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The Chamberlin Model of Monopolistic Competition

- Monopolistic competition occurs if many firms

serve a market with free entry and exit, but in

which one firms products are not perfect

substitutes for the products of other firms.

The Chamberlin Model of Monopolistic Competition

- Two important implications
- Each firms is confronted by a downward sloping

demand curve. - Price and quantity decisions have no effect on

the behaviour of other firms in the industry. - A fundamental feature of the Chamberlin model is

the perfect symmetry of the position of all firms

in the industry.

The Chamberlin Model of Monopolistic Competition

- This results in the firm facing 2 different

demand curves - One describing what happens when the firm alone

changes its price (dd). - One describing what happens when all prices

change in unison (DD).

The Chamberlin Model of Monopolistic Competition

- Although firms realise that the prices of

similarly situated firms tend to move together,

they also realise that its own price movements is

not what causes other firms to change their

behaviour. - Thus firms are forced to think in terms of

movements along dd, in Fig 13.11, about the

consequences of a price move.

Figure 13-11 The Monopolistic Competitors Two

Demand Curves

Chamberlinian Equilibrium in the Short Run

- Note that at the profit-maximising price, P, the

demand curve DD intersects the demand curve dd. - This is as a result of the fundamental symmetry

that exists within the Chamberlinian firms. - In the short run there are economic profits.

Figure 13-12 Short-Run Equilibrium for the

Chamberlinian Firm

Chamberlinian Equilibrium in the Long Run

- Because of economic profits in the short run,

additional firms are lured into the

monopolistically competitive industry. - Assuming each firm competes on an equal footing,

the effect of entry is to cause an equal

proportional reduction in the quantity that each

firm can sell at any given price. - ? causing a leftward shift in demand curve dd.

Chamberlinian Equilibrium in the Long Run

- As long as economic profits exist, entry will

continue. - The demand curve, dd, shifts leftward to the

point where it is tangent to the LAC curve.

Figure 13-13 Long-Run Equilibriumin the

Chamberlin Model

Chamberlinian Equilibrium in the Long Run

- The profit-maximising level of output, where MR

MC, is exactly the same as the output level for

which the dd curve is tangent to the LAC curve. - It would not be in the interest of any firm to

maintain its price above P, profit-maximising

price level.

Perfect Competition VS Chamberlinian Monpolistic

Competition

- Several points of comparison
- Perfect competition satisfies allocative

efficiency, whilst monopolistic competition does

not. - Its is argued that monopolistic competition is

less efficient than perfect competition. - Monopolistic competition is more realsitic.
- Long run economic profits is zero in both.

Criticisms of the Chamberlin Model

- Chamberlins theory significantly complicates the

theory of perfect competition, without altering

its most important predictions. - The Chamberlin model assumes that each firm has

an equal chance to attract any of the buyers in

an industry. This may or may not be true!

Criticisms of the Chamberlin Model

- Models have been developed that incorporate the

specific features of a product that make buyers

choose it over all others. - We discuss one such model next.

A Spatial Interpretation of Monopolistic

Competition

- The degree of substitutability between

monopolistically competitive firms products

indicates how closely their industry resembles

perfect competition. - Products may differentiate along more than one

dimension location, size, quality, etc. And all

of these need to be taken into consideration.

A Spatial Interpretation of Monopolistic

Competition

- For example (taking distance into account)
- Suppose you live on a doughnut shape island that

has a circumference of 1 mile. - People are uniformly scattered around the island.
- There are 4 restaurants on the island that serve

a standardised meal. - Everyone one the island eats one meal at a

restaurant a day.

A Spatial Interpretation of Monopolistic

Competition

- How should these restaurants be spread out in

order to minimise the cost of eating out? - Costs
- Cost of travel t dollars/mile
- Restaurant costs TC F M.Q
- ATC F/Q M

Figure 13-14 An Industry in Which Location is

the Important Differentiating Feature

A Spatial Interpretation of Monopolistic

Competition

- If TC 50 5Q
- L (population) 100
- t 20/mile
- What will be the ATC of a meal served by a

restaurant? - What will be the overall ATC of a meal for person

living on the island?

The Optimal Number of Locations

- The optimal number of locations is the result of

a trade-off between the start-up and fixed costs

of opening new locations, and the savings from

lower transportation costs. - We need to calculate whether opening an

additional restaurant would result in the overall

average costs per meal to decline. If so then it

is feasible to open another restaurant.

The Optimal Number of Locations

- What is the overall average cost of a meal if 5

restaurants are opened? - More specifically, if there are N restaurants
- Average round-trip distance 1/2N
- Total transportation costs, Ctrans t.L/2N
- Total cost of meals served,
- Cmeals L.M N.F

Figure 13-15 Distances with N Outlets

Figure 13-16 The Optimal Numberof Outlets

The Optimal Number of Locations

- Our objective is to choose N so as to minimise

the sum of the 2 types of costs - Ctrans Cmeals.
- The slope of the Cmeals curve is equal to F.

Representing the cost of an additional outlet.

The Optimal Number of Locations

- The slope of the Ctrans curve is t.L/N2.

Representing the savings in transportation costs

from adding an additional outlet. - If F lt -t.L/N2, ten build an additional

restaurant, since the savings in transportation

costs more than compensates for the costs of an

additional restaurant.

The Optimal Number of Locations

- Optimal number of restaurants, N, is one for

which F t.L/N2 - ? N
- What is the economic interpretation of this

expression?

The Analogy to Product Characteristics

- The Spatial interpretation of monopolistic

competition can be applied not only to geographic

location but also to a variety of other product

characteristics. - For example the air-travel market
- grocery stores
- motor vehicles

Figure 13-17 A Spatial Interpretationof Airline

Scheduling

The Analogy to Product Characteristics

- The Spatial model is primarily concerned with the

trade-off between cost and convenience.

Paying for Variety

- Variety is costly.
- People who care a lot about special product

features are willing to pay more than others for

a product whose special features suit their

particular tastes. - Demand for variety increases with income
- ? luxury good

Figure 13-18 Distributing the Costof Variety

Paying for Variety

- The cost of variety is not distributed evenly

among all buyers. - People who do not place a high value on variety

get to enjoy it at the expense of those who care

most about it.

Figure 13-19 The Hot Dog Vendor Location Problem

Consumer Preferences and Advertising

- In monopolistically competitive and oligopolistic

markets products are differentiated, allowing

producers to shift their demand curves outwards

through advertising. - Traditional sequence Producers are agents of

consumers.

Consumer Preferences and Advertising

- Revised sequence Corporations decide what

products are cheapest and most convenient to

produce, and through advertising demand is

created. - Where products are slightly differentiated,

advertising may have a significant influence on

which product a consumer chooses. - ? traditional sequence.

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