Econometrics in Pollution Control

CHAPTER 13 | Monopolistic Competition: The Competitive Model in a More Realistic
Setting 65
CHAPTER 13 | Monopolistic
Competition: The
Competitive Model in a
More Realistic Setting
Brief Chapter Summary and Learning
Objectives
13.1 Demand and Marginal Revenue for a Firm in a
Monopolistically Competitive Market (pages 452–454)
Explain why a monopolistically competitive firm has downward-sloping
demand and marginal revenue curves.
 A monopolistically competitive firm must cut its price to sell more, so its marginal
revenue curve will slope downward and be below its demand curve.
13.2 How a Monopolistically Competitive Firm Maximizes

Profit in the Short Run (pages 454–457)
Explain how a monopolistically competitive firm maximizes profit in the short
run.
 All firms maximize profits by producing where marginal revenue is equal to marginal
cost. A monopolistically competitive firm will maximize profits where price is greater
than marginal cost.
13.3 What Happens to Profits in the Long Run? (pages 457–

462)
Analyze the situation of a monopolistically competitive firm in the long run.
 When a monopolistically competitive firm makes a short-run economic profit,
entrepreneurs will enter the market, causing the firm’s demand curve to shift to the left and
become more elastic. In the long run, a monopolistically competitive firm will break even.
13.4 Comparing Monopolistic Competition and Perfect

Competition
(pages 462–465)
Compare the efficiency of monopolistic competition and perfect competition.
 Unlike perfectly competitive firms, monopolistically competitive firms charge a price
greater than marginal cost and do not produce at minimum average total cost.
13.5 How Marketing Differentiates Products (pages 465–466)
Copyright © 2019 Pearson Education, Inc.

66 CHAPTER 13 | Monopolistic Competition: The Competitive Model in a More
Realistic Setting
Define marketing and explain how firms use it to differentiate their products.
 Firms use brand management and advertising to differentiate their products.
13.6 What Makes a Firm Successful? (pages 466–469)

Identify the key factors that determine a firm’s success.
 A firm can be profitable if it can differentiate its product or if it can produce its product at
a lower average cost than competing firms.

Setting 67
Key Terms
Brand management, p. 466. The actions of a Monopolistic competition, p. 452. A market
firm intended to maintain the differentiation of a structure in which barriers to entry are low and
product over time. many firms compete by selling similar, but not
identical, products.
Marketing, p. 465. All the activities necessary
for a firm to sell a product to a consumer.
Chapter Outline
Will Panera’s “Pure Food” Advantage Last?
Restaurants need to differentiate their food from other restaurants to succeed. Panera Bread, like Chipotle
Mexican Grill and Shake Shack operate “fast-casual” restaurants. In 2017, Ron Shaich, the chair of
Panera’s board of directors, announced that its 2,000 restaurants had converted to serving only “clean
food” – containing no artificial preservatives or other additives. Other fast-casual and fast-food
restaurants were not able to make this claim. The process of converting to “clean food” was costly but if
consumers care enough about food ingredients to make the investment pay off, Panera’s competitors will
likely begin serving “clean food” as well.
Demand and Marginal Revenue for a Firm in a

Monopolistically Competitive Market (pages 452–
13.1 454)
Learning Objective: Explain why a monopolistically competitive firm
has downward-sloping demand and marginal revenue curves.
Monopolistic competition is a market structure in which barriers to entry are low and many firms compete
by selling similar, but not identical, products.
A. The Demand Curve for a Monopolistically Competitive Firm

An increase in the price of a monopolistically competitive firm’s product reduces the quantity sold.
B. Marginal Revenue for a Firm with a Downward-Sloping Demand

Curve
When a firm cuts its price, one good thing happens: The firm will sell more, which is called the output
effect. But one bad thing happens when price is cut: The firm will receive less revenue for each unit of
output it could have sold at the higher price, which is called the price effect. Every firm that has the
ability to affect the price of the good or service it sells will have a marginal revenue curve that is below its
demand curve. When the firm lowers its price, marginal revenue will be positive when the additional
revenue from selling one more unit of output is greater than the revenue lost from receiving a lower price.
Marginal revenue will be negative when the additional revenue from selling one more unit of output is
less than the revenue lost from receiving a lower price.

Realistic Setting
Teaching Tips
The retail market for gasoline is an example of monopolistic competition you can use with your students.
Gas stations display their prices so drivers can see them. Ask your students why they would buy from a
certain station. One possible response, especially for stations located on busy highways, is: “I buy from a
station on the right side of the street so I don’t have to make two left turns.” Students will understand why
someone would pay only a slightly higher price for this convenience.
Extra Solved Problem 13.1

Despite Higher Prices, Craft Breweries Compete with Their Larger
Rivals
Although the total volume of beer sales in the United States decreased in 2016, sales of craft beer rose by
6.2 percent and craft beer’s share of the beer market climbed to 12.3 percent. Craft breweries include
small regional breweries, brewpubs (restaurants that brew and sell beer), and microbreweries. Craft
breweries target consumers who are willing to pay higher prices for a high-quality, and even exotic,
product. In addition to appealing to traditional beer drinkers, craft brews can attract consumers who
otherwise drink distilled spirits, such as vodka and scotch. Although large companies such as Anheuser-
Busch InBev and MillerCoors dominate the beer market, craft breweries in recent years have enjoyed
more rapid sales growth. Garret Oliver, brewmaster for Brooklyn Brewery, explains the popularity of his
craft brewery: “It is better to have two beers that taste great than to have six beers that don’t taste like
anything, and I think people have finally come to realize that.”
Sources: “National Beer Sales and Production Date,” Brewers Association, www.brewersassociation.org/statistics/national-beer-
sales-production-data/; Savid Kesmodel, “In Lean Times, a Stout Dream,” Wall Street Journal, March 18, 2009; and David
Zinczenko and Leighton McClellan, “Trading Buds for Micro-Brewskis: Craft Beer’s Renaissance Continues to Grow,” ABC
News, August 30, 2013.
a. Explain the significance of a firm having a downward-sloping demand curve.

b. Use a craft brewery as an example of a monopolistically competitive firm that has a downward-
sloping demand curve.

Setting 69
Solving the Problem

Step 1: Review the chapter material.
This problem is about the demand curve of a monopolistically competitive firm, so you may
want to review the section “Demand and Marginal Revenue for a Firm in a Monopolistically
Competitive Market,” which begins on page 452 in the textbook.
Step 2: Answer (a) by explaining the significance of a firm having a

downward-sloping demand curve.
A perfectly competitive firm faces a perfectly elastic, or horizontal, demand curve. As a
result, the firm has no control over price. A firm with a downward-sloping demand curve has
some control over the price it charges: The firm can raise its price without quantity demanded
falling to zero.
Step 3: Answer (b) by using a craft brewery as an example of a

monopolistically competitive firm.
A craft brewery is a small firm that operates in a local or regional market. The owner or
manager can set the price of his beer above the price of other beers (e.g., Coors or Budweiser)
if his customers believe the price is worth paying for superior quality or variety. However,
many substitutes exist for this product, so if price is set too high, customers can and will buy
other lower-priced or better-tasting beers. Some customers may also switch to distilled spirits,
such as a gin and tonic or whisky sour.
How a Monopolistically Competitive Firm Maximizes

13.2 Profit in the Short Run (pages 454–457)
Learning Objective: Explain how a monopolistically competitive firm
maximizes profit in the short run.
All firms maximize their profits by producing where marginal revenue equals marginal cost. Unlike a
perfectly competitive firm, a monopolistically competitive firm will produce where P > MC.
Extra
Apply the Is the Trend Toward Healthy Eating a Threat to
Concept Chipotle’s Market Niche?
A burger, French fries, and a soft drink. Or a pepperoni pizza with extra cheese. For generations, these were
typical meals for many teenagers and young adults. Today, however, some people view these traditional
fast-food meals as unhealthy. “Fast-casual” restaurants such as Chipotle have benefitted from that view.
Chipotle advertises that it is committed “to sourcing the very best ingredients we can find and preparing
them by hand.” The restaurant chain also notes that it prepares its food only with “vegetables grown in
healthy soil, and pork from pigs allowed to freely root and roam outdoors or in deeply bedded barns.”
Here’s how one news story summarized the appeal of fast-casual restaurants like Chipotle: They offer “food
that’s fresh, wholesome and designed to move.” In an interview, Chipotle CEO Steve Ells said, “People
understand that as a country, we are not as healthy as we should be, that a lot of our health issues are
probably related to diet, and that we could be a lot healthier and happier if we just ate the right foods.”
Clearly, part of Chipotle’s appeal is that it offers a healthier alternative to traditional fast food such as
burgers and pizza. So, an article in the New York Times showing that many restaurant meals, including

Realistic Setting
those offered at Chipotle, had a lot of calories caused the firm’s management some concern. The U.S.
Department of Agriculture recommends that adults consume between 1,600 and 2,400 calories per day,
depending on their age, gender, and level of activity. For instance, a 20-year old woman who is
moderately active can consume about 2,200 calories per day without gaining weight. According to the
New York Times article, a single Chipotle meal of a small burrito, chips and guacamole, and a Coke would
amount to nearly that many calories.
Chipotle’s management argued that few of its customers ordered meals that were that high in calories. A
follow-up New York Times article noted that data on online ordering gathered from the GrubHub Web site
indicated that the typical meal ordered at Chipotle contained only 1,070 calories. But the data also
showed that the typical Chipotle meal contained almost 100 percent of the recommended daily intake of
salt and nearly 75 percent of the recommended intake of saturated fat. Another news story pointed out that
a McDonald’s Big Mac might actually provide better nutrition than many of Chipotle’s burritos.
In competing against traditional fast-food restaurants such as McDonald’s and Domino’s, Chipotle has
clearly benefitted from the view of many consumers that its meals are healthier than burgers, pizza, and
traditional Mexican food served by fast-food restaurants like Taco Bell. Chipotle’s success in the market
niche of fast-casual Mexican food seems to depend at least in part on whether consumers continue to view
its meals as nutritious. Industry analysts are divided over whether these issues pose a significant threat to
Chipotle’s continued success in its market niche.
Sources: Jay Cheshes, “The Chipotle Effect: How Chefs Are Reinventing Fast Food,” Wall Street Journal, February 6, 2015;
“Chipotle: Fast Food with ‘Integrity,’” bloomberg.com, February 16, 2007; Charles Passy, “10 Things Chipotle Won’t Tell You,”
marketwatch.com, June 16, 2015; Josh Barro, Troy Griggs, David Leonhardt, and Claire Cain Miller, “What 2,000 Calories
Looks Like,” New York Times, December 22, 2014; Kevin Quealy, Amanda Cox, and Josh Katz, “At Chipotle, How Many
Calories Do People Really Eat?” New York Times, February 17, 2015; and information on the chipotle.com Web site.
What Happens to Profits in the Long Run? (pages
13.3 457–462)
Learning Objective: Analyze the situation of a monopolistically
competitive firm in the long run.
A. How Does the Entry of New Firms Affect the Profits of Existing
Firms?
When firms earn economic profits, entrepreneurs have an incentive to enter the market and establish new
firms. The demand curve of an established firm will shift to the left and become more elastic. Eventually,
the demand curve will shift until it is tangent to the firm’s average total cost curve. A firm may suffer
economic losses in the short run. In the long run, firms will exit an industry if they suffer economic
losses. The exit of some firms will shift the demand curve for the output of a remaining firm to the right.
Eventually, the representative firm will charge a price equal to average total cost and break even.
B. Is Zero Economic Profit Inevitable in the Long Run?

Owners do not have to accept breaking even. Firms try to continue earning a profit by reducing their
costs, providing exceptional service, or by convincing consumers that their products are different from
their competitors’ products.

Can It Be Profitable to Be the High-Price Seller?
h.h.gregg is an appliance and electronics retailer with stores in 20 states. As a relatively small firm, it has
to pay more for its appliances, televisions, and other goods from manufacturers than does a large chain,

Setting 71
such as Best Buy. Because h.h.gregg must pay higher prices to manufacturers, it must charge higher
prices to consumers. How is h.h.gregg able to succeed in competition with Best Buy, Wal-Mart, Amazon,
and other big retailers, despite charging higher prices?
According to an article in the Wall Street Journal: “h.h.gregg’s commissioned sales staff is an advantage
over national chains with young, lower-paid hourly workers that tend to stay for shorter periods.”
h.h.gregg’s CEO noted that: “We have sales people that have been with us 10 to 20 years, and customers
who come in and ask for them by name.”
Use this information to explain how an h.h.gregg store might be more profitable than a similar Best Buy
store, despite the fact that the h.h.gregg store charges higher prices. Use a graph for h.h.gregg and a graph
for Best Buy to illustrate your answer.
Solving the Problem

This problem is about how a monopolistically competitive firm maximizes profits and about
how firms attempt to earn economic profits in the long run, so you may want to review the
section “How a Monopolistically Competitive Firm Maximizes Profit in the Short Run,” which
begins on page 454, and the section “Is Zero Economic Profit Inevitable in the Long Run?” on
page 461.
Step 2: Explain how part h.h.gregg can remain profitable despite its
high costs.
If an h.h.gregg store has higher costs than a comparable Best Buy store, it can have greater
profits only if the demand for its goods is higher. According to the Wall Street Journal article,
h.h.gregg has differentiated itself from the competition, particularly from large chain stores
such as Best Buy, by offering better customer service. By having salespeople who are more
knowledgeable and more experienced than the salespeople hired by competitors, h.h.gregg has
attracted consumers who need help in buying televisions and appliances. The higher demand
from these consumers must be enough to offset h.h.gregg’s higher costs.
Step 3: Draw graphs to illustrate your argument.

For simplicity, the graphs here assume that televisions are the product being sold. Panel (a)
shows the situation for h.h.gregg, and panel (b) shows the situation for Best Buy. The graphs
show that the h.h.gregg store has both greater demand and higher costs than the Best Buy
store. Because the greater demand more than offsets the higher costs, the h.h.gregg store
makes a larger profit.

Realistic Setting
Sources: Debbi Cai, “Hhgregg 4th-Quarter Profit Down 82% on Weaker Same-Store Sales,” Wall Street Journal, May 20, 2013;
Scott Tilghman, “Hhgregg Could Get a Leg Up,” Barron’s, June 2, 2011; and Miguel Bustillo, “Small Electronics Chains Thrive
in Downturn,” Wall Street Journal, May 27, 2009.
Question
h.h.gregg has been successful in retailing appliances and electronics by combining high prices with
excellent customer service. In late 2008, Saks Fifth Avenue tried a new strategy in retailing luxury
clothing. Saks decided to slash prices on designer clothing by 70 percent just before the beginning of the
holiday sales season. According to an article in the Wall Street Journal, “Saks’s risky price-cut strategy
was to be one of the first to discount deeply, rather than one of the last.” The article continued:
Saks’s maneuver marked an open abandonment of the longstanding unwritten pact between
retailers and designers.... Those old rules boiled down to this: Leave the goods at full price at
least two months, and don’t do markdowns until the very end of the season.
Is Saks’s strategy of becoming the low-priced luxury clothing retailer likely to succeed? Contrast Saks’s
strategy with the strategy of h.h.gregg in terms of how likely the two strategies are to be successful over
the long run.
Source: Vanessa O’Connell and Rachel Dodes, “Saks Upends Luxury Market with Strategy to Slash Prices,” Wall Street Journal,
February 9, 2009.
Answer
Saks may have difficulty becoming a low-priced, luxury clothing retailer. If Saks lowers prices on luxury
clothing, other luxury clothing retailers are likely to do so as well, giving Saks no price advantage over
competing retailers. It may help Saks to differentiate its product by providing better customer service than
its competition. With h.h.gregg, customer service is very important because the company sells electronics
and appliances, products for which consumers need reliable information in terms of features, quality, and
operation. Many clothing customers need less help from salespeople than do appliance customers.
Therefore, in the long run, the strategy is more likely to be successful for h.h.gregg than for Saks.

Setting 73
Comparing Monopolistic Competition and Perfect

13.4 Competition (pages 462–465)
Learning Objective: Compare the efficiency of monopolistic
competition and perfect competition.
There are two important differences between long-run equilibrium in monopolistic competition and
perfect competition. Monopolistically competitive firms charge a price greater than marginal cost and
they do not produce at minimum average total cost.
A. Excess Capacity under Monopolistic Competition

Because a monopolistically competitive firm maximizes profit at an output level that is not at the
minimum point of its average total cost curve, it has excess capacity. If the firm increased its output, it
could produce at a lower average cost.
B. Is Monopolistic Competition Inefficient?

In a monopolistically competitive market neither productive efficiency nor allocative efficiency are
achieved. Economists have debated whether this results in a significant loss of well-being to society in
these markets compared with perfectly competitive markets.
C. How Consumers Benefit from Monopolistic Competition

The demand curve for a monopolistically competitive firms slopes downward because the good or service
the firm is selling is differentiated from the goods or services sold by competing firms. Firms differentiate
their products to appeal to consumers. When firms are successful in differentiating their products, this
indicates that some consumers find these products preferable to the alternatives. Consumers, therefore,
are better off than they would have been had these companies not differentiated their products.
Consumers face a trade-off when buying the product of a monopolistically competitive firm: Consumers
pay a price greater than the marginal cost, and the product is not produced at minimum average cost, but
they benefit from being able to purchase a product that is more closely suited to their tastes.
Teaching Tips
An example of consumers’ willingness to pay for greater convenience is the supermarket express check-
out line. Supermarkets have express lines for consumers who have just a few items to buy. Supermarkets
incur higher costs to maintain the extra lines, but most shoppers don’t mind paying somewhat higher
prices to avoid waiting in line.

Markets Offer Consumers More Choices
In its 1998 Annual Report, the Federal Reserve Bank of Dallas commented on the growing variety of
choices available to consumers:
Just since the 1970s, there’s been an explosion of choice in the marketplace—the assortment
of new [automobile] models has risen from 140 to 260, soft drinks from 20 to more than 87…
over-the-counter pain relievers from 17 to 141. The U.S. market offers 7,563 prescription
drugs, 3,000 beers, 1,174 amusement parks, 340 kinds of breakfast cereal, 50 brands of bottled
water…Today’s consumers have access to more book titles, more movies and more
magazines…

Realistic Setting
This proliferation of products, models and styles isn’t capitalism run amok. Variety shouldn’t
be dismissed as extravagance. It’s a wealthy, sophisticated society’s way of improving the lot
of consumers. The more choices, the better. A wide selection of goods and services increases
the chance each of us will find, somewhere among all the shelves and showrooms, products
that meet our requirements.
Source: W. Michael Cox and Richard Alm, “The Right Stuff: America’s Move to Mass Customization.” Federal Reserve Bank of
Dallas 1998 Annual Report, pp. 3–5. www.dallasfed.org
a. Compare the long-run equilibrium positions of firms in perfect competition and monopolistic
competition.
b. Evaluate the efficiency of producing products in monopolistically competitive markets rather than
in perfectly competitive markets.
Solving the Problem

This problem compares perfect competition and monopolistic competition, so you may want
to review the section “Comparing Monopolistic Competition and Perfect Competition,”
which begins on page 462 in the textbook.
Step 2: Compare the long-run equilibrium positions of firms in

perfect competition and monopolistic competition.
Perfect Monopolistic
Competition Competition
Equal to marginal cost Greater than marginal cost
Equal to average total cost Equal to average total cost
Firms charge a price:
Equal to minimum Greater than minimum
average total cost average total cost
Allocative efficiency Is achieved Is not achieved (price > marginal cost)
Productive efficiency Is achieved Is not achieved (excess capacity)
Step 3: Evaluate the efficiency of producing products in

monopolistically competitive markets rather than perfectly
competitive markets.
Although monopolistically competitive firms do not achieve allocative or productive efficiency,
these firms achieve success in the marketplace by offering consumers products that better
match their tastes than the standardized products offered by perfectly competitive firms.
Extra
Apply the The Edsel—Ford’s Famous Flop
Concept
Needless to say, advertising campaigns are not always successful. In 1957, the Ford Motor Company
introduced a new car, the Edsel, designed to compete with the Buick from General Motors. Ford set up a
new division of the company to produce the Edsel in five different models and hired the advertising firm

Setting 75
Foote, Cone & Belding to prepare a massive advertising campaign. Among other things, Ford purchased
an hour of prime television time on the CBS network to broadcast The Edsel Show, hosted by Frank
Sinatra, Bing Crosby, and Louis Armstrong, three of the biggest stars of the 1950s. Ford set a sales goal of
200,000 cars during the first year of production. Unfortunately, most of the car-buying public found the
styling of the Edsel, with oversized headlights and an elaborate front grill, unappealing. First-year sales
were only about 63,000 cars. During the same period, General Motors sold more than 230,000 Buicks.
Ford decided to shift its advertising account for the Edsel from Foote, Cone & Belding to Kenyon &
Eckhardt. Despite a revised advertising campaign, sales of the Edsel remained very low. Ford sold fewer
than 45,000 Edsels during the car’s second year of production. In November 1959, after only two years in
production, Ford stopped making the Edsel. One of the largest advertising campaigns in history failed to
make the Edsel successful.
Extra
Peter Thiel, e-Cigarettes, and the Monopoly in
Apply the
Monopolistic Competition
Concept
The term monopolistic competition is a combination of two words with opposite economic meanings:
monopoly—meaning an industry with one firm—and competition—meaning an industry with many
firms. A true monopoly—like a town’s water department delivering tap water to homes—has no
competition and is very rare, but the economists who first began using the term monopolistic competition
wanted to emphasize that most firms have, in a sense, a limited monopoly. If you open a pizza parlor on
the corner, yours will be the only pizza parlor on that corner and probably the only pizza parlor on that
block and possibly—if you are lucky!—the only pizza parlor in that part of town. The “competition” in
monopolistic competition was meant to emphasize that if your firm is a success and you make a profit,
new firms will enter the market and your profit is likely to be competed away.
Peter Thiel is a billionaire entrepreneur. He is a cofounder of PayPal, the online payment system, and was
an early investor in firms such as LinkedIn, Zynga, and Facebook. Thiel has emphasized that the key to
starting a successful firm is rarely to provide an existing product at a higher quality or lower price.
Instead, Thiel recommends focusing on the monopoly part of monopolistic competition by coming up
with a new product or service or a product or service that meets an existing consumer demand in an
entirely new way. Before PayPal, people could pay for Internet services using a credit card or by mailing
a check. But these means of paying had drawbacks: In the early days of the Internet, many sellers on eBay
and elsewhere didn’t have the ability to accept credit cards or wanted to avoid the fees that credit card
companies charge sellers. Checks take time to clear through banks, making sellers wait for payment and
buyers wait for goods to be shipped. PayPal gave consumers using eBay and other Web sites a new way
to pay for purchases.
One columnist summarized Thiel’s approach: “He’s talking about doing something so creative that you
establish a distinct market, niche and identity. You’ve established a creative monopoly and everybody has
to come to you if they want that service, at least for a time.” In a course Thiel taught at Stanford
University, he argued that an entrepreneur should aim for “owning a market”—at least for a period: “For a
company to own its market, it must have some combination of brand, scale cost advantages, network
effects, or proprietary technology.”
One of Thiel’s latest projects is investing in NJOY, a firm that makes e-cigarettes. E-cigarettes look like
regular tobacco cigarettes but use a battery to turn a liquid containing nicotine into a vapor. E-cigarettes
have a potential advantage over conventional cigarettes in providing nicotine to smokers without the risks
of cancer, heart disease, and other health problems. U.S. consumers spend about $100 billion per year on

Realistic Setting
conventional cigarettes, so converting even a small percentage of smokers to e-cigarettes could prove
very profitable. But a firm selling e-cigarettes faces a number of problems. The U.S. Food and Drug
Administration has stated that further research is necessary to determine whether e-cigarettes may pose
health risks to smokers. Some states have banned their sale to minors, and some businesses—including
Starbucks—have banned their use.
Sources: Mike Esterl, “E-Cigarettes Fire Up Investors, Regulators,” Wall Street Journal, June 9, 2013; Teresa Novellino, “With
Cash, Sean Parker and Peter Thiel Follow NJOY’s Vapor Trail,” http://upstart.bizjournals.com, June 10, 2013; David Brooks,
“The Creative Monopoly,” New York Times, April 23, 2012; and Blake Masters, “Ten Lessons from Peter Thiel’s Class on
Startups,” Forbes, June 7, 2012.
Question
According to Peter Thiel: “For a company to own its market, it must have some combination of brand,
scale cost advantages, network effects, or proprietary technology.” Thiel has invested in the NJOY
e-cigarette firm.
a. What does Thiel mean by a company “owning” its market?
b. What information would you need to know to determine whether NJOY owns—or is likely to
own in the future—the e-cigarette market?
Source: Blake Masters, “Ten Lessons from Peter Thiel’s Class on Startups,” Forbes, June 7, 2012.
Answer
a. The term “owning a market” refers to a firm’s ability to differentiate itself from its competitors so
that it can build brand loyalty and charge a higher price for its product.
b. You would need to know something about NJOY’s costs, how its product compares with the
products sold by competitors, whether it uses proprietary technology not available to its competitors,
whether significant economies of scale exist in the e-cigarette markets, and whether the firm can
create significant brand loyalty.
Extra
Apply the The Rise and Decline and Rise of Starbucks
Concept
In the spring of 2009, an article from Bloomberg News summed up the situation that Starbucks was in:
“After more than a decade of sensational buzz, Starbucks is struggling nationwide as it faces slowing
sales growth and increased competition.” The initial success and later struggles of Starbucks are a familiar
pattern for firms in monopolistically competitive markets.
When Starbucks began rapidly expanding, CEO Howard Schultz knew that fresh-brewed coffee was
widely available in restaurants, diners, and donut shops. He believed, though, that he had a strategy that
would differentiate Starbucks from competitors: Starbucks would offer a European espresso bar
atmosphere, with large, comfortable chairs, music playing, and groups of friends dropping in and out
during the day. From the mid-1990s through the mid-2000s, this strategy worked very well, and Starbucks
opened nearly 17,000 stores worldwide. But the profitability of Starbucks attracted competitors. Other
nationwide chains, such as Caribou Coffee, Peet’s Coffee, and Diedrich Coffee, and regional chains, such
as Dunn Brothers Coffee, provided stores with similar atmospheres, as did many individually owned
coffeehouses.
In addition, Dunkin’ Donuts began building more upscale restaurants, and McDonald’s began selling
espresso-based coffee drinks for prices considerably below charged by Starbucks. Schultz was worried

Setting 77
that in opening thousands of coffeehouses worldwide, Starbucks had made the customers’ experience less
distinctive and easier for competitors to copy.

Realistic Setting
Beginning in 2010, Schultz managed a remarkable turnaround, with Starbucks’ sales and profits
increasing. Some of the success was attributable to an expansion in overseas markets, where competition
was not as strong as in the United States. By 2013, the firm had sales of more than $1 billion in Asia and
planned to open thousands of additional stores in China. But the firm’s focus remained on staying one
step ahead of its competition in the United States. The revival of Starbucks in the United States was based
on several factors: The firm gave customers more freedom to customize drinks; it started a loyalty
program that included free refills and other perks for regular customers; it started a mobile payment
system that allowed customers to pay with their smartphones; and it provided stores with machines that
brewed higher-quality coffees. Stephen Gillett, the firm’s chief information officer, improved in-store Wi-
Fi so customers could use it without having to go through a logon screen and could get free access to
content from sources such as the Wall Street Journal and USA Today, as well as see exclusive movie
trailers. The objective was to keep customers in the store longer so they would buy more coffee. The
customer loyalty program, by reducing the average price for frequent customers, helped fight the
impression that Starbucks coffee was too expensive to buy a cup every day.
By 2015, Starbucks strategy seemed to be working. The firm had expended to 22,000 stores in 66 countries.
“Anyone who suggested in ‘08 or ‘09 that Starbucks was reaching saturation in the United States was just
flat out wrong.”
In a monopolistically competitive industry, maintaining profits in the long run is very difficult. Only by
constantly innovating was Starbucks able to return to profitability after several years of struggling with
intense competition from other firms.
Sources: Annie Gasparro, “Starbucks Shuffles Global Management Team,” Wall Street Journal, May 2, 2013; Annie Gasparo,
“U.S., China Boost Starbucks,” Wall Street Journal, April 25, 2013; Andrew Harrer, “Starbucks Corporation,” Bloomberg News,
April 13, 2009; and Janet Adamy, “Dunkin’ Donuts Tries to Go Upscale, But Not Too Far,” Wall Street Journal, April 8, 2006.
Question
An article in Forbes magazine in 2013 discussed the reasons for the ability of Starbucks to remain
profitable despite competition. The author argued the most important reason for the firm’s success was
“Right market segmentation. The company has stayed with the upper-scale of the coffee market,
competing on comfort rather than convenience....”
a. What does the author mean by “market segmentation”?

b. What does the author mean by the “upper-scale” of the coffee market? Why might it be more
difficult for other firms to compete with Starbucks in that segment of the coffeehouse market?
Source: Panos Mourdoukoutas, “Starbucks and McDonald’s Winning Strategy,” Forbes, April 25, 2013.
Answer
a. In using the term “market segmentation,” the author is referring to the different groups of people
who buy coffee and Starbucks’ attempt to appeal to a particular group (the “comfort” group).
b. The author is referring to those coffee consumers who may be willing to pay more for coffee
because they are drawn more by the overall Starbucks experience than just the opportunity
to buy a cup of coffee. Other firms, such as McDonald’s and Dunkin’ Donuts, do not offer
that “experience,” so it is more difficult for them to compete with Starbucks.

Setting 79
Extra
Apply the Are All Cupcakes the Same?
Concept
The more basic a product, the more difficult you would expect it to be for an entrepreneur to differentiate
her product enough from competitors to earn an economic profit, even in the short run. Mia Bauer was
able to pull off this difficult feat when she convinced many consumers that she had developed a very
different variety of a familiar product—the cupcake.
In 2002, Mia Bauer could find cupcakes only in basic flavors—strawberry, vanilla, and chocolate—in
most bakeries and supermarkets. She thought that consumers might prefer the more elaborate cupcakes
she baked; for example, Caramel Macchiato, which is a chocolate cupcake filled with caramel and topped
with a frosting of coffee cream cheese. Rather than sell the cupcakes to bakeries or supermarkets, Mia and
her husband Jason opened their own gourmet cupcake store, Crumbs Bake Shop, in New York City. At the
time, there were only three other stores in the United States devoted exclusively to selling cupcakes. The
Bauers believed that their cupcakes were so much tastier than other cupcakes that consumers would be
willing to pay the relatively high price of $3.75 for a single cupcake. Initially, the Bauers’ gamble paid
off, and their store was profitable. They eventually opened 63 cupcake stores in 10 states.
Because barriers to entry are low, an entrepreneur can easily open a new cupcake store. By 2013, many
entrepreneurs had opened cupcake stores to compete with the Bauers. Many of these stores offered
gourmet cupcakes similar to the Bauers’ cupcakes—but at lower prices. When asked how he could
compete with these new entrants, John Bauer said, “Everybody sells cupcakes and will continue to do so,
[but] we’re building a nationally recognizable brand.”
A nationally recognizable brand wasn’t enough, however, and by late 2013, falling sales led the Bauers to
close 10 stores. Sales continued to fall, and in July 2014, the Bauers closed all of their remaining stores
and declared bankruptcy. A few months later, new owners assumed control of the firm and reopened some
of the stores—with a new menu much less focused on cupcakes. The head of a market research firm
commented that to succeed, the new owners “need to … convince people that the new products are going
to be different in some way.”
Unfortunately for the Bauers, while consumers may not believe that all cupcakes are the same, they
apparently didn’t believe that cupcakes from Crumbs Bake Shop were significantly different from other
cupcakes.
Sources: Sara Randazzo, “Crumbs Bake Shop Closing Its Doors,” Wall Street Journal, July 7, 2014; Julie Halpert, “Crumbs Bake
Shop about to Get Bigger,” newsweek.com, February 3, 2011; Hilary Stout, “For Crumbs, Growth May Have Come Too Fast,”
New York Times, July 8, 2014; and Phyllis Furman, “Crumbs Bake Shop Set to Reopen First of 16 NYC-Area Stores,” New York
Daily News, October 14, 2014.
How Marketing Differentiates Products (pages 465–

13.5 466)
Learning Objective: Define marketing and explain how firms use it to
differentiate their products.
Firms can differentiate their products through marketing, which refers to all the activities necessary for a
firm to sell a product to a consumer. Marketing includes activities such as determining which product to
produce, designing the product, advertising and distributing the product, and monitoring how consumer
tastes affect the market for the product. Firms use two marketing tools to differentiate their products:
brand management and advertising.

Realistic Setting
A. Brand Management
Brand management refers to the actions of a firm intended to maintain the differentiation of a product over
time. Firms use brand management to postpone the time when they will no longer be able to earn economic
profits.
B. Advertising
When a firm advertises a product it tries to shift the demand curve to the right and to make it more elastic.
But advertising also increases costs. If the increase in revenue that results from advertising is greater than
the increase in costs, the firm’s profits will increase.
C. Defending a Brand Name

To defend a brand name, a firm can apply for a trademark, which grants legal protection against other
firms using its product’s name. Legally enforcing trademarks can be difficult. Each year, U.S. firms lose
billions of dollars in sales worldwide as a result of unauthorized use of their trademarked brand names.
Teaching Tips
Kleenex is a trademarked product that is often used to refer to a generic product (facial tissue). Kleenex
has been a registered trademark of the Kimberly-Clark Corporation since 1924. The use of Kleenex to
refer to any facial tissue is so widespread that it is defined in this way in the Oxford and Merriam-Webster
dictionaries.

Setting 81
What Makes a Firm Successful? (pages 466–469)

13.6 Learning Objective: Identify the key factors that determine a firm’s
success.

Realistic Setting
A firm’s owners and managers can control some of the factors that allow it to make economic profits.
Examples include the firm’s ability to differentiate its product and produce a product at a lower average
cost than competing firms. Some factors that affect a firm’s profitability are not directly under the firm’s
control; for example, increases in input prices. Sheer chance also plays a role in the success of a business.

Factors Affecting the Success of Craft Breweries
A firm’s owners and managers can control some of the factors that can enable them to earn economic
profits, but other factors are outside of the firm’s control.
List some of the controllable and uncontrollable factors of the Brooklyn Brewery, a firm mentioned in
Extra Solved Problem 13.1 on craft breweries.
Solving the Problem

This problem is about the factors that determine a firm’s profitability, so you may want to
read the section “What Makes a Firm Successful?” which begins on page 466 in the textbook.
Step 2: Controllable factors.
Controllable factors for the firm include the ability to differentiate its product. Examples:
craft breweries—the types of beer brewed and the ingredients used to brew them.
Step 3: Uncontrollable factors.
Uncontrollable factors include: (1) Prices of inputs. Examples for craft breweries—malt, hops,
labor, energy. (2) Shifts in consumer tastes, causing shifts in demand. (3) Marketing efforts of
rival firms.
Extra Economics in Your Life & Career:
Competition at the Gas Pump
Question: People often observe that prices of some items (gasoline prices, because they are very
visible, are an example) charged by different sellers are similar and assume that this is evidence of a lack
of competition or even collusion. Collusion is a term used to describe an agreement among producers not
to compete with one another. How can the similarity of gasoline prices be used as evidence of a
competitive, rather than an uncompetitive, market?
Answer: The easiest way to answer this question is to ask how motorists would respond if one
gasoline station charged substantially more (let’s say 50 cents per gallon) than another nearby station. The
station charging the lower price would have long lines, while the other station would quickly see its
business vanish. Since there is little difference in the product offered by each station, the price difference
would quickly disappear. A more convenient location or different services (“more pumps, no waiting!”)
may explain a much smaller difference in price.
Extra AN INSIDE LOOK News Article to Use in Class

Visit www.myeconlab.com for current An Inside Look news articles.

Solutions to End-of-Chapter Exercises
Demand and Marginal Revenue for a Firm in a

13.1 Monopolistically Competitive Market
Learning Objective: Explain why a monopolistically competitive firm
has downward-sloping demand and marginal revenue curves.
Review Questions
1.1 In both perfectly competitive and monopolistically competitive markets, there are many firms and
low barriers to entry. However, while products are identical in perfectly competitive markets,
products are similar—but not identical—in monopolistically competitive markets. Wheat and
many raw materials are sold in perfectly competitive markets; haircuts and restaurant meals are
sold in monopolistically competitive markets.
1.2 A local McDonald’s faces a downward-sloping demand curve for Quarter Pounders because if it
increases its price, customers will substitute away from Quarter Pounders and buy something else—
such as burgers at Wendy’s or Burger King. If a local McDonald’s raises its prices, it won’t lose all
of its customers, however, because it might be located more conveniently than other restaurants for
some people or some people might strongly prefer Quarter Pounders to similar products.
1.3 Average revenue is equal to total revenue divided by quantity sold. Because total revenue is
price multiplied by quantity, dividing by quantity leaves just price. So, average revenue is equal
to price. (Note that price equals average revenue for every firm, not just for monopolistically
competitive firms.) For any firm that is a price setter, marginal revenue is less than price
because when the firm lowers price to sell an additional unit, it must lower the price on all units
(not just the last unit).
Problems and Applications

1.4 a. If the industry was perfectly competitive there would be many firms, all of which would be
small relative to the total market for wine. All firms would sell identical products. The
quantity demanded for Chip Case’s Wine Emporium would decrease to zero if Chip tried to
raise his prices because consumers would switch to buying (identical) wine from other
sellers.
b. If the industry was monopolistically competitive the quantity demanded of Chip’s wine
would decrease, but not to zero. By differentiating his product (for example, by using
different varieties of grapes to make his wine and by advertising his wine) Chip can
convince some of his customers to buy his wine at the higher price. The demand curve for
his wine is downward sloping, but relatively elastic because there are many sellers of a
similar product. Napa Valley’s wine industry is, in fact, an example of monopolistic
competition, not perfect competition.
1.5 If Purell’s advertising campaign is successful, the demand curve for its sanitizer would
become steeper; that is, less elastic. If consumers believe Purell’s sanitizer is superior to
that of its competitors, Purell would increase brand loyalty among its consumers; therefore,
even if Purell were to increase the price of its sanitizer, many of its customers would continue
to buy it.

Realistic Setting
1.6
Snow Skiing Total Average Marginal

Lessons per Price Revenue Revenue Revenue
Day (Q) (P) (TR = P × Q) (AR = TR/Q) (MR = ∆TR/∆Q)
0 $80.00 $0 — —
1 75.00 75.00 $75.00 $75.00
2 70.00 140.00 70.00 65.00
3 65.00 195.00 65.00 55.00
4 60.00 240.00 60.00 45.00
5 55.00 275.00 55.00 35.00
6 50.00 300.00 50.00 25.00
7 45.00 315.00 45.00 15.00
8 40.00 320.00 40.00 5.00
1.7 All wheat farms sell identical goods. But restaurants do not sell identical goods. If a wheat farmer
raises his price above the market price, he will lose all of his buyers. A Panera restaurant can raise
its prices without losing all of its buyers because it is selling products that are not identical to the
products sold by other similar restaurants.
1.8 In a perfectly competitive market, marginal revenue is equal to price, so marginal revenue cannot
be negative because price cannot be negative. Because the marginal revenue curve is downward
sloping for a monopolistically competitive firm, at a high enough level of output marginal
revenue will become negative. However, as we saw in Chapter 12, firms produce where marginal
revenue equals marginal cost. Because marginal cost is never negative, a monopolistically
competitive firm would never produce where marginal revenue is negative.
1.9 The output effect is represented by the dark shaded area in the following graph, which is equal to
$4.75. The price effect is represented below by the lighter shaded area, which is equal to ($5.00 
$4.75) × 10 = $2.50. Therefore, the marginal revenue of the eleventh unit is $4.75  $2.50 = $2.25.

Setting 85
1.10 a. Sally’s revenue from selling 100,000 tomatoes at $5.00 each is $500,000. Her revenue from
selling 200,000 tomatoes at $3.25 each is $650,000. Therefore, her marginal revenue is equal to
the change in her revenue divided by the change in her output, or ($650,000  $500,000)/
(200,000  100,000) = ($150,000/100,000) = $1.50.
b. The output effect is the change in revenue as a result of the lower price. This amount is equal
to the increase in the quantity of tomatoes sold as a result of lowering price multiplied by the
new price: 100,000 × $3.25 = $325,000. The price effect is equal to the revenue lost as a
result of lowering the price for the consumers who were willing to buy tomatoes at $5.00:
($5.00  $3.25) × 100,000, or $1.75 × 100,000 = $175,000. Therefore, Sally’s total revenue
increases by ($325,000  $175,000) or $150,000 as a result of lowering her price to $3.25. As
we saw in part (a), her marginal revenue from the price cut is $1.50.
How a Monopolistically Competitive Firm Maximizes

13.2 Profit in the Short Run
Learning Objective: Explain how a monopolistically competitive firm
maximizes profit in the short run.
Review Questions
2.1 Because P > MR for a monopolistically competitive firm, a profit-maximizing monopolistically
competitive firm producing where MR = MC will necessarily produce where P > MC. In other
words, a monopolistically competitive firms will have produced more than the profit-maximizing
level of output if it produces where P = MC.
2.2 If, by grooming another dog, Isabella adds $68.50 to her costs and only $60.00 to her revenues,
her profit will fall by $8.50 if she grooms 126 dogs rather than 125 dogs.
2.3 Profit = Revenue – Cost = Quantity × (price – average cost) = 350 × ($3.25 – $3.00) = $87.50.

2.4 We need to calculate marginal revenue and marginal cost, which can be done by adding three new
columns to the table:
Ciabatta Bread Total Revenue Marginal Total Cost Marginal Cost

Sold per Hour Price (TR) Revenue (TC) (MC)
(Q) (P) (MR)
0 $6.00 0 — $ 3.00 —
1 5.50 $ 5.50 $5.50 7.00 $4.00
2 5.00 10.00 4.50 10.00 3.00
3 4.50 13.50 3.50 12.50 2.50
4 4.00 16.00 2.50 14.50 2.00
5 3.50 17.50 1.50 16.00 1.50
6 3.00 18.00 0.50 17.00 1.00
7 2.50 17.50 –0.50 18.50 1.50
8 2.00 16.00 –1.50 21.00 2.50

Realistic Setting
a. Maria should sell 5 loaves of ciabatta bread. At this quantity, MC = MR. She should charge a
price of $3.50 per loaf of bread. Her profit will equal TR  TC, or $17.50 – $16.00 = $1.50.
b. The marginal revenue from selling the profit-maximizing loaf of bread is $1.50, which is the
same as the marginal cost of selling this loaf of bread.
2.5 Jerry is correct. We cannot determine the profit-maximizing number of lamps without knowing
the revenue that would be earned from selling lamps. Minimizing average costs is not the same as
maximizing profit. The profit-maximizing level of output is typically not the same output that
would minimize average costs.
2.6
As shown on the graph, average total cost shifts up from ATC1 to ATC2, while marginal cost shifts
up from MC1 to MC2. The profit-maximizing quantity falls from q1 to q2, while the profit-
maximizing price increases from P1 to P2. With unchanged demand and higher costs, Panera’s
profit declines. In fact, Panera hoped that consumers would respond favorably to its “clean food”
campaign, resulting in an increase in demand large enough to offset the increase in costs, which
would increase the firm’s profit.
2.7 a. The following graph shows that when the marginal and average total cost curves shift up, the
profit-maximizing price rises from P1 to P2.

Setting 87
b. Germano seems to be assuming that demand is perfectly elastic and that his industry is
perfectly competitive, so that by increasing the price of the book, sales would fall to zero. If a
publisher does not raise the price of a book following an increase in its production cost, its
marginal revenue from the last few copies will be less than the marginal cost—so it will earn
a smaller profit than it would at a higher price.
c. If demand is relatively inelastic, a higher price should result in a relatively small decrease in
the quantity demanded. Raising price to cover higher costs will result in a smaller decrease in
profit when demand is relatively inelastic than when demand is relatively elastic.
2.8 a. Initial revenue = $440 × 500,000 = $220,000,000. Revenue after price cut: $360 × 800,000 =
$288,000,000. So, he expected total revenue to rise.
b. Recall that the midpoint formula uses the average of the initial and final quantity and the
initial and final price. The average of the initial and final prices of Model Ts is
$440 + $360
= $400 ,
2
and the average of the initial and final quantities is
500,000 + 800,000
= 650,000.
2
So, the percentage change in the quantity demanded is
800,000  500,000
�100 = 46.2% ,
650,000
and the percentage change in the price is
$360  $440
�100 = 20.0%.
$400
Therefore, the price elasticity of demand for Model Ts is

Realistic Setting
46.2%
= 2.3.
20.0%
c. Profit = Revenue – Cost. $60,000,000 = $288,000,000 – (ATC × 800,000); therefore, to earn a
profit of $60,000,000, the ATC for making 800,000 cars must be $285. ATC for 500,000
Model Ts: Total Cost = Revenue – Profit = $220,000,000 – $60,000,000 = $160,000,000.
Therefore, ATC = $160,000,000/500,000 = $320. So, the ATC of producing 800,000 Model Ts
was lower than the ATC of producing 500,000 Model Ts.
d. Yes. If the profit is the same and he is selling more cars, he must be making a smaller profit
per car. We can check this by calculating the profit per car (price minus ATC): For 500,000
cars, profit per car = $440 – $320 = $120 per car; for 800,000 cars, profit per car = $360 –
$285 = $75 per car.
2.9 a. TR = P × Q. Because the price at the profit-maximizing level of output of 1,700 is $3.20,
Elijah’s TR = $3.20 × 1,700 = $5,440. Total cost = ATC × Q, so Elijah’s total cost = $2.40 ×
1,700 = $4,080.
b. Profit = TR – TC, so Elijah’s profit = $5,440  $4,080 = $1,360
What Happens to Profits in the Long Run?

13.3 Learning Objective: Analyze the situation of a monopolistically
competitive firm in the long run.
Review Questions
3.1 New firms entering an industry cause the demand curves for the products of existing firms to shift
to the left. Existing firms will sell less at every price, so their profits will decline.
3.2 Economic profit takes into account some nonmonetary opportunity costs that accounting profit
does not. So, economic profit will typically be smaller than accounting profit. If a firm has zero
accounting profit, it will be making an economic loss, while a firm with zero economic profit will
earn positive accounting profit.
3.3 By taking advantage of technological advances and by continuing to differentiate its product, a
firm may continue to earn an economic profit, but entry will eventually drive a firm’s economic
profit to zero in the long run.
3.4 If the demand curve for the Red Robin restaurant is D1, profit is equal to the area: (P1  ATC1) ×
Q1. If the demand curve is D2, profit is equal to the area: (P2 – ATC2) × Q2. Because ATC2 is
greater than P2, the restaurant will suffer a loss when the demand curve is D2.

3.5 As long as entry barriers are low, Panera’s high level of economic profit will lead to the entry of
new firms that will compete with Panera by copying its approach. Therefore, ten years from now
it is likely that Panera’s economic profit per restaurant will be lower than it is today.
3.6 a. To maximize profit, Angelica should sell sandwiches up to the quantity where MC = MR. She
should sell 55 beef brisket sandwiches at a price of $4.50 each.

Setting 89
b. Her loss is equal to the difference between price and average total cost, multiplied by quantity
= ($4.50 − $5.50) × 55 = −$55.00. Because the price is greater than her average variable cost,
she should continue to produce in the short run even though she is suffering a loss.
c. No, because she is suffering a loss. If such losses persist, she should shut down her store and
exit the industry.
3.7 The analysis is incorrect. The student has forgotten that economic costs include a normal rate of
return on the owners’ investment in the firm. Therefore, firms will not leave the industry when
they earn zero economic profit. Also, in the long run, the price will be equal to average total cost
—which is the breakeven point—not above average total cost as the student mentioned.
3.8 The following graph assumes that the Foot Locker store is initially selling the profit-maximizing
level of output, q1, where MC equals MR1 (point A). The store charges the profit-maximizing
price, P1. The store suffers an economic loss because its average total cost is greater than the
price. The area representing the loss is indicated by the light gray area in the graph. As other
stores exit the market, this Foot Locker store’s demand curve shifts to the right and becomes more
inelastic (D2). The store now sells the new profit-maximizing level of output, q2, where MC
equals the new marginal revenue curve, MR2 (point B). It charges the higher price, P2. The store is
now earning an economic profit because price P2 is above average total cost. The area
representing the profit is indicated by the dark gray area in the graph.
3.9 These attributes are unlikely to ensure that Panera, Chipotle, and other chains will earn economic
profit in the long run because the short-run profits they earn will invite entry by firms that
produce similar, though not identical, products. The menu changes made by Chipotle and Panera
would not be difficult for other restaurants to copy. Therefore, it seems unlikely that these menu
changes will enable Chipotle and Panera to earn an economic profit in the long run.
Monopolistically competitive firms will experience neither economic profits nor economic losses
in the long run, unless the firms continually differentiate their products.

Realistic Setting
3.10 a. In increasing the number of lower-priced menu items, it is likely that Red Robin is reacting to
the competition it faced from McDonald’s, which typically offers more lower-priced menu
items than does Panera Bread. By emphasizing improved “speed-to-table” service time, it is
more likely that Red Robin is reacting to competition from Panera Bread. Panera and other
fast-casual restaurants have gained customers by serving food faster than traditional table
service restaurants like Red Robin. By reducing “speed-to-table,” Red Robin can reduce the
advantage that Panera has in this respect.
b. The two strategies are characteristic of firms in monopolistically competitive industries that
have to differentiate their products to compete with other firms. In this case, it appears that
Red Robin is attempting to copy the strategies of competing firms rather than introducing
new ways of differentiating its products.
3.11 a. If McDonald’s efforts to remodel its restaurants and install kiosks that customers can use to order
menu items are profitable, it can expect other fast-food restaurants to offer similar services for
their customers. These strategies appear to be ones that can be easily copied by competitors.
b. Although McDonald’s may earn a short-run economic profit, in the long run existing firms
and new entrants to the fast-food industry should be able to copy these strategies and
compete away McDonald’s profit. Unless McDonald’s introduces new measures to further
increase demand or reduce costs, it will break even in the long run.
3.12 a. Competition among the vegetable stands prevents any one of the stands from charging prices
that would enable it to earn an economic profit for more than a brief period of time. Certainly,
in the long run the stands will break even rather than earn a profit.
b. Supermarkets have higher costs (for example, investments in buildings and refrigerators) that
are required to offer customers a wider variety of products than those sold by the street
vendors. It is unlikely that supermarkets would be able to cover their costs of selling their
vegetables if they were to charge prices similar to, or lower than, the prices charged by the
vegetable stands.
Comparing Monopolistic Competition and Perfect

13.4 Competition
Learning Objective: Compare the efficiency of monopolistic
competition and perfect competition.
Review Questions
4.1 In the long run, a perfectly competitive firm charges a price equal to marginal cost, and it
produces the quantity that minimizes average total cost. A perfectly competitive firm is
allocatively and productively efficient. A monopolistically competitive firm charges a price that is
above marginal cost (so it is not allocatively efficient), and it produces a quantity that is less than
the amount that minimizes average total cost (so it is not productively efficient). Despite these
differences, perfectly competitive and monopolistically competitive firms both earn zero
economic profits in the long run.
4.2 A monopolistically competitive firm is not productively efficient because it does not produce at
minimum average total cost. Excess capacity stems from the fact that when a monopolistically
competitive firm produces where MR = MC, it produces a level of output that is below the
quantity for which average total cost is minimized.

Setting 91
4.3 A monopolistically competitive firm is not allocatively efficient because it charges a price that is
greater than marginal cost.
4.4 Monopolistic competition probably doesn’t cause a significant loss in economic well-being to
society. Consumers experience increased economic well-being when they are able to buy
products that are more closely suited to their tastes. Monopolistically competitive firms are only
successful in differentiating their products when the differentiation improves consumer well-
being. Monopolistically competitive firms have higher costs as a result of not being productively
efficient and, therefore, charge higher prices. But by their actions in buying products offered by
monopolistically competitive firms, consumers reveal that these products increase their well-
being despite having higher prices.

4.5 There is no contradiction between producing where price is greater than marginal cost and zero
profit. Zero profit occurs when price equals average total cost, which holds in the long run for
both perfectly competitive and monopolistically competitive firms.
4.6 a. This graph shows a monopolistically competitive firm. We know this because the firm faces a
downward-sloping demand curve and a downward-sloping marginal revenue curve. A perfectly
competitive firm’s demand curve is the same as its marginal revenue curve, and the curve
would be horizontal.
b. The graph shows a short-run equilibrium because the price is greater than average total cost,
so the firm is earning an economic profit. Monopolistically competitive firms earn only an
economic profit in the short run.
c. If the firm were perfectly competitive, it would produce the quantity where the ATC is at its
minimum. On the graph, this quantity is 7.
4.7 a. By having a different Web site and packaging for each of its nine restaurants Green Summit is
differentiating its product to better appeal to consumers with different tastes. Although food is
prepared in a single kitchen, consumers may believe that the food is “high-quality” – in part –
because of this differentiation. Green Summit must believe that the differentiation increases
its revenue more than the additional costs it incurs.
b. Green Summit’s strategy would not result in greater costs of food preparation because food is
cooked in a central location, but it incurs greater promotion and packaging costs. Therefore,
Green Summit’s strategy decreases productive efficiency. However, it increases allocative
efficiency and customer well-being because production of food is more in accordance with
consumer preferences.
4.8 a. Profit = TR  TC. Because at the profit-maximizing level of output of 1,200, TR = $24,000
and TC = $24,000, the firm is earning zero economic profit.
b. Because the firm is not operating at the lowest point on its ATC curve, it is not productively
efficient. And because the firm is not producing the level of output where P = MC, it is not
allocatively efficient.
4.9 a. Whole Foods’ production costs would be lower if it had not offered so many different items for
its customers. If, for example, Whole Foods sold standardized food items that were identical to
other foods vendors, it would be similar to a perfectly competitive firm. Whole Foods is better
described as a monopolistically competitive firm; such firms charge prices greater than their

Realistic Setting
marginal costs (they do not achieve allocative efficiency) and do not produce at minimum
average total cost (they have excess capacity and do not achieve productive efficiency).
b. The success that Whole Foods has achieved is evidence that the measures it has taken to
differentiate its products appeals to its customers, who are willing to pay higher prices for the
greater variety that Whole Foods offers. Whole Foods’ customers are better off than they would
be if the company did not differentiate its products.
How Marketing Differentiates Products

13.5 Learning Objective: Define marketing and explain how firms use it to
differentiate their products.
Review Questions
5.1 Marketing consists of all the activities that are necessary for a firm to sell a product to a
consumer. Marketing is not limited to advertising. For example, product placement and defending
a brand name are also forms of marketing.
5.2 Firms are concerned about brand management because maintaining their product’s unique
identity and its good reputation help to prevent competitors from attracting the firms’ customers.

Setting 93

5.3 Advertising is a fixed cost, so an increase in spending on advertising shifts up the ATC curve, but
not the MC curve. The firm’s profit-maximizing price and quantity are unchanged, but its profit is
reduced.
5.4 Looking at what consumers are already buying is a good way to find out what customers want, but it
probably isn’t a good way to make an economic profit because other firms already have this
information and are selling products to these customers. Entering the market with products exactly
like your competitors will only work if your firm somehow has lower costs than the other firms.
Firms that discover new information about what customers want can temporarily make a profit
supplying a new product until new firms enter the market and competition drives the firm’s profit to
zero.
5.5 a. The “high end” refers to the market for high-income consumers who are willing to pay as much
as $12 for a cup of coffee. By stating that “the middle is slowing down” Joachimsthaler refers
to the slowing down of the demand for Starbucks coffee by middle-income consumers, who
would balk at paying prices as high as $12 for a cup of coffee. Joachimsthaler’s comments
imply that there are consumers who are willing pay high prices for coffee, just as there are
consumers who are willing to pay relatively high prices for beer sold by craft breweries.
b. Schultz’s plan to establish luxury coffee shops illustrates product differentiation: it is designed
to appeal to consumers who are more willing to buy coffee at prices higher than prices charged
by established Starbucks coffee shops. This plan also reflects Starbucks’s marketing strategy
(this refers to all of the activities necessary to sell a product to consumers) and its attempts at
brand management (the actions Starbucks takes to maintain the differentiation of its coffee
products over time).
5.6 Thermos was originally a brand name for a particular type of vacuum flask, but by the 1960s, other
firms had begun selling “thermos” containers. Although the Thermos company sued, a court
decision declared that “thermos” had become a generic term that any firm could use, provided the
word was spelled with a lower case “t” to avoid confusion with the Thermos company. Once the
courts have declared a company’s brand name generic, there is not much the company can do.
Rebranding the product would lose the name recognition the firm had built up over time. Another
famous example of a product image mishap is Reebok’s Incubus running shoes for women. Reebok
was surprised to learn that in medieval legend an incubus was a male demon who preyed on
sleeping women. After a big frenzy in the press, Reebok changed the shoe’s name.

Realistic Setting
5.7 Successful marketing allows a firm to differentiate its products. JustFab can use data from its Web
site to become aware of changes in consumer demand sooner than its rivals can. By better
controlling its inventory and quickly responding to changes in fashion trends the firm can
increase its short-run economic profit.
What Makes a Firm Successful?

13.6 Learning Objective: Identify the key factors that determine a firm’s
success.
Review Questions
6.1 A monopolistically competitive firm’s profitability depends on its ability to differentiate its
product (especially to make it seem more desirable than competitors’ products) and to produce its
product at a lower average total cost than competing firms.
6.2 A monopolistically competitive firm can earn an economic profit only if it always stays one step
ahead of its competitors by continually differentiating its product or lowering its costs.

6.3 a. If Gogo is just copying the service offered by existing competitors, it seems unlikely that it
will regain market share. To regain market share, Gogo will likely have to differentiate its
service from the services offered by its competitors.
b. The funds Gogo spent on the cellular towers is a sunk cost that Gogo can ignore in rolling out
its new service. Only the additional revenue from its new service relative to the additional
cost of providing the service is relevant to Gogo in determining the profitability of the new
service. But if Gogo is still making payments on bank loans or bonds used to raise the funds
to build the towers, it’s possible that it may have difficulty raising the funds necessary to
finance its new service.
6.4 Competition is a risk because it can reduce a firm’s profit by driving down the price of its
products. The barriers to entry are low in retailing, so the competition is intense.
6.5 Design flaws can indeed reduce profits for “first movers” and leave room for competitors who
can enter the new market with a better product. Firms that enter a market later often have had
enough time to improve the products they offer and better gauge product characteristics that are
important to consumers. Apple took this approach when entering the markets for digital music
players, smartphones, and smartwatches.
6.6 It is not easy always because, for many firms, success is due to both skill and luck. There are
certain factors that skilled managers can control in order to increase the value of their products,
such as successful product differentiation and having lower costs than competing firms. Other
factors that result in profits are not so easily controlled and can be the result of sheer luck. For
example, sales of an energy drink may increase if a popular athlete or celebrity is seen drinking it,
or a restaurant’s profits may increase because celebrities are spotted eating there. It is difficult to
predict or change consumer tastes and preferences.

Setting 95
Suggestions for Critical Thinking Exercises
CT13.1 a. The cost curves would stay the same, but the demand curve would be downward sloping and
the MR curve would separate from the demand curve and would be downward sloping.
b. Presumably the firm would have more profits as it decided to make this move. Note: This
question asks students to compare two market structures in a detailed way.
CT13.2 Clearly the answer depends on the good or service that the student has in mind. While this
exercise open-ended, it does connect general ideas from the text with something students care
about.
CT13.3 Answers will depend on the sources students find. Some students will likely mention weekend
stayovers, seat position (an isle or middle seat), and baggage allowances (particularly with the
new bargain fares offered by major U.S. airlines starting in 2017).

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CHAPTER 13 | Monopolistic Competition: The Competitive Model in a More Realistic

13.2 How a Monopolistically Competitive Firm Maximizes

13.3 What Happens to Profits in the Long Run? (pages 457–

13.4 Comparing Monopolistic Competition and Perfect

13.5 How Marketing Differentiates Products (pages 465–466)

Copyright © 2019 Pearson Education, Inc.

13.6 What Makes a Firm Successful? (pages 466–469)

Copyright © 2017 Pearson Education, Inc.

Demand and Marginal Revenue for a Firm in a

A. The Demand Curve for a Monopolistically Competitive Firm

B. Marginal Revenue for a Firm with a Downward-Sloping Demand

Copyright © 2019 Pearson Education, Inc.

Extra Solved Problem 13.1

a. Explain the significance of a firm having a downward-sloping demand curve.

Copyright © 2017 Pearson Education, Inc.

Solving the Problem

Step 2: Answer (a) by explaining the significance of a firm having a

Step 3: Answer (b) by using a craft brewery as an example of a

How a Monopolistically Competitive Firm Maximizes

Copyright © 2019 Pearson Education, Inc.

B. Is Zero Economic Profit Inevitable in the Long Run?

Extra Solved Problem 13.3

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Solving the Problem

Step 3: Draw graphs to illustrate your argument.

Copyright © 2019 Pearson Education, Inc.

Copyright © 2017 Pearson Education, Inc.

Comparing Monopolistic Competition and Perfect

A. Excess Capacity under Monopolistic Competition

B. Is Monopolistic Competition Inefficient?

C. How Consumers Benefit from Monopolistic Competition

Extra Solved Problem 13.4

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Solving the Problem

Step 2: Compare the long-run equilibrium positions of firms in

Step 3: Evaluate the efficiency of producing products in

Copyright © 2017 Pearson Education, Inc.

Copyright © 2019 Pearson Education, Inc.

Copyright © 2017 Pearson Education, Inc.

Copyright © 2019 Pearson Education, Inc.

a. What does the author mean by “market segmentation”?

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How Marketing Differentiates Products (pages 465–

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C. Defending a Brand Name

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What Makes a Firm Successful? (pages 466–469)

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Extra Solved Problem 13.6

Solving the Problem

Extra AN INSIDE LOOK News Article to Use in Class

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Demand and Marginal Revenue for a Firm in a

Problems and Applications

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Snow Skiing Total Average Marginal

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How a Monopolistically Competitive Firm Maximizes

Problems and Applications

Ciabatta Bread Total Revenue Marginal Total Cost Marginal Cost

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Copyright © 2019 Pearson Education, Inc.

Copyright © 2019 Pearson Education, Inc.