Chamberlin's Two Demand Curves

Chamberlin's Two Demand Curves

It is now time to consider the demand situation actually facing the monopolistically competitive firm. Chamberlin described the firm as actually facing two demand curves, although he behaved as if only one is relevant. A diagram might clarify his rather cryptic statement. Figure 1 depicts two demand functions, DD and dd, which intersect at point C. Both of these functions are negatively sloped since the firm is assumed to have some control over price. Suppose that the firm, which is assumed to be in a monopolistically competitive market, is charging price Pm and selling quantity Qm. How does the firm (whose product faces a large number of competing substitute products) view the situation? Given that all firms in his product group produce substitutable goods, the seller believes that he could increase sales considerably by lowering his price below Pm. The seller also believes that a marked reduction in sales will result from raising his price above Pm, however, since he believes that none of his competitors will follow. Thus, assuming that the seller believes that his action will go unnoticed by his rivals, the demand curve facing the firm would be dd.
A slight problem renders the individual seller's assumption unwarranted, however. If our representative seller can profit from a price reduction, so can any of his rivals, assuming, as Chamberlin did, that costs for all firms are identical. Thus it is reasonable to expect that all the monopolistic competitors would have an incentive to reduce prices. If all reduced prices vis-a-vis our representative seller's reduction, sales would expand to the firm only from the general price reduction and not at the expense of his rivals. DD depicts the demand curve, given that rival firms follow the price actions of any one firm.

Figure

Both curves dd and DD are drawn under the assumption that advertising expenditures are at a constant level for each firm. Should the firm under consideration increase its amount of competitive advertising, given that other firms do not react similarly, the demand functions facing the firm in Figure 1 would shift to the right, and profits could be increased. Advertising expenditures would be optimized for the firm when $1 of additional selling costs added exactly $1 to the firm's receipts.