1 Managerial Economics & Business Strategy Chapter 8 Managing in Competitive, Monopolistic, and Monopolistically Competitive Markets
2 I. Perfect Competition Overview Characteristics and profit outlook. Effect of new entrants. II. Monopolies Sources of monopoly power. Maximizing monopoly profits. Pros and cons. III. Monopolistic Competition Profit maximization. Long run equilibrium.
3 Perfect Competition Environment Many buyers and sellers. Homogeneous (identical) product. Perfect information on both sides of market. No transaction costs. Free entry and exit.
4 Key Implications Firms are price takers (P = MR). In the short-run, firms may earn profits or losses. Long-run profits are zero.
5 Unrealistic? Why Learn? Many small businesses are price-takers, and decision rules for such firms are similar to those of perfectly competitive firms. It is a useful benchmark. Explains why governments oppose monopolies. Illuminates the danger to managers of competitive environments. Importance of product differentiation. Sustainable advantage.
6 Managing a Perfectly Competitive Firm (or Price-Taking Business)
7 Setting Price $ S $ P e D f D Market Q M Firm Q f
8 Profit-Maximizing Output Decision MR = MC. Since, MR = P, Set P = MC to maximize profits.
9 Graphically: Representative Firm s Output Decision $ Profit = (P e - ATC) Q f* MC ATC P e AVC P e = D f = MR ATC Q f* Q f
10 A Numerical Example Given P=$10 C(Q) = 5 + Q 2 Optimal Price? P=$10 Optimal Output? MR = P = $10 and MC = 2Q 10 = 2Q Q = 5 units Maximum Profits? PQ - C(Q) = (10)(5) - (5 + 25) = $20
11 Should this Firm Sustain Short Run Losses or Shut Down? $ Profit = (P e - ATC) Q f* < 0 MC ATC AVC ATC P e Loss P e = D f = MR Q f* Q f
12 Shutdown Decision Rule A profit-maximizing firm should continue to operate (sustain short-run losses) if its operating loss is less than its fixed costs. Operating results in a smaller loss than ceasing operations. Decision rule: A firm should shutdown when P < min AVC. Continue operating as long as P min AVC.
13 Firm s Short-Run Supply Curve: MC Above Min AVC $ MC AVC ATC P min AVC Q f* Q f
14 Short-Run Market Supply Curve The market supply curve is the summation of each individual firm s supply at each price. P Firm 1 Firm 2 P P Market S 1 S 2 S M Q Q 30 43Q
15 Long Run Adjustments? If firms are price takers but there are barriers to entry, profits will persist. If the industry is perfectly competitive, firms are not only price takers but there is free entry. Other greedy capitalists enter the market.
16 Effect of Entry on Price? S* $ S $ Entry P e P e* D f* D D f Market Q M Firm Q f
17 Effect of Entry on the Firm s Output and Profits? $ MC AC P e D f P e* Df* Q L Q f * Q
18 Summary of Logic Short run profits leads to entry. Entry increases market supply, drives down the market price, increases the market quantity. Demand for individual firm s product shifts down. Firm reduces output to maximize profit. Long run profits are zero.
19 Features of Long Run Competitive Equilibrium P = MC Socially efficient output. P = minimum AC Efficient plant size. Zero profits Firms are earning just enough to offset their opportunity cost.
20 Monopoly Environment Single firm serves the relevant market. Most monopolies are local monopolies. The demand for the firm s product is the market demand curve. Firm has control over price. But the price charged affects the quantity demanded of the monopolist s product.
21 Natural Sources of Monopoly Power Economies of scale Economies of scope Cost complementarities
22 Created Sources of Monopoly Power Patents and other legal barriers (like licenses) Tying contracts Exclusive contracts I. Collusion Contract... II. III.
23 Managing a Monopoly Market power permits you to price above MC Is the sky the limit? No. How much you sell depends on the price you set!
24 A Monopolist s Marginal Revenue P TR 100 Elastic Unit elastic Inelastic 40 Unit elastic Q MR Elastic Inelastic Q
25 Monopoly Profit Maximization Produce where MR = MC. Charge the price on the demand curve that corresponds to that quantity. $ Profit MC ATC P M ATC D Q M MR Q
26 Useful Formulae What s the MR if a firm faces a linear demand curve for its product? P = a + bq MR = a + 2 bq, where b < 0. Alternatively, MR = 1+ E P E
27 A Numerical Example Given estimates of P = 10 - Q C(Q) = 6 + 2Q Optimal output? MR = 10-2Q MC = Q = 2 Q = 4 units Optimal price? P = 10 - (4) = $6 Maximum profits? PQ - C(Q) = (6)(4) - (6 + 8) = $10
28 Long Run Adjustments? None, unless the source of monopoly power is eliminated.
29 Why Government Dislikes P > MC Monopoly? Too little output, at too high a price. Deadweight loss of monopoly.
30 Deadweight Loss of Monopoly $ Deadweight Loss of Monopoly MC ATC P M MC D Q M MR Q
31 Arguments for Monopoly The beneficial effects of economies of scale, economies of scope, and cost complementarities on price and output may outweigh the negative effects of market power. Encourages innovation.
32 Monopoly Multi-Plant Decisions Consider a monopoly that produces identical output at two production facilities (think of a firm that generates and distributes electricity from two facilities). Let C 1 (Q 2 ) be the production cost at facility 1. Let C 2 (Q 2 ) be the production cost at facility 2. Decision Rule: Produce output where MR(Q) = MC 1 (Q 1 ) and MR(Q) = MC 2 (Q 2 ) Set price equal to P(Q), where Q = Q 1 + Q 2.
33 Monopolistic Competition: Environment and Implications Numerous buyers and sellers Differentiated products Implication: Since products are differentiated, each firm faces a downward sloping demand curve. Consumers view differentiated products as close substitutes: there exists some willingness to substitute. Free entry and exit Implication: Firms will earn zero profits in the long run.
34 Managing a Monopolistically Competitive Firm Like a monopoly, monopolistically competitive firms But have market power that permits pricing above marginal cost. level of sales depends on the price it sets. The presence of other brands in the market makes the demand for your brand more elastic than if you were a monopolist. Free entry and exit impacts profitability. Therefore, monopolistically competitive firms have limited market power.
35 Marginal Revenue Like a Monopolist P TR 100 Elastic Unit elastic Inelastic 40 Unit elastic Q MR Elastic Inelastic Q
36 Monopolistic Competition: Profit Maximization Maximize profits like a monopolist Produce output where MR = MC. Charge the price on the demand curve that corresponds to that quantity.
37 Short-Run Monopolistic Competition $ Profit MC ATC P M ATC D Q M MR Quantity of Brand X
38 Long Run Adjustments? If the industry is truly monopolistically competitive, there is free entry. In this case other greedy capitalists enter, and their new brands steal market share. This reduces the demand for your product until profits are ultimately zero.
39 Long-Run Monopolistic Competition $ Long Run Equilibrium (P = AC, so zero profits) MC AC P* P 1 Entry D MR D 1 Q 1 Q* MR 1 Quantity of Brand X
40 Monopolistic Competition The Good (To Consumers) Product Variety The Bad (To Society) P > MC Excess capacity Unexploited economies of scale The Ugly (To Managers) P = ATC > minimum of average costs. Zero Profits (in the long run)!
41 Optimal Advertising Decisions Advertising is one way for firms with market power to differentiate their products. But, how much should a firm spend on advertising? Advertise to the point where the additional revenue generated from advertising equals the additional cost of advertising. Equivalently, the profit-maximizing level of advertising occurs where the advertising-to-sales ratio equals the ratio of the advertising elasticity of demand to the own-price elasticity of demand. A R = E Q, A E Q, P
42 Maximizing Profits: A Synthesizing Example C(Q) = Q 2 Determine the profit-maximizing output and price, and discuss its implications, if You are a price taker and other firms charge $40 per unit; You are a monopolist and the inverse demand for your product is P = Q; You are a monopolistically competitive firm and the inverse demand for your brand is P = 100 Q.
43 Marginal Cost C(Q) = Q 2, So MC = 8Q. This is independent of market structure.
44 MR = P = $40. Set MR = MC. 40 = 8Q. Q = 5 units. Price Taker Cost of producing 5 units. C(Q) = Q 2 = = $225. Revenues: PQ = (40)(5) = $200. Maximum profits of -$25. Implications: Expect exit in the long-run.
45 Monopoly/Monopolistic Competition MR = 100-2Q (since P = Q). Set MR = MC, or 100-2Q = 8Q. Optimal output: Q = 10. Optimal price: P = (10) = $90. Maximal profits: PQ - C(Q) = (90)(10) -( (100)) = $375. Implications Monopolist will not face entry (unless patent or other entry barriers are eliminated). Monopolistically competitive firm should expect other firms to clone, so profits will decline over time.
46 Conclusion Firms operating in a perfectly competitive market take the market price as given. Produce output where P = MC. Firms may earn profits or losses in the short run. but, in the long run, entry or exit forces profits to zero. A monopoly firm, in contrast, can earn persistent profits provided that source of monopoly power is not eliminated. A monopolistically competitive firm can earn profits in the short run, but entry by competing brands will erode these profits over time.
Practice Questions Week 8 Day 1 Multiple Choice Identify the choice that best completes the statement or answers the question. 1. The characteristics of a market that influence the behavior of market participants
MBA 640 Survey of Microeconomics Fall 2006, Quiz 6 Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) A monopoly is best defined as a firm that
WSG8 7/7/03 4:34 PM Page 113 8 Market Structure: Perfect Competition and Monopoly OVERVIEW One of the most important decisions made by a manager is how to price the firm s product. If the firm is a profit
Chapter 6 Competitive Markets After reading Chapter 6, COMPETITIVE MARKETS, you should be able to: List and explain the characteristics of Perfect Competition and Monopolistic Competition Explain why a
Chapter 6 The Two Extremes: Perfect Competition and Pure Monopoly Learning Objectives List the four characteristics of a perfectly competitive market. Describe how a perfect competitor makes the decision
Principles of Microeconomics, Quiz #5 Fall 2007 Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question on the accompanying scantron. 1) Perfect competition
Perfectly Competitive Markets It is essentially a market in which there is enough competition that it doesn t make sense to identify your rivals. There are so many competitors that you cannot single out
Principles of Microeconomics Fall 2007, Quiz #6 Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question on the accompanying scantron. 1) A monopoly is
A monopolist s marginal revenue is always less than or equal to the price of the good. Marginal revenue is the amount of revenue the firm receives for each additional unit of output. It is the difference
Perfect Competition Chapter 10 CHAPTER IN PERSPECTIVE In Chapter 10 we study perfect competition, the market that arises when the demand for a product is large relative to the output of a single producer.
Understanding Economics 2nd edition by Mark Lovewell and Khoa Nguyen Chapter 5 Perfect Competition Chapter Objectives! In this chapter you will: " Consider the four market structures, and the main differences
Chapter 8. Competitive Firms and Markets We have learned the production function and cost function, the question now is: how much to produce such that firm can maximize his profit? To solve this question,
CHAPTER 6 MARKET STRUCTURE CHAPTER SUMMARY This chapter presents an economic analysis of market structure. It starts with perfect competition as a benchmark. Potential barriers to entry, that might limit
Chapter 7 Monopoly, Oligopoly and Strategy After reading Chapter 7, MONOPOLY, OLIGOPOLY AND STRATEGY, you should be able to: Define the characteristics of Monopoly and Oligopoly, and explain why the are
CHAPTER 12 MARKETS WITH MARKET POWER Microeconomics in Context (Goodwin, et al.), 2 nd Edition Chapter Summary Now that you understand the model of a perfectly competitive market, this chapter complicates
ANSWERS TO END-OF-CHAPTER QUESTIONS 23-1 Briefly indicate the basic characteristics of pure competition, pure monopoly, monopolistic competition, and oligopoly. Under which of these market classifications
Chapter 11 PERFECT COMPETITION Competition Topic: Perfect Competition 1) Perfect competition is an industry with A) a few firms producing identical goods B) a few firms producing goods that differ somewhat
MPP 801 Monopoly Kevin Wainwright Study Questions MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The marginal revenue facing a monopolist A) is
In this chapter, look for the answers to these questions: Why do monopolies arise? Why is MR < P for a monopolist? How do monopolies choose their P and Q? How do monopolies affect society s well-being?
Final Exam Economics 101 Fall 2003 Wallace Final Exam (Version 1) Answers 1. The marginal revenue product equals A) total revenue divided by total product (output). B) marginal revenue divided by marginal
CHAPTER 11 PRICE AND OUTPUT IN MONOPOLY, MONOPOLISTIC COMPETITION, AND PERFECT COMPETITION Chapter in a Nutshell Now that we understand the characteristics of different market structures, we ask the question
Chapter 16 Monopolistic Competition and Oligopoly Market Structure Market structure refers to the physical characteristics of the market within which firms interact It is determined by the number of firms
chapter 9 The industry supply curve shows the relationship between the price of a good and the total output of the industry as a whole. Perfect Competition and the >> Supply Curve Section 3: The Industry
1 Monopoly Why Monopolies Arise? Monopoly is a rm that is the sole seller of a product without close substitutes. The fundamental cause of monopoly is barriers to entry: A monopoly remains the only seller
CHAPTER 10 MARKET POWER: MONOPOLY AND MONOPSONY EXERCISES 3. A monopolist firm faces a demand with constant elasticity of -.0. It has a constant marginal cost of $0 per unit and sets a price to maximize
Price Theory Lecture 6: Market tructure Perfect Competition I. Concepts of Competition Whether a firm can be regarded as competitive depends on several factors, the most important of which are: The number
AP Microeconomics Review 1. Firm in Perfect Competition (Long-Run Equilibrium) 2. Monopoly Industry with comparison of price & output of a Perfectly Competitive Industry 3. Natural Monopoly with Fair-Return
N. Gregory Mankiw Principles of Economics Chapter 15. MONOPOLY Solutions to Problems and Applications 1. The following table shows revenue, costs, and profits, where quantities are in thousands, and total
In this chapter, look for the answers to these questions: How is similar to perfect? How is it similar to monopoly? How do ally competitive firms choose price and? Do they earn economic profit? In what
Practice Multiple Choice Questions Answers are bolded. Explanations to come soon!! For more, please visit: http://courses.missouristate.edu/reedolsen/courses/eco165/qeq.htm Market Equilibrium and Applications
1 I S L 8 0 5 U Y G U L A M A L I İ K T İ S A T _ U Y G U L A M A ( 4 ) _ 9 K a s ı m 2 0 1 2 CEVAPLAR 1. Conigan Box Company produces cardboard boxes that are sold in bundles of 1000 boxes. The market
Chapter 9: Perfect Competition Perfect Competition Law of One Price Short-Run Equilibrium Long-Run Equilibrium Maximize Profit Market Equilibrium Constant- Cost Industry Increasing- Cost Industry Decreasing-
ECON 103, 2008-2 ANSWERS TO HOME WORK ASSIGNMENTS Due the Week of June 23 Chapter 8 WRITE  Use the demand schedule that follows to calculate total revenue and marginal revenue at each quantity. Plot
Perfectly Competitive Markets A firm s decision about how much to produce or what price to charge depends on how competitive the market structure is. If the Cincinnati Bengals raise their ticket prices
Chap 13 Monopolistic Competition and Oligopoly These questions may include topics that were not covered in class and may not be on the exam. MULTIPLE CHOICE. Choose the one alternative that best completes
Name: Date: 1. Most electric, gas, and water companies are examples of: A) unregulated monopolies. B) natural monopolies. C) restricted-input monopolies. D) sunk-cost monopolies. Use the following to answer
R. Larry Reynolds Pure Competition urely competitive markets are used as the benchmark to evaluate market P performance. It is generally believed that market structure influences the behavior and performance
A Detailed Price Discrimination Example Suppose that there are two different types of customers for a monopolist s product. Customers of type 1 have demand curves as follows. These demand curves include
Pre-Test Chapter 21 ed17 Multiple Choice Questions 1. Which of the following is not a basic characteristic of pure competition? A. considerable nonprice competition B. no barriers to the entry or exodus
Chapter 15: While a competitive firm is a taker, a monopoly firm is a maker. A firm is considered a monopoly if... it is the sole seller of its product. its product does not have close substitutes. The
Monopoly: static and dynamic efficiency M.Motta, Competition Policy: Theory and Practice, Cambridge University Press, 2004; ch. 2 Economics of Competition and Regulation 2015 Maria Rosa Battaggion Perfect
Equilibrium of a firm under perfect competition in the short-run. A firm is under equilibrium at that point where it maximizes its profits. Profit depends upon two factors Revenue Structure Cost Structure
1. Which of the following would shift the demand curve for new textbooks to the right? a. A fall in the price of paper used in publishing texts. b. A fall in the price of equivalent used text books. c.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The four-firm concentration ratio equals the percentage of the value of accounted for by the four
Microeconomics Topic 7: Contrast market outcomes under monopoly and competition. Reference: N. Gregory Mankiw s rinciples of Microeconomics, 2 nd edition, Chapter 14 (p. 291-314) and Chapter 15 (p. 315-347).
Chapter 9 Lecture Notes 1 Economics 35: Intermediate Microeconomics Notes and Sample Questions Chapter 9: Profit Maximization Profit Maximization The basic assumption here is that firms are profit maximizing.
Economies of scale and international trade In the models discussed so far, differences in prices across countries (the source of gains from trade) were attributed to differences in resources/technology.
Managerial Economics Unit 3: Perfect Competition, Monopoly and Monopolistic Competition Rudolf Winter-Ebmer Johannes Kepler University Linz Winter Term 2012 Winter-Ebmer, Managerial Economics: Unit 3 1
CHAPTER 9: PURE COMPETITION Introduction In Chapters 9-11, we reach the heart of microeconomics, the concepts which comprise more than a quarter of the AP microeconomics exam. With a fuller understanding
Pre-Test Chapter 23 ed17 Multiple Choice Questions 1. The kinked-demand curve model of oligopoly: A. assumes a firm's rivals will ignore a price cut but match a price increase. B. embodies the possibility
Chapter 8 Production Technology and Costs 8.1 Economic Costs and Economic Profit 1) Accountants include costs as part of a firm's costs, while economists include costs. A) explicit; no explicit B) implicit;
Managerial Economics & Business Strategy Chapter 9 Basic Oligopoly Models Overview I. Conditions for Oligopoly? II. Role of Strategic Interdependence III. Profit Maximization in Four Oligopoly Settings
Economics 147 John F. Stewart Theory of Perfectly Competitive Markets University of North Carolina Chapel Hill Theory: The Structure of an Economic Model Economic theory is based on deductive logic, if
MANAGERIAL ECONOMICS: THEORY, APPLICATIONS, AND CASES W. Bruce Allen Keith Weigelt Neil Doherty Edwin Mansfield CHAPTERS 6-7 Perfect Competition, Monopoly, And Monopolistic Competition OBJECTIVES Explain
Principles of Economics: Micro: Exam #2: Chapters 1-10 Page 1 of 9 print name on the line above as your signature INSTRUCTIONS: 1. This Exam #2 must be completed within the allocated time (i.e., between
1 Economics 130-Windward Community College Review Sheet for the Final Exam This final exam is comprehensive in nature and in scope. The test will be divided into two parts: a multiple-choice section and
Name: 1. During the long run: Economics 100 Exam 2 A. Output is limited because of the law of diminishing returns B. The scale of operations cannot be changed C. The firm must decide how to use the current
Market Structures This hand-out gives an overview of the main market structures including perfect competition, monopoly, monopolistic competition, and oligopoly. Summary Chart Perfect Competition Monopoly
Lab 12: Perfectly Competitive Market 1. Perfectly competitive market 1) three conditions that make a market perfectly competitive: a. many buyers and sellers, all of whom are small relative to market b.
1 Examples on Monopoly and Third Degree Price Discrimination This hand out contains two different parts. In the first, there are examples concerning the profit maximizing strategy for a firm with market
1. The supply of gasoline changes, causing the price of gasoline to change. The resulting movement from one point to another along the demand curve for gasoline is called A. a change in demand. B. a change
Econ 101: Principles of Microeconomics Chapter 14 - Monopoly Fall 2010 Herriges (ISU) Ch. 14 Monopoly Fall 2010 1 / 35 Outline 1 Monopolies What Monopolies Do 2 Profit Maximization for the Monopolist 3
CHAPTER 18 MARKETS WITH MARKET POWER Principles of Economics in Context (Goodwin et al.) Chapter Summary Now that you understand the model of a perfectly competitive market, this chapter complicates the
CHAPTER 8 PROFIT MAXIMIZATION AND COMPETITIVE SUPPLY TEACHING NOTES This chapter begins by explaining what we mean by a competitive market and why it makes sense to assume that firms try to maximize profit.
ECON 3310 Homework #4 - Solutions 1: Suppose the following indicates how many units of output y you can produce per hour with different levels of labor input (given your current factory capacity): PART
Chapter 14 Monopoly 14.1 Monopoly and How It Arises 1) A major characteristic of monopoly is A) a single seller of a product. B) multiple sellers of a product. C) two sellers of a product. D) a few sellers
UNIVERSITY OF CALICUT SCHOOL OF DISTANCE EDUCATION BA ECONOMICS III SEMESTER CORE COURSE (2011 Admission onwards) MICRO ECONOMICS - II QUESTION BANK 1. Which of the following industry is most closely approximates
R.E.Marks 1998 Oligopoly 1 R.E.Marks 1998 Oligopoly Oligopoly and Strategic Pricing In this section we consider how firms compete when there are few sellers an oligopolistic market (from the Greek). Small
Pre-Test Chapter 18 ed17 Multiple Choice Questions 1. (Consider This) Elastic demand is analogous to a and inelastic demand to a. A. normal wrench; socket wrench B. Ace bandage; firm rubber tie-down C.
Economics 431 Fall 003 1st midterm Answer Key 1) (7 points) Consider an industry that consists of a large number of identical firms. In the long run competitive equilibrium, a firm s marginal cost must
Managerial Economics & Business Strategy Chapter 3 uantitative Demand Analysis McGraw-Hill/Irwin Copyright 2010 by the McGraw-Hill Companies, Inc. All rights reserved. Overview I. The Elasticity Concept
EXAM TWO REVIEW: A. Explicit Cost vs. Implicit Cost and Accounting Costs vs. Economic Costs: Economic Cost: the monetary value of all inputs used in a particular activity or enterprise over a given period.
I. Learning Objectives In this chapter students will learn: A. The significance of resource pricing. B. How the marginal revenue productivity of a resource relates to a firm s demand for that resource.
Monopol monopl.gif (GIF Image, 289x289 pixels) Chapter 24 http://i4.photobu Motivating Questions What price and quantit does a monopol choose? What are the welfare effects of monopol? What are the effects
Managerial Economics Unit 1: Demand Theory Rudolf Winter-Ebmer Johannes Kepler University Linz Winter Term 2012/13 Winter-Ebmer, Managerial Economics: Unit 1 - Demand Theory 1 / 54 OBJECTIVES Explain the
1 How to Study for Chapter 18 Pure Monopoly Chapter 18 considers the opposite of perfect competition --- pure monopoly. 1. Begin by looking over the Objectives listed below. This will tell you the main
HW #7: Solutions QUESTIONS FOR REVIEW 8. Assume the marginal cost of production is greater than the average variable cost. Can you determine whether the average variable cost is increasing or decreasing?
Chapter 7: Market Structure in Government and Nonprofit Industries Soft Drinks HTTP:/www.economics.emory.edu/Working_Pa pers/wp/2008wp/frisvold_08_08_paper.pdf What is a Market? A market is a process in
Managerial Economics & Business Strategy Chapter 5 The Production Process and Costs McGraw-Hill/Irwin Copyright 2010 by the McGraw-Hill Companies, Inc. All rights reserved. Overview I. Production Analysis
Market Structure: Oligopoly (Imperfect Competition) I. Characteristics of Imperfectly Competitive Industries A. Monopolistic Competition large number of potential buyers and sellers differentiated product
Class: Date: ID: A Principles Fall 2013 Midterm 3 Multiple Choice Identify the choice that best completes the statement or answers the question. 1. Trevor s Tire Company produced and sold 500 tires. The