Professional Documents
Culture Documents
Chapter 8 F2013 Lecture Slides
Chapter 8 F2013 Lecture Slides
Chapter 8 F2013 Lecture Slides
Competition and market types in economic analysis Pricing and output decisions in perfect competition Pricing and output decisions in monopoly markets Implications of perfect competition and monopoly for managerial decisions
29/10/2013
29/10/2013
Examples: monopoly
pharmaceuticals with patents regulated utilities (although this is changing) last chance gas station on the edge of the desert
29/10/2013
Examples: oligopoly
oil refining processed foods airlines internet access and cell phone service
29/10/2013
Perfectly elastic demand curve: consumers are willing to buy as much as the firm is willing to sell at the going market price
The firm receives the same marginal revenue from the sale of each additional unit of product; equal to the price of the product There is no limit to the total revenue that the firm can gain in a perfectly competitive market
29/10/2013
Produce a level of output at which the additional revenue received from the last unit is equal to the additional cost of producing that unit (i.e. MR=MC) Both the TR/TC and MR=MC approach lead to the same price/output decision For the perfectly competitive firm, the MR=MC rule may be restated as P=MC because P=MR in perfectly competitive market
29/10/2013
Case A: economic profit The point where P=MR=MC is the optimal output (Q*) profit = TR TC Q* =(P - AC)
The firm incurs a loss. At optimum output, price is below AC however, since P > AVC, the firm is better off producing in the short run, because it will still incur fixed costs greater than the loss
Contribution margin: the amount by which total revenue exceeds total variable cost CM = TR TVC
if CM > 0, the firm should continue to produce in the short run in order to defray some of the fixed cost
29/10/2013
Shutdown point: the lowest price at which the firm would still produce
At the shutdown point, the price is equal to the minimum point on the AVC If the price falls below the shutdown point, revenues fail to cover the fixed costs and the variable costs. The firm would be better off if it shut down and just paid its fixed costs.
In the long run, the price in the competitive market will settle at the point where firms earn a normal profit over the long run.
Economic profit invites entry of new firms
Shifts the supply curve to the right Puts downward pressure on price Reduces profits to normal levels Shifts the supply curve to the left Puts upward pressure on price Increases profits to normal levels.
the earlier the firm enters a market, the better its chances of earning above-normal profit for a period of time as new firms enter the market, firms must find ways to produce at the lowest possible cost, or at least at cost levels below those of their competitors firms that find themselves unable to compete on the basis of cost might want to try competing on the basis of product differentiation
29/10/2013
Assume demand is linear: it is downward sloping because the firm is a price setter Assume MC is constant and choose output where MR=MC, set price at P*
Demand is the same as before, as is MR MC is upward sloping, which shows diminishing returns Set output where MR=MC
29/10/2013
The most important lesson is not to be arrogant or complacent and assume the firms ability to earn economic profit can never be diminished. Changes in the business environment eventually break down a dominating companys monopolistic power
In the case of perfect competition, the firm has virtually no power to set the price--they are price takers and make normal profits. A monopoly has market power to set its price. All firms attempt to produce at a quantity where MR=MC to maximize profit or minimize loss.
10