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Industrial Organization

In: Business and Management

Submitted By jayt060
Words 5314
Pages 22
Modern Industrial Org. – Post Midterm Study Notes

October 19/2010

Product Differentiation and Monopolistic Competition

Differentiated Products
• Products considered differentiated when consumers view as imperfect substitutes
• Could be products of different firms or different brands produced by same firm
• Implies that a firm can raise price without losing all demand
• Example: o Frozen orange juice o Bottle water o Cola o Ready-to-eat breakfast cereal o Automobiles

Two Issues
• How is the # of products/brands/firms determined? Is it the correct #?
• How do firms that produce differentiated products compete

Monopolistic Competition
• Chamberlain (1933) o Idea: Firms have same markets power but make zero profits o Face downward sloping demand curve o Free entry drives profits to zero o Representative consumer: views all brands as equally good substitutes for each other (symmetric) o With differentiated products implies preference for variety

Undifferentiated Products
• Cournot model w/ fixed costs and free entry
• Entry implies zero profits
• P = AC
• # of firms determined by how many required to drive price down for AC
• As fixed cost declines more firms enter and price approaches MC
• Graphical Example, cost functions o Welfare: to get efficient outcome, need to subsidize one firm and force to charge MC o Tradeoff: more firms drive price down, but increases expenditure on fixed costs o Best thing you can do without subsidizing firms, is to restrict entry
• Behavior of firms still to produce here MR= MC
• Residual demand is more complicated
• Algebraic examples
• Equilibrium (cournot?) under monopolistic competition has two problems o Price not equal to MC o Number of brands (variety) is not optimal o Show: fixed costs lead to too little variety

Suboptimal Product Variety
• Graphical examples of Brand X and

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