businesses, mainly because they can provide personal contact (see the box, "why Service Stinks',). when you har,e a problem, you can go right to the top and talk directly rvith the boss (which is especialheasy when it's a one-person business). You are deating with a live human being rather than a computer-based mailing, a recorded message, or an unnavigable website. Ambience, cleanliness, personal attention, convenience of location, easy credit, free delivery service, and good service in general are all reasons why buyers might shop at one store rather than at its competitors. Thus product differentiation does not necessarily mean there are any physical differences among the products. They might all be the same, but how they're sold may make all the difTerence. On the other hand, there are, of course, some very real physical product differences. Different brands of orange juice, beer, cigars, ice cream, and hamburgers do taste different and are differcnt in physical composition. Buyers often differentiate based on real physical differences among products. But diff'erentiation takes place only in the buyer's mind, and it may or may not be based on real physical differences.
:{r',f

i't^:c'-:'tl}','*{-:.i):;-{"t::t;-r;,i3-;,.-:i':

Price discriminationl sounds like a terrible thing, something that violates our basic constitutional rights. sometimes it's bad, and other times it,s not bad at all. In fact, price discrimination is often a disguised subsidy to the poor.
I .tr'';ii.i - i::a!'::t'., ii ': izi' :t:!:i'i.

Doctors often charge rich patients

or even a very large

,:t;;1 ;... ./1;1 :;:i:

,a,.!!il.-,

10

times what they charge poor

lAlthough price discrimination is generally associated with monopolists, you don't have to be a monopolist-

firm-to

engage

in price discrimination.

Monopolistic Competition

269

hrts for the same service. Airrines sometimes anow riders under 16 years of age to frr half the regular fair (,.youthfare',). Like elsewhere, restaurants near the retirement communities

:*r,:,:iij:?lf::; which are low-priced meals served plate specials," ke

Egement
works out werl for buyers

of South Florida are To create more.business during slack rime, many oner their

6 p.u' so now the restaurants are filred with senior citizens, been unwilring andlor unabre to pay the prices

and sellers. The buyerJg", ,o oir" out for less Ey, while the sellers get more business during slack time. n:r::^*.."IT.ple_ Tii.:: the 1940s' A&p had of price discrimi"nation .,a, p.oOaUly that of A&p mar_ during three grades

t ;r"';;some cases, n,*v oiriom wourd on the ."gut;;irrr"r menu. This

b"efore

gruoJa, it "r*-rrr."gi was the most 4ensive. Nothing but the best for our family. My parents were friendry with another family in the husband, a n in his early 50s, found out he had stomach cancer. neighborhood. Themy .,Ah-a!,, mother, "Ifrs. S. always bought grade C!,, "*"iui*"a
cancer, but there was absolutely no difference among the grades. "f why did A&P go to all this trouble to concoct such an elaborate subterfuge? !r oreating separate grades of canned peas, corn, beans, and other foods, it wasBecause able to EI, tetrs of millions of dollars in profits. The firm that practices price discrimination needs 'm or more separate groups of buyers. The doctor to be able to distinguish betweer clearly t' pfient's ability to pay, so when you go to the doctor, ,L-does this whei she sizes up you. d yhether food stamps are accepted, and be sure to say you,re a,.rost raggedy clothes, colrege student. In addition to distinguishing among separate group, oi buyers, the price discriminator rst be able to prevent buyers from resening the product (i.e., stop those'wiro buy at a row pbe from selling to those who would otherwise buy at a tirr* pi*J7-ri rrr" ts_*a_u_rrur_ pa-old buys an airline ticket at half fare and resells it to someone who is 35 ilire loses money. Most r5-and-a-half-year-ords don't have lots of money, years old, the fteis a way of filling an otherwise empty seat; but when the 35-year-old fliesso the special half-fare and ruild have been willing to pay full fme, the airline loses money. In the case of A&p, there ras no problem preventing the grade c customers from resening heir. f; to the grade A @storers because shoppers voruntarily separated themselves i"G trr.." *urt"rr. we've been talking about how the monopolistic competitor; i;;;;

l1s;*"11l tord GIe. My motler:1T: me that she arways bought

hrql""

quatity, B,was fairly good, and.C was_well, C was

of canned goods: A, B, and c. Grade A

A few years later the Federal rrade Commission (FTC) prohibited A&p ldes A, B' and c. The FTC didn't do this because 'Mr. s.;;-;io*u"t from seling

L'-use

ycu need tr: be able ro

'lb practice price discrirnination.

distinguish }:et*,'een at least

{i)

twu sets of Liuyers and

{2} Frevent one set of buyers Iionr recclljnr the pr,'ducr to another set.

-lculate his profit.

Solution:

discrimination. Let's work out an example to show how he actually .nanages to do this. To ry:p things simpre we're assumi"i tr" t u, lonstant returns to r-le. so he can increase his output from 1 to 200 at the sine ,r"rug"-ro,ur cost of $4. C-onleelentlf his marginal cost berween each of those outputs i, S+. -an In Figure 5, we see that he maximizes his profit at "irJ ouput +i. co ahead and

tg practicing price

his profits

Profit

(price

:($z-gar"Ot
:$3x45 : $135

ATC)

Output

your 12th birthday and could lo longer get into the movies at the children,s Fic? Did vou ever get a vounger-rooking.kid tobuy youiii.t"t v.r^",, off as under :2 to the ticket taker? What? you sri// do-ir?

:'R'emember when you passed

Figure 6 shows what happens when this monopolistic competitor practices price discrimination by charging $g to one group of buyers (panel *a S6.SO to a second group

")

f*;";j

6 .ir.J

270

CHAPTER

11

10

I I
7 6

@
IL

g5
4 3
2
1

40

50

70

80

90

100

1't0

120

130

140

150

Output

Flgare 5
Monopolistic Corirpetitor Charging One Price

Panel a
10 o

Panel b 10

I
A

a
7
6

7
tr

? o5 o
'E o-

4'
.9
o-

5 4
3

3
2
1

2
1

0 10

20

40

0 70 8o 90

50 Output

,00

0'10

20

30

40 50
OutPut

60

Ftgure 6
Monopolistic Competitor Practicing Price Discrimination

of buyers (panel b). You'll notice that the buyers paying the higher price have a
buyers in panel a.

less

elastic demand curve than the buyers paying the lower price. First calculate the profit the monopolistic competitor ealns by charging $8 to the

I _ I I I I
_

Monopolistic Competition
Solution:

271

Proflt

: (price - AIC) x Output :($8-$4)x20

vqlPur

I I -

f
I I I I -

=$4x20 :$80
Now carculate the profit he earns by charging $6.50 to the buyers in paner b.

soiunon:

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n

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me

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Let's return again to those airlines. How come u nigfrt from New york to Houston t1m:s a: much if you don't sray over on Saturday night? you probably figured TT-*": stnce.business travelers want to get home on that' weekends, the airiines

Iii"["JtiTJ":]il::l:Lft $ffitxli:';.#iil:#l,]?Jffi ffJ":tf:: and other practitioners of price discrimination knew their markets f -lt.the
atr-lines

"* "f,*g"
so

Before th.e advent of Medicare, Medicaid, HMos, and private health insurance, docy :::r:,i*ily practicad price discrimination. But they did so in a very good way. They :Try :h-9"9. their relatively rich patients as much as ten times more than they dii tbetr poorer patients' In essence, the rich were subsidizing the poor. Was their medical yT:rlr,t_" ym1,? prettf much, although maybe the doctors didn,t always order expenlab worl( tor the poorer patients. And, of -y" schmoozing with the wealthier patients. course, doctors may have spent a bit more ume degree storeowners price _ T a lesserwere often extended also practiced prices,discrimination-again in a good *?l- ,,T credit, lower and even freebies. This $e of f"g. Fce drscrimination is much less in evidence today. But you can get a pretty good idea :j lZt:.:::qd 6,0: ]0, and 80 vears aso by watching old movies tike The r,ast Angry -y:,(:! ],'/1rc11 Paur Muni played an aging doctor who continued practicing in a neighb"or_ hood that had grown increasingly poor) andrb Kiil a Mockinguira Gn *ti"r, ciegory Peck plays a depression-era Georgia lawyer who accepted farm"produce for Iegal fels). The next time you see or hear the words, new introductory offer, the ch-ances are good that these are the words of a price discriminator. The company is offering new customers a special deal that is not available to old customers .,New lsee thi box, Cus_ Iomers Get Better Deals than Old Customers,').
There are vending machines that now charge more for a can of soda on a hot day than other days- would you be willing to pay a higher price on a hot day? Because of consumer Iro{ests' the Coca-Cola Company put off installing these machines in the United States.

t'ell.that each customer's demand schedule became a separate market. This would make Possrble perJect p.rice discrimination (see the box, "Perfect price Discrimination,,).

sr

Price discrimination is woven into our economic fabric, and in most cases it is basically a mechanism for rationing scarce goods and services. For example, because nearly Ev-eryone seems to want to go to the movies at eight on Saturday night, the theaters

WORK
Perfect Price I)iscrimination
If price discrimination were carried to its logical conclusion, we would have perfect price discrimination. Every buyer in the market would lose his or her entire consumer surplus in the process. Let's review the definition of consumer surplus, which was discussed in the "Theory of Consumer Behavior" chapter: Consumer surplus is the dffirence betw'een what 1,ou pay for some good or sen'ice and what you would have been willing to pay.We'11start with a very simple situation. Amanda is willing to pay $30 for a pair ofjeans, and Kristin
is willing to pay $25.
second. And suppose Kristin is willing to pay $25 for:.-,r first pair and $15 for the second. If the seller knew this ar: was able to take advantage of this information, he wou-; charge Amanda $30 for the first pair and $20 for the se;ond. And Ifuistin would be charged $25 for the first pa:; and $15 fbr the second. Now we'll wind things up. Imagine there are 20 bui ers in the market for jeans. The seller has som-ehow fout: out exactly how much each pair ofjeans is worth to each r: the buyers. By charging them exactly those prices, he urhave managed to carry out perfect price discrimination. O:

If the seller were to charge $20, then

Amanda would enjoy a consumer surplus of $i0 and Kristin would enjoy one of $5. But if the seller kne*- how much each woman was willing to pay for a pair of jeans,

if the seller were abtre to tell Amanda that the price was $30 and tell Kristin separately that the price was $25, he would completely eliminate their consumer surpluses. Now we'1l add another wrinkle. Suppose Amanda is willing to pay $30 for the first pair ofjeans and $20 for the
and
u:,,-

course. it would be virtually impossible to carry out pnr-: discrimination on such a large scale. But when you thiruabout all those ridiculous sets of rules the airlines set uptickets must be purchased 7 or 14 or 21 days in advance, n,: refunds, no changes, and you've got to stay over for at leas:

one Saturday nighr*what they're really trying to do is squeeze out as much of their customers' consumer suipluses as they can.

encourage moviegocrs to see films at other times by charging considerably less. But th: main motivation for price discrimination is, of course. to raise proflts. If price discrimination w'ere carried to its logical conclusion. we would have perfect price discrimination.

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There are many cases where new customers get a better deal than old customers do. This is true for sales from the Victoria's Secret catalog: The comparly's computerized records teli it when you last bought. The catalog ofTers lower prices if your last purchase was a long time ago. Similarly, this week Roadrunner cable modems are offering a $19.95 rnonthly price fbr three months (instead of the usual $44.95) if you sign on now. Both represent good examples of pure demand-based price discrimination: The good or service offered is identical,

and the only dillerence between customers is how wedded to the good or service they appear to be. The companies assume that liequent buyers or long-term users

will buy anyway and thus they have an

inelastic

dernand. A.nother precondition for price discrimination is met too: The companies are sure beforehand that the low-priced good or service-the lingerie or the highspeed Internef c6nneslien-will not be resold.*
*Excerpted from Daniel Hamermesh, Economics ls Everywhere (New York: McGraw-Hill. 2004), pp. 150-5i.

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It appears. from our analysis of the long-run position of the monopolistic competitor ir: Figure 3 that the lirm does not produce at the minimum point of its ATC curve. Economists criticize monopolistic competition as wastelul on two counts: too manv firms in the industry and overdifferentiation. Are there too many beauty parlors? Not if you w'ant to get your hair done on Fridal or Saturday atternoon. Too many gas statiors? Not when there are gas lines. Too manr' Chinese restaurants? Not on Sundays. Are there too many grocery stores and too man). real estate offices? Clnly when they're not busy. But rnost business firms, which appar272

Monopolistic Conpetition
6m1- excess capacity during cenain times of the day or the week, are set up to loads, so there aren't necessarily too many monopolistic competitors. Ilh respect to the second criticism, is there really overdifferentiation? Perhaps there don't

273

E Fak

he sbstantial differences among grocery stores, drugstores, luncheonettes, dry cleaners,

whether we're aware of it or not, our entire environment is flavored by product Can -vou imagine a nr:-frills fferrentiation. Imagine that next December every commercial Christmas display is done wr:rki? L L"Iack and white. Imagine what our supermarkets would look like with all black-andrkte boxes, jars, and cans. And imagine what people would look like if they all wore ft same styles and colors. In a word, product differentiation adds flavor, texture, and rriery to our lives. Whether we want to pay the price is a matter of individual taste. The product differentiation engendered by monopolistic competition is a strong
,=crnterforce to the McDonaldization of America. In the opening paragraph of a book -r-lerr. Karal Ann Marling paints a vivid picture of our country.
One source of a pervasive millennial malaise is the perception that American life has come down to a coupie of monster corporations selling the same Gap chinos and Egg McMuffins on every corner, from sea to shining sea-that the rich pageantry of the national folklife, in all its pungent variety, has played itself out in a roadside litter of discarded clamshell burger boxes and chicken buckets. Every city looks just the same, its presence marked upon the larldscape not by impressive civic monuments but by a garishly lighted corridor of brand-name drive-ins, poinling the way from the Interstate to an all but abandoned urban center; McDonald's, Arby's, Wendy's, Taco Bell, Pizza Hut. Topeka or Syracuse, Cheyenne or Memphis-only the order of the pseudo-haciendas and the golden arches changes.3

-{lni

parlors, buf consider the alternative" Consider the drab monotony of the stores oiEastem Europe, including the old Soviet Union. Maybe this lack of differentiation, l@rHiTation, enables the sellers to cut costs somewhat. But is it worth it? - I.bar are you really buying when you go to a fancy restaurant? Surely not just a L*doubtedly you'll order something on a somewhat higher culinary plane than a !}l,r--. large fries, and a Coke, but is that meal worth $80? It is when it is served by u-ith a phony French accent, there are flowers on your table, a nice linen table;andlelight, soft music, and a solicitous maitre d', plus the restaurant is a restored :ittrrury carriage house. (See Curent Issue, "Selling Status," on the next page.) Xmopolistic competition, with its attendant product differentiation, may be viewed t and inefficient, and a case can easily be made that iris. Think of all the money oo advertising, packaging, marketing, and sales promotion, as well as interiors, and window displays. These expenses add perhaps l0 or 20 percent to the prices uxr things we buy; so we may well ask, Is it worth it? You decide. fil bet you're saying to yourself, "There he goes again, copping out and passing the .- .{,nd you're right. You see, the buck stops with you because it's your buck and 3r,rr decision about how to spend it. Do you want to spend it on advertising, ambience, service, and convenience, or are ttasically a no-frills person? Do you usually buy no-frills brands il the supermarket, rxrash rather than first-class, drive an economy car, and consider dinner in a fast-food ium "eating ouf'? If you have answered yes to each of these questions, you are - el a no-frills person who knows the value of a dollar. However, if you answered no to all the above, you are clearly a person of refined aod high style-a vety au courant person (that's French for "up-to-date"). Whether iike it or not, product differentiation is the way monopolistic competitors compete.

A hamburger by any other

costs twice as much.

nanxe

-Evan
ls rnonopolistic ctrnlpetitiorl
wiisteiul and inet'ficie*r?

Esar

business does engage in lively, innovative competition. The next tirne you're walking along a shopping street, take note of how the storekeepers try to entice you with their window ,iisplays. To the degree that they're successful, they have induced you to differentiate their Froducts from all the others. That is what monopolistic competition is all about.
:Karal Ann Marling, "sameness Is Glorious," New York Times Book Review, December 26, 1999,

rith respect to price, but they compete still more vigorously with respect to ambience, -n'ice, and the .rest of the intangibles that attract customers. In this arena American

Finally, let's consider the nature of competition. Monopolistic competitors do compete

p. 34.

274

CHAPTER

11

Current Issue: Selling Status

Starbucks does a great job selling status, along with its coffee and hot chocolate. Yoo can pay $2.20 for a hot chocolate or $3.20 for a white chocolate mocha. Why the dollar price differential? After all, how much more does it cost to make the white chocolate mocha than to make the plain hot chocolate? Maybe a few cents. Tim Harford observes that "By charging wildly different prices for products that have largely the same cost, Starbucks is able to smoke out customers who are less sensitive about the price."a Harford also asks why airport departure areas across the world are so shoddy. Or why the stewardesses stand ready to physically restrain coach passengers who attempt to leave a plane before the last first-class passenger has left the aircraft. The first-class passengers paid for fust class treatment. If everyone is treated first class, there'd be no point in paying a premium price. You can buy a perfectly good wrist watch in Walgreen's or Rite Aid for less than $15, one that will tell time just as accurately as one of those fancy watches for which people pay over $10,000. If you took a blind taste, you could probably find a bunch of chocolates that you liked as well as Godivas-but cost much less than $45 a pound. And if you're a clever shopper, maybe you do your Christmas shopping at discount stores and use wrapping paper from Tiffany's. Have you ever thought about opening a restaurant? Restaurants are getting to be pretty complicated places considering that local laws usually dictate that you segregate yortr diners by smoking preference (pro or con). Why not segregate your dinerc by status? ' That's rightl We've got a table for two in our low-status section. What'$ that? Otr, there's a 15-minute wait for a high-status table. What's the difference? Well, if you need to ask, then you probably belong in the low-status section. Do th.e high-status diners get better food? No, the food's the same. And the service? The same, Then what ls the difference? Price. That's right-we charge twice as much for the same food and service in the high-status section as in the low-status section. How can we get away with that? It's easy. Everyone knows who's in which section. We know the cheapos and the big spenders, the tightwads and the sports. Why are people willing to pay twice as much for &e same food and the same service? They're paying for status. And by selling status, you can really boost your profis. So go ahead and open your restaurant. And save a nice table for me. In which section? I'll give you three guesses.

Qrestions for Further Thought and Discussion

l. In what
respects does a monopolistic competitor differ from a perfect competitor? 2. Explain why the monopolistic competitor breaks even in the long run. 3. Is the monopolistic competitor inefflcient? Try to argue the question from both sides.
4- Vy'hat are the

two necessary conditions under which price discrimination can take place? Give an example of price discrimination.
produces too little?

5. Do monopolistically competitive industries have too many firms, each of which

Are you in favor ofprice discrimination or against it? Try to argue pro and con. 7. What are the ways in which a firm can ditferentiate its product from those of its
6.

competitors?
8. Practical Applicatton: Make a list of five firms with whom you or your family members have done business this week. Which are monopolistic competitors?

alrm Harford, The Undercover Economist (NewYork: Oxford University Press,2006), p. 35.