Chapter 8homepage.fudan.edu.cn/yiqingxie/files/2016/12/EMA_Chap08.pdf · 2016-12-08 · Competitive...
Transcript of Chapter 8homepage.fudan.edu.cn/yiqingxie/files/2016/12/EMA_Chap08.pdf · 2016-12-08 · Competitive...
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
Managerial Economics & Business Strategy
Chapter 8 Managing in Competitive,
Monopolistic, and Monopolistically
Competitive Markets
8-2
Overview
I. Perfect Competition – 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.
8-3
Perfect Competition Environment
§ Many buyers and sellers. § Homogeneous (identical) product. § Perfect information on both sides of market. § No transaction costs. § Free entry and exit.
8-4
Key Implications
§ Firms are “price takers” (P = MR). § In the short-run, firms may earn profits or
losses. § Entry and exit forces long-run profits to zero.
8-5
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.
8-6
Managing a Perfectly Competitive Firm
(or Price-Taking Business)
8-7
Setting Price
Firm Qf
$
Df
Market QM
$
D
S
Pe
8-8
Profit-Maximizing Output Decision
§ MR = MC.
§ Since, MR = P,
§ Set P = MC to maximize profits.
8-9
Graphically: Representative Firm’s Output Decision
$
Qf
ATC
AVC
MC
Pe = Df = MR
Qf*
ATC
Pe
Profit = (Pe - ATC) × Qf*
8-10
A Numerical Example § Given
– P=$10 – C(Q) = 5 + Q2
§ 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
8-11
$
Qf
ATC
AVC
MC
Pe = Df = MR
Qf*
ATC Pe
Profit = (Pe - ATC) � Qf* < 0
Should this Firm Sustain Short Run Losses or Shut Down?
Loss
8-12
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.
8-13
$
Qf
ATC
AVC
MC
Qf*
P min AVC
Firm’s Short-Run Supply Curve: MC Above Min AVC
8-14
Entry and Exit Decision Rule § In the long run, there is no fixed cost.
– A profit-maximizing firm shall choose to exit whenever it is making an economic loss.
– If any existing firm is making an economic profit in the short run, more firms will choose to enter the market.
§ Decision rule: – More and more firms exit when P < min ATC. – More and more new firms enter as long as P ≥ min
ATC. – Until P = ATC
8-15
Firm’s Long-run Equilibrium
S1
Profit
D1
D2
MC
ATC
P1
Market
Q
P
(market)
One firm
Q
P
(firm)
P2 P2
Q1 Q2
S2
Q3
A firm begins in long-run eq’m…
…but then an increase in demand raises P,… …leading to SR
profits for the firm. Over time, profits induce entry, shifting S to the right, reducing P…
…driving profits to zero and restoring long-run eq’m.
A
B
C
8-16
Long-run Supply Curve
MC Market
Q
P
(market)
One firm
Q
P
(firm)
In the long run, the typical firm earns zero profit.
LRATC
long-run supply
P = min. ATC
The LR market supply curve is horizontal at P = minimum ATC.
8-17
Long run Equilibrium – Example TC(q) = 40q – 6q2+q3/3 D(P) = 2200 -100P Find Q*, q*, P*, n*.
§ Decision rule: MC=MR=P=ATC § Step 1: MC(q) = 40-12q +q2
§ Step 2: AC(q) = 40-6q+q2/3
§ Step 3: MC=AC
2q2/3=6q 2q/3=6 q*=9
8-18
Long run Equilibrium – Example TC(q) = 40q – 6q2+q3/3 D(P) = 2200 -100P Find Q*, q*, P*, n*.
§ Decision rule: MC=MR=P=ATC
§ Step 4: P*=AC(q) = 40-6q+q2/3=40-54+27=13=p*
§ Step 5: Q*=D(P) = 2200 -100P*=2200 – 100(13)=900 § Step 6: n* = Q*/q*=100
8-19
Managing a Monopolist
§ Number of firms: one § Barriers to entry or exit from the industry: extremely
great § Type of product: unique, no close substitute § Key characteristic: only one firm
§ Eg. Xcel
8-20
Marginal Revenue
Q Q
P TR
100
0 0 10 20 30 40 50 10 20 30 40 50
800
60 1200
40
20
Inelastic
Elastic
Elastic Inelastic
Unit elastic
Unit elastic
MR
8-21
Monopoly: Profit Maximization
§ Maximize profits – Produce output where MR = MC.
§ Inverse Elasticity Pricing Rule
MR = P + ∂P∂Q
Q = P + ∂P∂Q
QPP = P 1+ 1
∂Q∂P
⎛⎝⎜
⎞⎠⎟PQ
⎛⎝⎜
⎞⎠⎟
⎛
⎝
⎜⎜⎜
⎞
⎠
⎟⎟⎟= P 1+ 1
ε⎛⎝⎜
⎞⎠⎟
MC(Q*) = P * 1+ 1εQ,P
⎛
⎝⎜
⎞
⎠⎟
L = P *−MC *P *
= − 1εQ,P
8-22
Monopoly
$ ATC
MC
D
MR QM
PM
Profit
ATC
X
8-23
Managing a Monopolistically Competitive Firm
§ Like a monopoly, monopolistically competitive firms – have market power that permits pricing above marginal cost. – level of sales depends on the price it sets.
§ But … – 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.
8-24
Short-Run Monopolistic Competition
$ ATC
MC
D
MR QM
PM
Profit
ATC
Quantity of Brand X
8-25
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.
8-26
$ AC
MC
D
MR
Q*
P*
Quantity of Brand X MR1
D1
Entry
P1
Q1
Long Run Equilibrium (P = AC, so zero profits)
Long-Run Monopolistic Competition
8-27
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)!
8-28
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.
PQ
AQ
EE
RA
,
,
−=
8-29
Maximizing Profits: A Synthesizing Example
§ C(Q) = 125 + 4Q2
§ 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 = 100 – Q; – You are a monopolistically competitive firm and the
inverse demand for your brand is P = 100 – Q.
8-30
Marginal Cost
§ C(Q) = 125 + 4Q2,
§ So MC = 8Q.
§ This is independent of market structure.
8-31
Price Taker
§ MR = P = $40. § Set MR = MC.
• 40 = 8Q. • Q = 5 units.
§ Cost of producing 5 units. • C(Q) = 125 + 4Q2 = 125 + 100 = $225.
§ Revenues: • PQ = (40)(5) = $200.
§ Maximum profits of -$25. § Implications: Expect exit in the long-run.
8-32
Monopoly/ Monopolistic Competition
§ MR = 100 - 2Q (since P = 100 - Q). § Set MR = MC, or 100 - 2Q = 8Q.
– Optimal output: Q = 10. – Optimal price: P = 100 - (10) = $90. – Maximal profits:
• PQ - C(Q) = (90)(10) -(125 + 4(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.
8-33
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.