Monopolistic Competition

Question 1

What is vertical product differentiation

Answer 1

Consumers rank some products above others at the same price based on some objective criteria

Question 2

What is horizontal differentiation

Answer 2

Different consumers prefer different products due to different tastes

Question 3

What are the features of Chamberlin’s model

Answer 3

• Downward sloping demand schedule
• Each firm will act as if its price and quantity decisions have no effect on the behaviour of other firms as each firm is small

Question 4

Explain the two demand curves of monopolistic competition

Answer 4

• Demand curve dd is individual firm varying the price with an elastic demand response
• Demand curve DD is other firms matching the price change with a less elastic demand response

Question 5

Explain short run equilibrium for the monopolistic firm

Answer 5

• Each firm acts according to dd demand curve
• All pick P* price but one firm changing price does not cause others to follow ( no strategic interdependence)
• P> MC, MR=MC and make economic profit

Question 6

Explain long run equilibrium in monopolistic

Answer 6

• Economic profits attract entrants
• Demand shifts down until no profits, just touching LRAC
• No economic profit, P>MC, not at minimum ATC

Question 7

Criticisms of Chamberlin model of monopolistic

Answer 7

• Difficult to define the concept of an industry group
• Assumes each firm has equal chance of attracting any new buyers

Question 8

For spatial models of Monopolistic competition, how does the number of N firms affect transport costs?

Answer 8

• As N increases, transport costs fall
• But production costs rise with N so optimal number of outlets N* is where combined costs are minimised

Question 9

What is the trade off between convenience and cost for an airline

Answer 9

• If an airline increases frequency of flights then they will have to use smaller planes and so there is a higher average cost per seat thus they will charge higher fares

Question 10

Explain the concept of paying for variety

Answer 10

• Premium products may have only slightly higher MC but the difference is in R and D
• Higher price allows firms to recoup R and D costs