Monopolistic Competition

MonopolisticCompetitionChapterCHAPTER OUTLINEI. Describe and identify monopolistic competition.A. Large Number of Firms1. Small Market Share2. No Market Dominance3. Collusion ImpossibleB. Product DifferentiationC. Competing on Quality, Price, and Marketing1. Quality2. Price3. MarketingD. Entry and ExitE. Identifying Monopolistic Competition1. The Four-Firm Concentration Ratio2. The Herfindahl-Hirschman Index3. Limitations of Concentration Ratios2. Explain how a firm in monopolistic competition determines its output andprice in the short run and the long run.A. The Firm’s Profit-Maximizing DecisionB. Profit Maximizing Might Be Loss MinimizingC. Long Run: Zero Economic ProfitD. Monopolistic Competition and Perfect Competition1. Excess Capacity2. MarkupE. Is Monopolistic Competition Efficient1. Deadweight Loss2. Making the Relevant Comparison3. The Bottom line

382 Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE3. Explain why advertising costs are high and why firms use brand names inmonopolistic competition.A. Innovation and Product Development1. Cost Versus Benefit of Product Innovation2. Efficiency and Product InnovationB. Advertising1. Advertising Expenditures2. Selling Costs and Total Costs3. Selling Costs and DemandC. Using Advertising to Signal QualityD. Brand NamesE. Efficiency of Advertising and Brand NamesCHAPTER ROADMAP• What’s New in this Edition?Chapter 15 has been up‐dated. The point that the maximumloss a firm will suffer is equal to its fixed cost is now madeexplicit.• Where We AreIn this chapter, we examine another market structure, monopolisticcompetition. The profit‐maximizing quantity andprice is discussed. The chapter shows why firms in monopolistcompetition decide to advertise, use brand names, anddevelop new products.• Where We’ve BeenThe previous chapters studied perfectly competitive firmsand monopoly firms. The material dealing with monopoly isused in this chapter because monopolistic competition issimilar in some regards to monopoly.• Where We’re GoingThe next chapter covers the last industry structure, oligopoly.Then Chapter 17 studies how the government chooses toregulate monopolies and antitrust law. The material inChapter 17 primarily uses results from Chapter 13, on perfectcompetition, and Chapter 14, on monopoly.

Chapter 15 . Monopolistic Competition 383IN THE CLASSROOM• Class Time NeededYou can complete this chapter in one and half to two sessions. By this point thestudents are familiar with the diagrams illustrating how firms in monopolisticcompetition select their profit‐maximizing price and quantity, so be sure to pointout this similarity. Use two sessions if you have students who will be majoring inbusiness disciplines because the material on advertising and brand names will behelpful to them.An estimate of the time per checkpoint is:• 15.1 What is Monopolistic Competition?—10 to 15 minutes• 15.2 Output and Price Decisions—40 to 50 minutes• 15.3 Product Development and Marketing—10 to 25 minutes

384 Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCECHAPTER LECTURE• 15.1 What is Monopolistic Competition?Monopolistic competition is a market structure in which• A large number of firms compete. Each firm has a small market share and collusion isimpossible.• Each firm produces a differentiated product. Product differentiation means that eachfirm makes a product that is slightly different from the products of competing firms.Some people will pay more for one variety of a product, so the demand curve for thefirm’s product is downward sloping.• Firms compete on product quality, price, and marketing.• Firms are free to enter and exit the market.Identifying Monopolistic CompetitionThere are two measures of market concentration used to help identify whether a market is competitiveor dominated by a small number of firms:• The four-firm concentration ratio is the percentage of the total revenue accounted forby the four largest firms in the industry. The four‐firm concentration ratio ranges betweennear 0 (extremely competitive) to 100 (not very competitive).• The Herfindahl–Hirschman index (HHI) is the square of the percentage market share ofeach firm summed over the largest 50 firms (or summed over all the firms if there arefewer than 50) in a market. The HHI ranges between near 0 (extremely competitive) to10,000 (a monopoly).• The U.S. Justice Department uses the HHI to classify markets:• Markets with an HHI of less than 1,000 are regarded as highly competitive• Markets with an HHI of between 1,000 and 1,800 are regarded as moderatelycompetitive.• Markets with an HHI above 1,800 are regarded as concentrated.• Concentration ratios have two major limitations:• Geographic Scope of the Market: Concentration ratios define the market as the entireUnited States, but the relevant market might be smaller than the entire nation (newspapers,for which the market is a city) or larger than the entire nation (automobiles,for which the market is the entire world).• Barriers to Entry and Firm Turnover: For some industries, a few firms might be currentlyoperating in the market but competition in these industries might be fierce,with firms regularly entering and exiting the industry.Ford Motor Company advertises that it is the largest seller of pickup trucks in the UnitedStates. Should we be concerned that Ford might have too much market power in that areaof the market? Ask the students to consider identifying what would be an appropriatedefinition for the “market” such that a proper market concentration measure might be calculated.Should only pickup trucks be included? Or should all cars and trucks be consideredas possible substitutes? How about minivans and/or SUVs?

Chapter 15 . Monopolistic Competition 385• 15.2Output and Price DecisionsThe Firm’s Profit-Maximizing Decisions• In the short run, a monopolisticallycompetitive firm makes its output andprice decisions just like a monopolyfirm. The figure shows a monopolisticallycompetitive firm’s downward slopingdemand curve and the downwardsloping MR curve that lies below thedemand curve.• The firm maximizes its profit by producingthe quantity where MR = MC andusing the demand curve to set the highestprice at which people will buy thequantity it produces. In the figure, thefirm produces 20 pizzas per hour andsets a price of $16 per pizza.• The firm in the figure earns an economicprofit because P > ATC. The amount ofthe economic profit is equal to the area of the darkened rectangle.• If P < ATC, the firm incurs an economic loss. The firm will shut down if P < AVC, so themaximum loss the firm will incur is equal to its fixed costs.Long Run: Zero Economic Profit• Unlike a monopoly, firms in monopolisticcompetition cannot earn economicprofit in the long run. If thefirms are earning an economic profit,other firms enter the market. Entrycontinues as long as firms in the industryearn an economic profit. As firmsenter, each existing firm loses some ofits market share. The demand for eachfirm’s product decreases and the firm’sdemand curve shifts leftward.• Eventually the demand decreasesenough so that the firms earn only anormal profit, where P = ATC. Entrythen stops. This outcome is illustratedin the figure, in which the firm produces13 pizzas per hour (whereMR = MC ) and sets a price of $12 per pizza.

386 Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCEMonopolistic Competition and Perfect CompetitionUnlike firms in perfect competition, firms in monopolistic competition have excess capacity and amarkup:• Excess Capacity: A firm has excess capacity if it produces less than the quantity at whichaverage total cost is a minimum. The quantity at which average total cost is a minimumis the efficient scale. A firm in perfect competition produces at the efficient scale but, asthe figure above shows, a firm in monopolistic competition produces less than the efficientscale of output.• Markup: A firm’s markup is the amount by which its price exceeds its marginal cost. Afirm in perfect competition has no markup but, as the figure above shows, a firm in monopolisticcompetition has a markup.Is Monopolistic Competition Efficient?Firms in monopolistic competition have higher costs than firms in perfect competition, but firmsin monopolistic competition produce variety, which is valued by consumers. So compared to thealternative of complete uniformity, monopolistic competition is efficient.• 15.2Output and Price DecisionsInnovation and Product DevelopmentMonopolistically competitive firms compete through product development and marketing. Newproduct development allows a firm to gain a temporary competitive edge and economic profitbefore competitors imitate the innovation. A firm decides upon the extent of innovation andproduct development by comparing the marginal cost of innovation or product development toits marginal revenue.Advertising• Advertising and packaging allow a firm to differentiate its product. Firms in monopolisticcompetition incur heavy advertising expenditures which make up a large portion ofthe price it charges for the product.• Selling costs, such as advertising, are fixed costs that increase the ATC at any given levelof output but do not affect the MC. Advertising efforts are successful if they increase demand,which can lead to increased profit. But if all firms advertise, more firms mightsurvive and so the demand for any one firm is less than otherwise.• Heavy marketing and advertising expenditures are a signal to consumers of a highqualityproduct. A signal is an action taken by an informed person (or firm) to send amessage to uninformed people.Brand NamesMonopolistically competitive spend a lot of money to promote brand names. A brand name givesconsumers information about the product quality.• Advertising and creating brand names are expensive. To the extent that they provide theconsumer with valuable information, they are a benefit of monopolistic competition. Butin some instances it seems as if the cost exceeds the benefit. So, ultimately the total efficiencyof monopolistic competition is ambiguous.

Chapter 15 . Monopolistic Competition 387• Lecture Launchers1. Students have no difficulty seeing monopolistic competition in the worldall around them. Emphasize that the work they’ve just done understandingthe models of perfect competition and monopoly are not wasted becausethe real‐world situation of monopolistic competition, as its name implies, isa mixture of both extremes. Some of what they learned in each of the twoprevious chapters survives and operates in the middle ground of monopolisticcompetition.2. Product differentiation is the heart of the difference between monopoly andcompetition. After listing the characteristics of monopolistic competitionand securing suggested examples of firms in monopolistic competition, youcan get your students to suggest how, if they ran a small coffee shop, theycould attract more customers than their competition. Or, discuss more generallyin what ways can producers in a monopolistically competitive marketincrease the demand for their product? Consider grocery stores: they havelittle latitude on prices as their markup is so small, so to build sales they attractcustomers in what ways? Some methods include friendliness, advertisingloss‐leaders, attractiveness of displays, speed, signage, perhaps evenclean restrooms!• Land Mines1. While students have gotten familiar with the demand, marginal revenue,and marginal cost curves over the past two chapters, still take the time topoint out the curves as you draw them. Use actual numbers for quantityand price.2. Unlike the case of perfect competition, the demand curve for a firm’s differentiatedproduct in monopolistic competition is downward sloping. Remindthe students about the ceteris paribus condition that defines a demandcurve. Along the demand curve for Nike tennis shoes, the prices ofAdidas, Fila, Head, K Swiss, Prince, Reebok, and Wilson tennis shoes areconstant. Some people prefer Nike to the other brands and will pay a bitmore for Nike. Other people prefer some other brand and will buy Nikeonly if its price is low enough. Buyers have brand preferences, but they willswitch brands if price differences are large enough. So the higher the priceof a Nike shoe, the prices of the other brands remaining the same, thesmaller is the quantity of Nike shoes demanded.3. Students seem to have a bit of trouble appreciating that entry and exitchange the demand for a firm’s product. Explain this effect by sticking withthe tennis shoes example. Explain that the demand for Nike tennis shoeschanges and the demand curve for Nike tennis shoes shifts if other firmsenter or exit. If Tommy Hilfiger and the Gap started to make tennis shoes,

388 Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCEsome of Nike’s former customers would switch to these two new brands,and the demand for Nike shoes would decrease. The demand curve forNike shoes would shift leftward. If Adidas, Fila, and Reebok stopped makingtennis shoes, some of their former customers would switch to Nike, andthe demand for Nike shoes would increase. The demand curve for Nikeshoes would shift rightward.

Chapter 15 . Monopolistic Competition 389ANSWERS TO CHECKPOINT EXERCISES• CHECKPOINT 15.1 What Is Monopolistic Competition?1a. The firms and the percentage of their total revenue shares are Truffles (30percent), Bond (20 percent), Mayfair (15 percent), All Nature (15 percent),Gold (15 percent), and Magic (5 percent). The four largest are Truffles,Bond, and then two of Mayfair, All Nature, and Gold. The four‐firmconcentration ratio is 30 + 20 + 15 + 15, which is 80.1b. The HHI equals 30 2 + 20 2 + 15 2 + 15 2 + 15 2 + 5 2 = 2,000.1c. Based on the four‐firm concentration ratio and the HHI, the chocolate industryis an oligopoly.1d. If firms in the chocolate industry face competition from foreign suppliers,the industry is more competitive than the four‐firm concentration ratio andHHI suggest. In this case the industry might be monopolistic competition.1e. To be sure that the industry is monopolistic competition, we need to knowthe extent to which firms engage in product differentiation, whether firmsare free to enter and exit, and the extent to which firms compete on productquality, price, and marketing.2. The new technology lowers the barriers to entry. Most likely there would beentry of new firms, so there would be greater product differentiation andfiercer competition on product quality, price, and marketing.• CHECKPOINT 15.2 Output and Price Decisions1a. Lorie maximizes profits by producing 10 racquets. (Marginal cost is $15 aracquet. Marginal revenue between zero and 10 racquets is $20 and between10 and 20 racquets is $10, so marginal revenue equals $15 at 10 racquets.)Lorie’s charges $20 a racquet, which is the price from the demandcurve for the 10th racquet a month. Lorie’s average fixed cost is $100 ($1,000÷ 10) and average variable cost (marginal cost) is $15 a racquet. Average totalcost is $115 a racquet. Lorie incurs an economic loss of $20 − $115, whichis $95 a racquet.1b. Firms will not enter; Firms will exit the restringing business.1c. In the long run, the demand for Lorie’s restringing business will increase ifshe stays in the market.1d. In the long run, Lorie will earn zero economic profit. Lori will either leavethe industry or if she remains open, the demand for her services increasesas other firms leave and she earns normal profit.

390 Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE• CHECKPOINT 15.3 Product Development and Marketing1a. The increase in demand will increase the number of cookies sold and mostlikely increase the price she charges. (The effect on the price depends on theprecise manner in which the demand curve shifts, but most likely her pricewill rise.) Her economic profit will increase.1b. If additional advertising enables sales to increase so that total revenue increasesmore than total cost, she can increase economic profit.

Chapter 15 . Monopolistic Competition 391ANSWERS TO CHAPTER CHECKPOINT EXERCISES1a. The cable television market is not an example of monopolistic competition.1b. The wheat market is not an example of monopolistic competition.1c. The athletic shoe market is an example of monopolistic competition. Thereare several producers of athletic shoes, with extensive product differentiationand competition on quality, price, and marketing.1d. The soda market is not an example of monopolistic competition.1e. The shaving cream market is an example of monopolistic competition.There are several producers of shaving cream, with product differentiationand competition on quality, price, and marketing.1f. The toothbrush market is an example of monopolistic competition. Thereare many producers of toothbrushes, with extensive product differentiationand competition on quality, price, and marketing.1g. The ready‐mix concrete market is not an example of monopolistic competition.2. The audio equipment market is an example of monopolistic competition.3a. Lite and Kool produces 125 pairs of shoes a week because this is the quantityat which marginal revenue equals marginal cost.3b. Lite and Kool charges a price of $75 a pair of shoes.3c. Lite and Kool’s price is $75 a pair of shoes and its marginal cost is $50 apair of shoes. So, Lite and Kool’s markup is $75 a pair of shoes − $50 a pairof shoes, which is $25 a pair of shoes.3d. Lite and Kool’s price is $75 a pair of shoes and its average total cost is $35 apair of shoes. So Lite and Kool makes an economic profit of $75 a pair ofshoes − $35 a pair of shoes, which is $40 a pair of shoes. Lite and Kool produces125 pairs of shoe a week, so its weekly economic profit is $40 × 125,which is $5,000 a week.3e. Firms in monopolistic competition do not always have excess capacity inthe short run.3f. Lite and Kool does not have excess capacity. Its efficient scale, where itsaverage total cost is at its minimum, is less than 125, so Lite and Kool isproducing beyond its efficient scale.3g. Firms enter the market because the existing firms, of which Lite and Koolis one, are earning an economic profit.

392 Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE4a. Figure 15.1 illustrates Stiff Shirt’s demandcurve, marginal revenue curve, average totalcost curve, and marginal cost curve. Stiff Shirtproduces 100 shirts a week because this is thequantity at which marginal revenue equalsmarginal cost.4b. Stiff Shirt charges a price of $85 a shirt.4c. Stiff Shirt’s price is $85 a shirt and its marginalcost is $70 a shirt. So, Stiff Shirt’smarkup is $85 a shirt − $70 a shirt, which is$15 a shirt.4d. Stiff Shirt’s economic profit equals the area ofthe gray rectangle in Figure 15.1 Stiff Shirt’sprice is $85 a shirt and its average total cost is$75 a shirt. So Stiff Shirt makes an economicprofit of $85 a shirt − $75 a shirt, which is $10a shirt. Stiff Shirt produces 100 shirts a week,so its weekly economic profit is $10 × 100, which is $1,000.4e. Stiff Shirt has excess capacity. Its efficient scale is greater than 100, so StiffShirt is producing less than its efficient scale.4f. If Stiff Shirt increased its production, its average total cost would fall.4g. Stiff Shirt does not increase its production because to do so would decreaseits economic profit.4h. Stiff Shirt is earning an economic profit, so firms will enter the market.4i. As more firms enter the market, the demandfor shirts from Stiff Shirt decreases and theprice of a shirt falls.5a. Figure 15.2 illustrates La Bella’s demandcurve, marginal revenue curve, average totalcost curve, and marginal cost curve. La Bellaproduces 75 pizzas a day because this is thequantity at which marginal revenue equalsmarginal cost.5b. La Bella charges a price of $15 a pizza.5c. La Bella incurs an economic loss equal to thearea of the gray rectangle in Figure 15.2 LaBella’s price is $15 a pizza and its average totalcost is $16 a pizza. So La Bella makes aneconomic profit of $15 a pizza − $16 a pizza,which is −$1 a pizza, that is, La Bella incurs aneconomic loss of $1 a pizza. La Bella produces

Chapter 15 . Monopolistic Competition 39375 pizzas a day, so its economic loss is $1 × 75, which is $75 a day.5d. La Bella is producing less than its efficient scale, so La Bella has excess capacity.5e. La Bella has a price markup because its price exceeds its marginal cost.5f. La Bella is incurring an economic loss, so firms will exit the market.5g. As firms exit the market, the price of a pizza rises.6a. Bob produces 75 burgers a day because this is the quantity at which marginalrevenue equals marginal cost.6b. Bob charges a price of $3 a burger.6c. Bob’s price is $3 a burger and his average total cost is $3 a burger. So Bobmakes zero economic profit.6d. Other firms will not enter the burger industry because the firms, of whichBob is one, are earning zero economic profit, that is, they are earning normalprofit.6e. Bob is producing less than his efficient scale, so Bob has excess capacity.6f. Bob has a price markup because price exceeds marginal cost.7a. Jeb is the wheat farmer. The market for wheat is perfectly competitive and,in the long run, firms in a perfectly competitive market produce at minimumaverage total cost. Jeb said that if he changed his production, his averagetotal cost would increase, which means that Jeb is producing atminimum average total cost. George runs the diner. Restaurants are in amonopolistically competitive market. Firms in monopolistic competitionhave excess capacity, which means that if they increase output, average totalcost would fall, which is what George described.7b. Jeb, the wheat farmer, is producing as efficiently as possible because he isminimizing his average total cost. Firms in perfect competition are efficient.George is not producing as efficiently as possible because he couldlower his average total cost if he produced more. Firms in monopolisticcompetition have excess capacity.7c. Though the conversation does not bear directly on economic profit, firmsin a competitive market—be it perfect competition or monopolistic competition—earnzero economic profit in the long run.

394 Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE8a. Figure 15.3 shows Mike’s situation with no advertising. Mike produces 500pairs of shoes a day, determined by the intersection of the MR curve andMC curve and sets a price of $100 a pair of running shoes.8b. Figure 15.4 shows Mike’s situation with advertising. Relative to the noadvertisingsituation in Figure 15.3, Mike’s average total cost is higher atevery level of output. The demand for Mike’s shoes has increased and thedemand curve and marginal revenue curve have shifted rightward. Mikenow produces 1,000 pairs of shoes a day, the quantity at which the marginalcost curve and new marginal revenue curve intersect. Mike sets aprice of $50 a pair of running shoes.8c. Mike’s markup is larger in the no‐advertising situation.8d. Mike has more excess capacity in the no‐advertising situation.9a. No, the behavior does not mean that these people are irrational. Theyvalue the benefits provided by the name brand enough to buy the higherpriced,branded product.9b. Brand names signal the consumer that a good or service has a high andconsistent quality.9c. Brand names give the producer the incentive to keep the quality of thegood or service high and consistent.9d. Brand names are efficient if the benefits of brand names exceed the costs ofcreating and maintaining brand names. In this case, banning brand namesleads to inefficiency.

Chapter 15 . Monopolistic Competition 395• Critical Thinking10. Advertising and brand names have costs and benefits. Both advertisingand establishing a brand name are costly endeavors. But these costs mustbe weighed against the benefits. For instance, some advertising providesconsumers with valuable information. And, brand names signal the consumerthat a good or service has a high and consistent quality. Brandnames also give the producer the incentive to keep the quality of the goodor service high and consistent. If the benefits of advertising and brandnames exceed the costs, then they are beneficial to society.11a. Students’ favorite commercials will vary from one student to the next.11b. Most advertisements have some signaling aspect to them, especially thosethat are most entertaining. So it will be a rare student whose favoritecommercial has no signal.11c. Advertisements increase the producer’s profit by influencing the demandfor the product and the costs of producing the product. If the advertisementincreases the demand sufficiently, the firm’s profit increases. Indeed,if demand increases enough, the average total cost of the good or servicefalls, which can further increase the producer’s profit.11d. The benefit of each advertisement will vary from one student to the next.Keep in mind that if the advertisement helps create or maintain a brandname, the advertisement reminds the consumer of the high and consistentquality of the product, which benefits the consumer. And the advertisementgives the producer the incentive to keep the product’s quality highand consistent, which also benefits the consumer.11e. The advertisement can create a deadweight loss to the extent to which itstifles competition. And the fewer the number of firms in the market, thecloser the output is to the monopoly output and the greater the deadweightloss.12a. Xerox does not want its brand name to be applied to all copiers becauseXerox has spent a great deal of money advertising the high quality of itscopiers. Xerox is concerned that consumers will come to think that thequality of its copies is the same as that of its competitors.12b. Consumers benefit to the extent that Xerox continues to spend resourcesensuring that the quality of its copiers remains high and consistent.

396 Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE• Web Exercises13a. The items picked by your students will vary from one student to the next.13b. The items picked by your students will vary from one student to the next.13c. The crucial point of explanation is that for the items selected as examplesof monopolistic competition (the answer to part (a)), the four‐firm concentrationratio should be less than 40 and the HHI be less than 1,800 thoughless than 1,000 is preferable. And, for items selected as examples that arenot monopolistic competition, the four‐firm concentration ratio should exceed60 and the HHI should be greater than 1,800.14a. The item and the price will vary from one student to the next.14b. The item and the price will vary from one student to the next.14c. The answer will vary from one student to the next. In general, the expectationis that the high‐price source offers a higher quality buying experience.For instance, the high‐price source might be one that is more well knownthan the low‐price source, so the shopper can feel more secure that theitem will be delivered if he or she buys from the high‐price source.14d. The students’ answers will vary from one student to another. Those whobuy from the high‐price source must be able to point to some attribute thatmore than compensates for the higher price they would pay.15a. Brand names benefit both the buyer and the seller. But unscrupulous peoplehave taken to counterfeiting brand name merchandise. Counterfeitingharms consumers because they are not getting what they believe they aregetting, namely an assurance of quality. In addition, if a consumer purchasesan inferior quality counterfeit brand name product, the consumer isunable to complain to anyone about the poor quality. So be prudent aboutbuying potentially counterfeited products.15b. The article generally does a good job in identifying the benefits of brandnames. The article states: “The owner of a brand uses it to insure that customersrecognize the source of the product and that it is an indication of aconsistent level of productʹs quality. Consumers can rely on a given brandto indicate the nature and quality to which he/she has become accustomed.”The article misses the idea that producers who brand their productswill strive to insure that the quality of the products remains high andconsistent.15c. The article is generally correct in its identification of the benefits to consumers.The article points out that “Consumers can rely on a given brandto indicate the nature and quality to which he/she has become accustomed.”

Chapter 15 . Monopolistic Competition 39716. The brand‐naming service offers to create brand names “based on the principlesof linguistic morphology.” The service asserts “The right brandname makes consumers and other businesses want to use your product orassociate with your company. The right brand name is what consumersremember when they want to use your product again.” It’s unclear how aparticular brand name can lead to a consumer wanting to use a particularproduct, so this claim seems overblown. It is, however, correct that consumersmust remember the brand name to buy the same product onceagain, so the second claim has some validity. The service also asserts that“A successful trade name should be instantly recognizable,” which alsohas validity. Essentially, a brand name will not have the benefits ascribedto it in this chapter unless consumers can remember the brand name andthe product to which it is affixed.

398 Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCEADDITIONAL EXERCISES FOR ASSIGNMENT• Questions• CHECKPOINT 15.1 What Is Monopolistic Competition?1. How would a merger between Pizza Hut and Papa Johns affect the fourfirmconcentration ratio for the home delivery pizza market? How would itaffect the Herfindahl‐Hirschman Index for the home delivery pizza market?• CHECKPOINT 15.2 Output and Price Decisions2. Draw an example of a firm in monopolistic competition that is incurring an economic loss. Besure to label all the curves. Indicate the area that equals the firm’s economic loss.• CHECKPOINT 15.3 Product Development and Marketing3. Explain how selling costs in monopolistic competition affect the efficiency of monopolisticcompetition.• Answers• CHECKPOINT 15.1 What Is Monopolistic Competition?1. Both Pizza Hut and Papa Johns are two of the three largest firms in thehome delivery pizza market. So a merger between Pizza Hut and PapaJohns would raise the four‐firm concentration ratio and raise the Herfindahl‐HirschmanIndex.• CHECKPOINT 15.2 Output and Price Decisions2. Figure 15.5 illustrates a firm in monopolisticcompetition that is incurring an economic loss.The economic loss equals the area of the grayrectangle.

Chapter 15 . Monopolistic Competition 399• CHECKPOINT 15.3 Product Development and Marketing3. The additional selling costs from product differentiation and marketingincrease consumer choice by providing variety. This benefits society andweighs in favor of the efficiency of monopolistic competition. Selling costsincrease the costs of a monopolistically competitive firm above those of aperfectly competitive firm or a monopoly. Also, at times the product differentiationis more apparent than real. These factors harm society and countagainst the efficiency of monopolistic competition.

400 Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCEUSING EYE ON THE U.S. ECONOMY• Examples of Monopolistic CompetitionYou can list several of the industries given in the figure on the board. Ask studentsto list them in order of competitiveness. You also can use these data topromote discussion on calculating the four‐firm concentration ratio and the Herfindahl‐HirschmanIndex.