Monopolistic Competition and Excess Capacity

Objectives

• Students will be able to draw a short-run monopolistically competitive firm earning economic profit at MR = MC.
• Students will be able to explain how entry shifts each firm's demand curve left until it is tangent to ATC.
• Students will be able to identify the three long-run conditions: P = ATC, MR = MC, and demand tangent to ATC.
• Students will be able to locate excess capacity and the markup of price over marginal cost on the long-run graph.

Materials (all free, no student accounts needed)

• Monopolistic Competition lesson
• Short-run/long-run sandbox with SR-LR toggle
• Monopolistic competition practice questions
• Monopoly lesson (prerequisite graph)
• AP Micro cram sheet

Five-minute warm-up, no prep

Open one of these on the projector. Students say what they think happens to price and quantity before anything moves, lock it in, and then the graph plays out step by step. No accounts, nothing graded or stored.

• Tea Gets Pricier
• Coffee Beans Get Expensive
• Printers Get Pricier, Ink Suffers

Warm-up (5 min)

• Project a list of five shampoo brands. Ask: are these firms price takers or price makers, and what one word explains their pricing power? (Differentiation.)
• Cold-call: does this market have high or low barriers to entry? (Low.)

Direct instruction (15 min)

• Draw the short-run graph: it looks like a monopoly (downward-sloping D, MR below it, MC, ATC), but note the demand curve is flatter because close substitutes exist.
• Find the short-run outcome: Qm at MR = MC, price read up on demand, and a profit rectangle if P is above ATC.
• Tell the entry story: low barriers mean profit attracts new firms, each rival pulls customers away, so every incumbent's demand curve shifts left until it is tangent to ATC.
• State the three long-run conditions together: P = ATC (zero economic profit), MR = MC, and demand tangent to ATC on its downward-sloping section, which leaves excess capacity with P above MC.

Guided practice (17 min)

• Project /sandbox/monopolistic-competition with the SR/LR toggle set to Short Run so the profit rectangle is visible.
• Cold-call a student to read the profit rectangle and explain what it will attract (entry).
• Click the Long Run button and have the class narrate what happens: demand slides left, the rectangle vanishes, and demand becomes tangent to ATC.
• With the long-run graph up, have a student point to excess capacity (the gap between the firm's quantity and the minimum-ATC quantity) and to the markup (P above MC).
• Think-pair-share: pairs write one way this long-run graph differs from a perfectly competitive firm's even though both earn zero profit. Take one and correct it to P = ATC greater than MC here versus P = MC = minimum ATC in perfect competition.

Independent practice (8 min)

• Students complete the items at /practice/monopolistic-competition, focusing on the excess-capacity and long-run-tangency questions.
• If time allows, each student redraws the long-run graph and labels excess capacity and the markup.

Exit ticket

• Draw a monopolistically competitive firm in long-run equilibrium and label the tangency point, P, and ATC.
• Why is the long-run demand curve tangent to ATC on its downward-sloping part rather than at the minimum?
• Name the two efficiency shortfalls versus perfect competition (excess capacity and P above MC).

Homework

• Read the 'What Students Get Wrong' section and write two sentences on why the long-run demand curve is NOT horizontal.
• Finish /practice/monopolistic-competition and note any item you missed.

Differentiation

• Support: give students the short-run graph pre-drawn so they only have to shift demand left to the tangency for the long run.
• Stretch: have advanced students contrast this long-run graph with the monopoly graph and explain why the deadweight loss is smaller here.
• For students who finish early, ask them to write the AP wording clues (differentiated products and free entry mean monopolistic competition; barriers to entry mean monopoly or oligopoly).

Misconceptions to head off

• Students think the long-run demand curve becomes horizontal. Correction: it slides left but stays downward-sloping, because the product is still differentiated; horizontal demand would be perfect competition.
• Students draw long-run demand tangent to the bottom of ATC. Correction: the tangency is on the downward-sloping part of ATC, leaving excess capacity with P above both MC and minimum ATC.
• Students read zero economic profit as the firm losing money. Correction: the firm earns a normal return, exactly what the owners would make in their next-best option.
• Students assume monopolistic competition and perfect competition graphs look the same because both earn zero profit. Correction: in perfect competition P = MC = minimum ATC, while here P = ATC is above both MC and minimum ATC.