Wk8 DQ - Managerial Eonomics
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Baye_9e_Chapter_082.pptxManaging in Competitive, Monopolistic, and Monopolistically Competitive Markets
© 2017 by McGraw-Hill Education. All Rights Reserved. Authorized only for instructor use in the classroom. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 8
Learning Objectives
Identify the conditions under which a firm operates as perfectly competitive, monopolistically competitive, or a monopoly.
Identify sources of (and strategies for obtaining) monopoly power.
Apply the marginal principle to determine the profit-maximizing price and output.
Show the relationship between the elasticity of demand for a firm’s product and its marginal revenue.
Explain how long-run adjustments impact perfectly competitive, monopoly, and monopolistically competitive firms; discuss the ramifications of each of these market structures on social welfare.
Decide whether a firm making short-run losses should continue to operate or shut down its operations.
Illustrate the relationship between marginal cost, a competitive firm’s short-run supply curve, and the competitive industry supply; explain why supply curves do not exist for firms that have market power.
Calculate the optimal output of a firm that operates two plants and the optimal level of advertising for a firm that enjoys market power.
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2
Perfect Competition
Perfectly competitive markets are characterized by:
The interaction between many buyers and sellers that are “small” relative to the market.
Each firm in the market produces a homogeneous (identical) product.
Buyers and sellers have perfect information.
No transaction costs.
Free entry into and exit from the market.
The implications of these conditions are:
a single market price is determined by the interaction of demand and supply
firms earn zero economic profits in the long run.
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Perfect Competition
3
Demand at the Market and Firm Levels Under Perfect Competition
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Perfect Competition
Market
output
0
Price
D
Price
Firm’s
output
S
Market
Firm
4
Short-Run Output Decisions
The short run is a period of time over which some factors of production are fixed.
To maximize short-run profits, managers must take as given the fixed inputs (and fixed costs), and determine how much output to produce by changing the variable inputs.
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Perfect Competition
5
Revenue, Costs, and Profits for a Perfectly Competitive Firm
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Perfect Competition
Firm’s output
$
0
Revenue
A
B
Slope of
E
Costs
Slope of
Maximum
profits
6
Competitive Firm’s Demand
The demand curve for a competitive firm’s product is a horizontal line at the market price. This price is the competitive firm’s marginal revenue.
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Perfect Competition
7
Profit Maximization under Perfect Competition
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8-8
Perfect Competition
Firm’s output
$
0
Profits
8
Competitive Output Rule
To maximize profits, a perfectly competitive firm produces the output at which price equals marginal cost in the range over which marginal cost is increasing.
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Perfect Competition
9
Competitive Output Rule In Action
The cost function for a firm is .
If the firm sells output in a perfectly competitive market and other firms in the industry sell output at a price of $20, what price should the manager of this firm charge? What level of output should be produced to maximize profits? How much profit will be earned?
Answer:
Charge $20.
Since marginal cost is , equating price and marginal cost yields: units.
Maximum profits are: .
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Perfect Competition
10
Short-Run Loss Minimization
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Perfect Competition
Firm’s output
$
0
Loss
11
The Shut-Down Case
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Perfect Competition
Firm’s output
$
0
Fixed Cost
Loss if produce
Loss if shut down
12
Short-Run Output Decision Under Perfect Competition
To maximize short-run profits, a perfectly competitive firm should produce in the range of increasing marginal cost where , provided that . If , the firm should shut down its plant to minimize it losses.
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Perfect Competition
13
Short-Run Firm Supply Curve for a Competitive Firm
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8-14
Perfect Competition
Firm’s output
$
0
Short-run supply
curve for individual firm
14
The Short-Run Firm and Industry Supply Curves
The short-run supply curve for a perfectly competitive firm is its marginal cost curve above the minimum point on the curve.
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Perfect Competition
15
The Market Supply Curve
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Perfect Competition
Market output
P
0
1
$10
$12
Market supply
curve
Individual firm’s
supply curve
500
S
16
Long-Run Decisions: Entry and Exit The Market and Firm’s Demand
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8-17
Perfect Competition
Market
output
0
Price
D
Price
Firm’s
output
0
Exit
Entry
17
Long-Run Competitive Equilibrium
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8-18
Perfect Competition
Firm’s output
$
0
Long-run competitive
equilibrium
18
Long-Run Competitive Equilibrium
In the long run, perfectly competitive firms produce a level of output such that
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8-19
Perfect Competition
19
Monopoly and Monopoly Power
Monopoly: A market structure in which a single firm serves an entire market for a good that has no close substitutes.
Sole seller of a good in a market gives that firm greater market power than if it competed against other firms.
Implication:
market demand curve is the monopolist’s demand curve.
However, a monopolist does not have unlimited market power.
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Monopoly
20
The Monopolist’s Demand
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Monopoly
Output
Price
0
A
B
Monopolist’s power is constrained
by the demand curve.
21
Sources of Monopoly Power
Economies of scale: exist whenever long-run average costs decline as output increases.
Diseconomies of scale: exist whenever long-run average costs increase as output increases.
Economies of scope: exist when the total cost of producing two products within the same firm is lower than when the products are produced by separate firms.
Cost complementarity: exist when the marginal cost of producing one output is reduced when the output of another product is increased.
Patents and other legal barriers
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Monopoly
22
Elasticity of Demand and Total Revenues
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Monopoly
Q
0
Revenue
Price
Firm’s
output
0
Unitary
Unitary
Elastic
Inelastic
Inelastic
Elastic
Maximum revenues
MR
23
Marginal Revenue and Elasticity
The monopolist’s marginal revenue function is
, where is the elasticity of demand for the monopolist’s product and is the price charged.
For
when .
when .
when .
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Monopoly
24
Marginal Revenue and Linear Demand
Given an linear inverse demand function
, where , the associated marginal revenue is
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Monopoly
25
Marginal Revenue In Action
Suppose the inverse demand function for a monopolist’s product is given by . What is the maximum price per unit a monopolist can charge to be able to sell 3 units? What is marginal revenue when ?
Answer:
The maximum price the monopolist can charge for 3 units is: .
The marginal revenue at 3 units for this inverse linear demand is: .
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Monopoly
26
Monopoly Output Rule
A profit-maximizing monopolist should produce the output, , such that marginal revenue equals marginal cost:
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Monopoly
27
Costs, Revenues, and Profits Under Monopoly
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Monopoly
Output
$
0
Cost function
Slope of
Slope of
Revenue function
Maximum
profit
28
Price
Quantity
Demand
MR
MC
ATC
)
Profits
Profit Maximization Under Monopoly
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Monopoly
Monopoly Pricing Rule
Given the level of output, , that maximizes profits, the monopoly price is the price on the demand curve corresponding to the units produced:
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Monopoly
30
Monopoly In Action
Suppose the inverse demand function for a monopolist’s product is given by and the cost function is . Determine the profit-maximizing price, quantity and maximum profits.
Answer:
Profit-maximizing output is found by solving: .
The profit-maximizing price is: .
Maximum profits are: .
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Monopoly
31
The Absence of a Supply Curve
Recall, firms operating in perfectly competitive markets determine how much output to produce based on price ().
Thus, a supply curve exists in perfectly competitive markets.
A monopolist’s market power implies .
Thus, there is no supply curve for a monopolist, or in markets served by firms with market power.
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Monopoly
32
Multiplant Decisions
Often a monopolist produces output in different locations.
Implications: manager has to determine how much output to produce at each plant.
Consider a monopolist producing output at two plants:
The cost of producing units at plant 1 is , and the cost of producing at plant 2 is .
When the monopolist produces a homogeneous product, the per-unit price consumers are willing to pay for the total output produced at the two plants is , where .
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Monopoly
33
Multiplant Output Rule
Let be the marginal revenue of producing a total of units of output. Suppose the marginal cost of producing units of output in plant 1 is and that of producing units in plant 2 is . The profit-maximizing rule for the two-plant monopolist is to allocate output among the two plants such that:
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Monopoly
34
Implications of Entry Barriers
A monopolist may earn positive economic profits, which in the presence of barriers to entry prevents other firms from entering the market to reap a portion of those profits.
Implication: monopoly profits will continue over time provided the monopoly maintains its market power.
Monopoly power, however, does not guarantee positive profits.
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Monopoly
35
Price
Quantity
Demand
MR
MC
ATC
A Monopolist Earning Zero Profits
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Monopoly
Deadweight Loss of Monopoly
The consumer and producer surplus that is lost due to the monopolist charging a price in excess of marginal cost.
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Monopoly
37
Price
Quantity
Demand
MR
MC
Deadweight Loss of Monopoly
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Monopoly
Deadweight loss
Monopolistic Competition
An industry is monopolistically competitive if:
There are many buyers and sellers.
Each firm in the industry produces a differentiated product.
There is free entry into and exit from the industry.
A key difference between monopolistically competitive and perfectly competitive markets is that each firm produces a slightly differentiated product.
Implication: products are close, but not perfect, substitutes; therefore, firm’s demand curve is downward sloping under monopolistic competition.
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Monopolistic Competition
39
Price
Quantity
Demand
MR
MC
ATC
Profit-Maximization under Monopolistic Competition
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Monopolistic Competition
Profits
Profit-Maximization Rule for Monopolistic Competition
To maximize profits, a monopolistically competitive firm produces where its marginal revenue equals marginal cost.
The profit-maximizing price is the maximum price per unit that consumers are willing to pay for the profit-maximizing level of output.
The profit-maximizing output, , is such that and the profit-maximizing price is .
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Monopolistic Competition
41
Long-Run Equilibrium
If firms in monopolistically competitive markets earn short-run
profits, additional firms will enter in the long run to capture some of those profits.
losses, some firms will exit the industry in the long run.
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Monopolistic Competition
42
Price
Quantity of Brand X
Demand0
MR0
MC
ATC
Effect of Entry on a Monopolistically Competitive Firm’s Demand
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8-43
Monopolistic Competition
Demand1
MR1
Due to entry of new
firms selling other brands
Price
Quantity of Brand X
MC
ATC
Long-Run Equilibrium under Monopolistic Competition
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8-44
Monopolistic Competition
Demand1
MR1
Long-run monopolistically
competitive equilibrium
The Long-Run and Monopolistic Competition
In the long run, monopolistically competitive firms produce a level of output such that:
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Monopolistic Competition
45
Implications of Product Differentiation
The differentiated nature of products in monopolistically competitive markets implies that firms in these industries must continually convince consumers that their products are better than their competitors.
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Monopolistic Competition
46
Implications of Product Differentiation
Two strategies monopolistically competitive firms use to persuade consumers:
Comparative advertising: form of advertising where a firm attempts to increase the demand for its brand by differentiating its product from competing brands
Brand equity
Niche marketing: a marketing strategy where goods and services are tailored to meet the needs of a particular segment of the market.
Green marketing
Successful differentiation and branding strategies can make managers brand myopic, resting on the brand’s past laurels and in doing so missing opportunities to enhance its brand
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47
Monopolistic Competition
Optimal Advertising Decisions
How much should a firm spend on advertising to maximize profits?
Depends, in part, on the nature of the industry.
The optimal amount of advertising balances the marginal benefits and marginal costs.
Profit-maximizing advertising-to-sales ratio is:
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Optimal Advertising Decisions
48
