and workers) as rational agents with objectives
that can be expressed as quantitative functions
It is the application of economic
methods in the managerial decision – making
process, is a fundamental part of any business or
management course.
As an approach to decision-making, managerial
economics is related to economic theory,
decision sciences and business functions.
The main branch of economic theory
with which managerial economics is related is
microeconomics, which deals essentially with
how markets work and interactions between the
various components of the economy.
In particular, the following aspects
microeconomic theory are relevant:
1. theory of the firm
2. theory of consumer behavior
(demand)
3. production and cost theory (supply)
4. price theory
5. market structure and competition
theory
These theories provide the broad conceptual
framework of ideas involved; at this stage it is
worth stating that these theories are examined and
discussed in a neoclassical framework.
It is an approach that treats the individual
elements within the economy (consumers, firms
(utilities and profits) that are to be optimized,
subject to certain quantitative constraints.
- A school of thought in economics in which
theories often revolve around utility and profit
maximization.
This approach (neoclassical) is often criticized as
dated and unrealistic, but can be defended.
* It is very versatile and can easily be extended to
take into account many of the aspects which it is
often assumed to ignore, for example transaction
costs, information costs, imperfect knowledge,
risk and uncertainty and so on.
There is one main difference between the
emphasis of microeconomics and that of
managerial economics:
Microeconomics tends to be descriptive,
explaining how markets work and what firms do
in practice, while managerial economics is often
prescriptive, stating what firms should do, in
order to reach certain objectives.
of
It is necessary to make another very important
distinction: that between positive and normative
economics.
It is an economic analysis that explains what
happens in the economy and why, without
making any recommendations to economic
policy.
- These are factual statements whose truth or
falsehood can be verified by empirical study or
logic.
- It is an economic statement that makes
recommendation to economic policy.
- It is used to make judgments about the economy
and prescribe solutions to economic problems.
- It involves value judgments and cannot be Managerial Economics tends to focus more on
verified by empirical study or logic. behavioral aspects when they concern
consumers rather than when they concern the
behavior of employees.

All firms consist of organizations that are divided

structurally into different departments or units,
even if this is not necessarily performed on a
formal basis. Typically, the units involved are:
1. production and operations
2. marketing
3. finance and accounting
4. Human resources
- All of these functional areas can apply the
theories and methods in managerial economics.
For example,
A production department may want to plan
and schedule the level of output for the next
quarter;
A Scientific theory does two things:
1. It describes or explains
relationships between
phenomena that we observe;
2. It makes testable predictions.
* Theories are indispensable to any science,
and over time they tend to be gradually
improved, meaning that they fit existing
observations better and make more accurate
forecasts.
It is obviously of vital importance to managers to
have good theories on which to base their
decision-making. A “good” theory has the
following characteristics:

The marketing department may want to know 1. It explains existing

what price to charge and how much to spend on observations well.
advertising;
2. It makes accurate forecasts.
The finance department may want to determine
whether to build a new factory to expand 3. It involves mensuration,
capacity; meaning that the variables
involved can be measured
The human resources department may want to reliably and accurately.
know how many people to hire in the coming
period and what it should be offering to pay 4. It has general application,
them. meaning that it can be applied
in a large number of different
-It might be noted that all the above decisions situations, not just a very
involve some kind of quantitative analysis; not all limited number of cases.
managerial decisions involve this kind of
analysis. 5. It has elegance, meaning that
the theory rests on a minimum
-There are some areas of decision-making where number of assumptions.
the tools and techniques of managerial economics
are not applicable. The better the theories used by managers the
better their decisions will be, in terms of being
Example. A sales manager may want to more likely to achieve managerial objectives.
motivate a salesperson to achieve a higher level
of performance.

In this case, an understanding and application of

behavioral and psychological principles is What is “supply and demand”?
relevant.
 • Supply and demand is how economists – If nothing else changes, the
track the dividing of resources & their demand of a good is greatest
value within a society for consumers when the price
is low. (WHY?)
• Two (2) goals:
Demand Curve for Xbox 360
– How much of a product do we
have?

– Is the demand for that product

strong?

What is the “law of supply”?

• The Law of Supply asks: “How much of

a good or service is a company willing
to produce at a ________ price?”

• Answer:

– If nothing changes, a company

will produce a greater
quantity of products when the What are the factors that determine “supply”?
price for that good is high.
• “P.I.G. T.O.E.S”
(WHY?)
– Productivity (workers,
Supply Curve for Xbox 360
machines, and/or assembly)

– Inputs (Change in the price of

materials needed to make the
good)

– Government Actions
(Subsidies, Taxes, and
Regulations)

– Technology (Improvements in
machines and production)

– Outputs (Price changes in

other products)
What is the “law of demand”?
– Expectations (outlook of the
• The Law of Demand asks: “What is the
future)
willingness of consumers to buy a
product at __________ price?” – Size of Industry (Number of
companies in the industry)
• Answer:
How does a supply curves move?
 • A supply curve shifts whenever a factor
that affects the supply of the good (other
than price) changes
– RIGHT: Increase in supply (at
all prices)
– LEFT: Decrease in supply (at
all prices)
What factors cause a shift in a supply curve?
• Two (2) reasons:
– A change in cost of production
• Increase = LEFT
• Decrease = RIGHT
– The role of technology in
production
• Increase =RIGHT
• Decrease = LEFT
Scenario #1
• Our Xbox factory finds out that our
workers are getting a 25% pay raise
(increase in the cost of labor) …
• What happens to the supply curve?
Supply Curve for Xbox 360
Scenario #2
• Our Xbox factory invents a technology
that produces twice as many Xboxs in a
day as before.
• What happens to the supply curve?
Supply Curve for Xbox 360
Scenario #3
• The CEO of our Xbox factory decides
to increase the price of our Xboxes as a
way to make more profit.
• What happens to the supply curve?
Supply Curve for Xbox 360
How does a demand curves move?

• A demand curve shifts whenever a

factor that affects the demand of the
good (other than price) changes

– RIGHT: Increase in demand

(at all prices) Scenario #1
– LEFT: Decrease in demand • A neighboring factory that produces
(at all prices) Xbox games drops their price as part of
a late winter sale…

• What happens to our demand curve?

Demand Curve for Xbox 360

What factors cause a shift in a demand curve? Scenario #2

• Three (3) reasons: • A rival company cuts the price of their
version of the Xbox, making it half the
– Change in a consumer’s
price of our product.
income
• What happens to our demand curve?
• Increase = RIGHT
Demand Curve for Xbox 360
• Decrease = LEFT

– Change in the price of a

“substitute” goods

• Increase = LEFT

• Decrease = RIGHT

– Change in consumer tastes

• Increase = RIGHT

• Decrease = LEFT
Scenario #3

• The local paper mill in a small town

(where Xbox sales are high) closes,
causing many people to lose their jobs. Excess Demand: “Not Enough”

• What happens to our demand curve? • Excess demand is when the quantity
demanded exceeds the quantity supplied
Demand Curve for Xbox 360 at a given price

– Also know as a “shortage”

• When this happens, price tends to rise

until equilibrium is restored

– Black markets

– Rationing

– Violence

What is “equilibrium”?
• Equilibrium is when quantity supplied
and quantity demanded are equal
– Perfection!!!!
• Many companies strive to reach
economic equilibrium

Excess Supply: “Having too much”

• Excess supply is when the supplied

exceeds quantity demanded at a given
price.

– Also known as a “surplus”

• When this happens, prices tend to fall

until equilibrium is restored

– Little re-sale value

– Lack of consumer interest

Supply-Demand Market Equilibrium
– Worthlessness
 b. Complements - good that is
jointly consumed with another
good
6. Weather/Climate
7. Product Quality

Normal good vs. inferior good

Normal good
 DVD/cd, meat, pork, etc.
 An increase in income lead to rightward
shift of the demand curve
Inferior good
 A fall in income causes the demand
Demand curve to shift to the right.

 A curve or schedule showing the

various quantities of a product Substitutes vs. complements

consumers are willing and able to buy at Substitutes are goods that can be used as a

possible prices during a specified period replacement for another.

of time Complements are goods that “go together”.

Law of Demand
 It states that as the price increases the Change in Demand vs. Change in Quantity

quantity demanded decreases, ceteris Demanded

paribus. (Ceteris paribus means holding Change in Demand

other factors/variables constant)  Rightward or leftward shift in the entire

demand curve caused by changes in

Non-price Determinants of Demand non-price determinants of demand

There are other variables/factors that can Change in quantity demanded

influence consumers’ behavior in acquiring goods  Movement between points along a fixed
and services. These variables/factors are called demand curve
non-price determinants or demand shifters.
1. Populations
2. Taste and Preferences
3. Income Illustrations:
4. Expectation of about future prices Change in Demand
5. Price of related goods
a. Substitute - good that
competes with another good
for consumer purchases
 SUPPLY

 A curve or schedule showing the

various quantities of a product sellers
are willing and able to produce and
offer for sale at possible prices during a
specified period of time

Law of Supply
 It states that as the price increases the
Change quantity demanded
quantity supplied increases, ceteris
paribus. (Ceteris paribus means holding
another factors/variable constant)

Non-price Determinants of Supply

There are other variables/factors that can

influence producers’ behavior in producing goods
and services. These variables/factors are called
non-price determinants or demand shifters.
 Number of Sellers
 Technology
 Resource prices
 Taxes and subsidies
 Expectation about future prices
 Weather and Climate

Change in Supply vs. Change in Quantity

Supplied

Table 2.1. Summary on the changes and effect on
the demand curve
Change in Supply
 Rightward or leftward shift in the entire
supply curve caused by changes in non-
price determinants of supply. A shift to
the right of the entire supply curve
means an increase in supply. A shift to
the left of the entire supply curve means
decrease in supply.
Change in quantity supplied
 Movement between points along a fixed
supply curve
Illustration:
Change in Supply
 Table 2.2 Summary on the changes and effect on
the supply curve

Change in quantity supplied

Market
 The interaction between the buyers and
sellers to determine the price and
quantity of goods and services
exchanged.

Surplus
 Situation at which quantity supplied is
greater than the quantity demanded.
Shortage
 Situation at which the quantity supplied
is less than the quantity demanded.
Table 2.3. Hypothetical Demand and Supply
Schedule for Product W per week
Change in quantity supplied

A table 2.3 shows that there will be a

shortage for Product W if the price is Pup 5.00
per unit. Consumers are willing and able to buy
83 pieces of this product while the sellers are
willing and able to sell only 65 pieces of Product
W. Shortage scenario can also be observed if the
price of Product W is Php10.00 and Pup 15.00.
Lower price of the product motivates consumer to
purchase more but it discourages sellers to sell
more. On the other hand, as the prices of Product
W increases sellers are encourage to sell more.
This result to surplus condition, prices will pull
downward to attain equilibrium point.
Equilibrium is a condition wherein the quantity
demanded is equal to quantity supplied. If the
price of Product W is Pup 20.00 per unit
consumers are willing and able to buy 20 unit of
Product W while the sellers are willing and able
to sell 20 units of his product. Hence, to attain an
equilibrium condition price should be set at Pup
20.00 per unit.
MAIN IDEAS
EQUILIBRIUM
 A market is in equilibrium if at the
market price the quantity demanded is
equal to the quantity supplied.
 The price at which the quantity
demanded is equal to the quantity
supplied is called the equilibrium price
or market clearing price and the
corresponding quantity is the
equilibrium quantity.
Market Disequilibrium (Demand)
Market Disequilibrium (Supply)
FLOOR PRICE
 It is the minimum price that a seller
would get for their product or service.
Such pricing helps to protect suppliers
from the losses. The price floor is
usually more than the equilibrium price.
 For example, suppose the farmers
produce massive quantities of corn due
to good weather conditions. The law of
demand says the price drops if there is
more supply. To ensure farmers get a
reasonable corn price, the government
steps in and sets the corn’s floor price.
Price Ceiling
 It is the highest price that is fixed or
decided by the Government or
Association, etc. A seller cannot sell his
product or service above this fixed
price. Unlike floor price, the price
ceiling helps to protect the buyers from
overpaying. In case, there is an
equilibrium price, then the price ceiling
is set below it.
 One good example of a price ceiling is
the rising rent of apartment in main
 cities. Since the demand is higher than
what is available, the rent in these cities
continues to rise. Such a rise in rent is
also a key factor driving workers out of
the city. So, if the authorities come up
with rent control laws that set a price
ceiling, more people will be able to
afford an apartment and survive in main
cities.

INCREASE IN DEMAND AND SUPPLY

RELATIVE MAGNITUDE OF CHANGE

DECREASE IN DEMAND AND SUPPLY

RELATIVE MAGNITUDE OF CHANGE

  Remember that demand curves are
normally downward sloping as
described by the law of demand
 However, certain changes in demand
curves occur as quantity demanded
reacts to changes in price.

Elastic demand – the changes in price

are relatively small. In this case,
demand curves tend to slope more
horizontally.
Inelastic demand – it means there is a
relatively large change in price of the
commodity.
 Demand curves for inelastic demand
tend to slope more vertically.

IMPORTANCE OF TOTAL REVENUE IN

PRICING DECISIONS
 Total Revenue: total sale of products
The relationships between price and quantity: by the producer or seller:
 Directly proportional (Supply)  This is expressed as
 Inversely proportional (Demand)

Under the ceteris paribus assumption:

 When price increases, it is expected that
quantity demanded will decrease (Law
of Demand) and quantity supplied will
increase (Law of Supply);
 When price decreases, it follows that
quantity demanded will increase and
quantity supplied will decrease.
 Demand and supply are not static in a EXAMPLES:
competitive market.
 Both respond to changes in price and
other factors.
 As a result, some shifts in the demand
and supply curves as reaction to the
changes in these various determinants.

Elasticity – It refers to the degree to which the

curves react to these changes.

PRICE ELASTICITY OF DEMAND AND

PRICING DECISIONS
  This happens when an increase in a
consumer’s income has caused a
substantial increase in the demand for a
product.
 On the other hand, when the resulting
income elasticity is a negative number,
the good is said to be inferior.
 A good becomes inferior when an
increase in income brings about a
decrease in demand.
BNVB  A good is said to be unitary if income
elasticity equals 1.
v

MVHM EXAMPLES:

INCOME ELASTICITY DEMAND

 Income elasticity of demand is the
degree of responsiveness of a
percentage change in quantity
demanded with a percentage change in
income. It is calculated using the
following formula:

Where: Qd id the quantity demanded and Y is

income.
 When the result of the income elasticity
is greater than 1, the product is called a
normal good but is considered as
luxury.
  The cross elasticity of demand is the
degree of responsiveness of a
percentage change in quantity of a good
with the percentage change in the price
of other goods.
 A positive cross elasticity indicates that
a good is a substitute of the other
while a negative cross elasticity means
the goods are complementing each
other.

CNVNBVM

In economics, the percentage change in demand

for the first good in response to the percentage
change in price of the second good is expressed in
this mathematical formula:

INCOME ELASTICITY OF DEMAND

 Based from the two examples, we can
see how each consumer responds to a
product when their income changes.
 In the case of Cerrine, because chicken
is a normal commodity for her, she
tends to consume more of this product
when she experienced a raise in her
income.
 However, if the commodity is inferior,
the consumer tends to consume less of
it when his/her income increases, like
in Aling Laura’s case. Note that the upper portion of the fraction
 Because she can afford to buy other (quantity) refers to product X; and the lower
goods which are less inferior to tuyo, portion of the fraction (price) refers to product Y.
she begun cutting her consumption of
tuyo and possibly spent her earnings on Let us consider the next table. It shows the
these other goods. relationship of quantity demanded and price for
CROSS ELASTICITY OF DEMAND each product, X and Y.
  In this respect, we will study how to
measure the relationship of quantity
supplied and price.
 Price elasticity of supply is computed as
follows:

 Before we go further, keep in mind that

when supply is elastic, producers are
able to increase production even with an
increase in the cost of production.
 However, when the supply of a product
becomes inelastic, producers are
hindered to produce more.
FKHGK  In this respect, when there is
considerable increase in price of goods
being sold, supply becomes elastic.
 However, when the change in price is
insignificant, supply is inelastic.

EXAMPLE:

PRICE ELASTICITY OF SUPPLY

 We discussed the consumer’s response
to the different factors – price, income,
and price changes of other products –
that affect their demand for products.
Now we will consider the price
elasticity of supply.
THE UTILITY APPROACH
• Utility – is the amount of satisfaction a
person gets from consuming a product.
It is synonymous to the satisfaction or
pleasure gained, not the use a consumer
gets.
• Utils is the rate of utility.

LAW OF DIMINISHING MARGINAL

UTILITY
• This law states that as a consumer uses
up a good or a service, he/she tends to
get less and less satisfied with it through
time. The greatest satisfaction is
experienced by consuming the first
quantity of the said good.
• This approach assumes that the
consumer has no budget constraint and
that he needs to maximize his utility for
one good.
• Total utility (TU) is the overall
happiness derived by a consumer with
regard to his consumption of a product
• Marginal utility (MU) is the amount of
additional utility received in every
consumption of an additional unit of
good.
• MU = change it TU / change in Q
EXAMPLE:
Imagine, a boy craving for siomai.
Quantity TU MU
1 10 -
2 19 9
3 26 7
4 30 4
5 30 0
6 26 -4
7 19 -7

OPTIMUM COMBINATION
• It states that a consumer will get a
maximum satisfaction from goods X
and Y when the MU of the last Peso-
spent on good X is exactly the same MU
 of the last-peso spend on good Y, a consumer applying the equimarginal
income being fixed. principle of maximizing utility.
EQUIMARGINAL PRINCIPLE • Consumer surplus = (10+9+7+4)
 Mathematical Equation – 4 + (11 + 10 + 8) – 6 = 49
o MU of y/Py
o MU of x/Px INCOME EFFECT and SUBSTITUTION
EFFECT
EXAMPLE: • Income effect occurs when a consumer
Mux starts with 10 and MUy starts at 11, Px=1 experiences an increase in his/her
and Py=2 budget
• Substitution effect is pivotal movement
Quantity MU of x MU of y
of the budget line toward a good that
1 10 11 has a lower price or comes with a
2 9 10 discount.
3 7 8
4 4 5
5 0 1 If B is 4, the price of x is 1, and the price of y is
6 -4 0 1, then the equation would be x + y = 4
7 -7 -1
The optimum combination of B= 4 and MRS is
at point C
Px = 1 and Py = 2
x+y=4
MUy / Py
Mux / Px Points Good Y Good X
A 4 0
Quantit MU MU B 3 1
MUx MUy
y of x of y C 2 2
1 10 11 10 5.5 D 1 3
2 9 10 9 5 E 0 4
3 7 8 7 4
4 4 5 4 2.5
5 0 1 0 0.5
6 -4 0 -4 0
7 -7 -1 -7 0.5

If the budget increased to 6, the price of x is 1,

and the price of y is 1, then the new equation
would be x + y = 6
The optimum combination of B = 6 and MRS
is at point I
x+y=6
ANSWER: Points Good Y Good X
F 6 0
• 4 units x P1 = P4/unit; 3 units x P2 G 5 1
= P6/unit H 4 2
Total: P10/unit. I 3 3
• Based on equimarginal principle, a J 2 4
combination of 4 units of good X and 3 K 1 5
units of good Y will cost a consumer L 0 6
P10. With this combination, the
maximum utility is met with a specific
budget. This is the optimum
combination of two products bought by
If B is 4, the point of y = 1, and the point of x =
0.5 (or buy 1 take 1) we will arrive at the Total cost is computed by simply adding the total
equation y +0.5x = 4 variable costs and total fixed costs.

y + 0.5x = 4
Points Good Y Good X
F 4 0
G 3 2
H 2 4
I 1 6
J 0 8

WATER DIAMOND THEORY

• The Paradox Value, as explained by
Adam Smith, it states that a good with
more value in use has less or little value
in exchange and a good with more value
in exchange has less or little value in
use.

REVENUE and PROFIT

 Revenue is the amount of money
received by firms from selling goods
and services.
 Profit is the difference between total
revenue and total costs.

The relationship between these two terms is

further expressed as:

COST ANALYSIS
 COST refers to actual or real expenses
incurred in the production of goods and
services.
 Identify fixed input as Total Fixed Cost
(TFC) and variable input as Total
Variable Cost (TVC)
 TFC includes costs that do not change
as the output increases. An example of
this is rent which is payment for land as
input, including raw materials.
 TVC includes costs that change as the
output increases. An example of this is
labor cost. These are short run costs,
but in the long run, all costs are
variable.
REVENUE and PROFIT
 For a firm to maximize profit in a
competitive market, marginal revenue
and marginal cost must be balanced
with the price.
 At the point when total revenue is only
TF TV M AV AT M
Q TC AFC TR TP
C C C C C R
110.
1 100 10 110 --- 100.0 10.0 25 --- -85
0
2 100 14 114 4 50.0 7.0 57.0 50 25 -64
117.
3 100 17.5 3.5 33.3 5.8 39.0 75 25 -42.5
5
121.
4 100 21.7 4.2 25.0 5.4 30.4 100 25 -21.7
7

5 100 26.2
126.
2
4.5 20.0 5.2 25.2 125 25 -1.2 Figure 1.2 ATC, AFC, AVC
6 100 31.2
131.
2
5 16.7 5.2 21.9 150 25 18.8 In Figure 1.2, average fixed cost decreases at a
7 100 37.7
137.
7
6.5 14.3 5.4 19.7 175 25 37.3 decreasing rate. Average available cost in the
8 100 46.7
146.
9 12.5 5.8 18.3 200 25 53.3
early stages decreases then stops & starts to
7
9 100 59 159
12.
11.1 6.6 17.7 225 25 66
expand at an increasing rate. Average total cost
3
1 has the characteristics of both fixed & variable
100 75 175 16 10.0 7.5 17.5 250 25 75
0
1
costs. What is important is the ability to identify
100 95 195 20 9.1 8.6 17.7 275 25 80
1
1
at which quantity the average total cost will be at
100 121 221 26 8.3 10.1 18.4 300 25 79
2 its lowest. In this example, it is when Q is 10
1
100 165 265 44 7.7 12.7 20.4 325 25 60
3
1
100 220 320 55 7.1 15.7 22.9 350 25 30
4
1
100 290 390 70 6.7 19.3 26.0 375 25 -15
5
1
100 390 490 100 6.2 24.4 30.6 400 25 -90
6

equal to total cost, no profit will be

made. However, there is also no loss at
this instance.
 This means that the firm has a break-
even in its production.
 A break-even point refers to a situation
where a firm’s gain from its economic
activity equals the costs it incurred.
Figure 1.3 TC, TR, & Break-even Point
Analysis
 Look at the table below. TC, MC, Figure 1.3 shows the relationship of TR & TC. In
AFC, AVC, ATC, TR, MR, & TP the early stages of production, the firm
were computed based on the formulas experiences initial losses because fixed costs are
for the costs and revenue, given TFC, too expensive and are not yet recovered. At
TVC, and Q. break-even, where output Q is around five units,
 P = 25 the firm experiences TR = TC, and adding more
output, the firm now experiences profit. This is
 After solving for TC, AFC, AVC, ATC, seen at the middle of the figure where TR is
MC, TR, MR, and TP, we now analyze above TC. It is also important to note that the
and plot the values we calculated firm experiences losses in late stages of
production due to the increasing total variable
Figure 1.1 TC, TFC, TVC cost. If the firm produces 6 to 14 units of output,
In Figure 1.1, both total cost & total variable it will continue to earn profit in the short run.
costs increase at an increasing rate. Total fixed This can also be seen in table 1.1
costs do not change as quantity or output
increases. The space between the total cost and
total variable represents the difference, which is
fixed cost. This is why total cost & total variable
costs will never intersect.
Figure 1.4 MR, MC, ATC. AVC, & the Profit-
maximization Level
Figure 6.4 shows the profit-maximization level in
a competitive market which is MR=MC=P, where
the price of the product is the same as the
marginal revenue and marginal cost. In this case,
the short run profit, is maximized at
P = 25.
Total Profit = (Price – ATC) Output
= (25 – 17.6) 11.9
= (7.4) 11.9
TP= 88.06
PERFECT and IMPERFECT
COMPETITION
Figure 1.4 MR, MC, ATC. AVC, & the Profit-
maximization Level
When the profit is zero, the firm is at break-even
point, where it might still opt to continue
operations. Once the firm starts to incur losses or
negative profits, it might be better for the firm to
continue operating to recover some losses.
However, a firm should decide to shut down if
the price of the product is equal to the firm’s
AVC
Total Profit = (Price – AVC) Output
= (5.2 – 5.2) 6
= (0) 6
TP = 0
PURE COMPETITION
o Consumer prefer spending less while
consuming more.
o The participation of more sellers in the
market gives consumers a wider
selection of alternatives where they
can spend more efficiently.
o Because of this arrangement, producers
tend to lower their prices to attract more
buyers and increase their total revenue
and profit.
o The presence of competition, therefore
changes the prices of goods and
services, as well as the quantities
produced or sold.
o In general, change depends on the
number of sellers in the market.
o At both ends of the competition, there
exist perfect and imperfect
competitions.
o In a perfect competition, no
participant in the market can
influence over market prices, albeit in
varying degrees.
o Pure Competition: is a market
structure where there are many buyers
and sellers.
o Numerous participants in the market
– none of them can cause changes in
 prices and quantities of goods and o At an output level where marginal cost
services equals marginal revenue, a monopolist
o “Price takers” – sellers in markets with is able to maximize his/her profit.
pure competition o This means that the monopolist will
o This is due to the fact that a single buyer increase output only if it is generating
is insignificant in this kind of structure a profit.
and can be easily replaced by new o Although the monopolist is a “price
buyers. maker”, he/she is not allowed to charge
o Sellers also experience the same any price he/she wants for utilities like
scenario water and electricity.
o Example: When a bangus buyer at o Specific government agencies control
Balintawak Market no longer buys their prices.
bangus poses a decrease in quantity
demanded, it does not follow that prices
will also decrease.
o Goods and services in a purely
competitive set up are homogenous or
exactly the same.
o Example: are the Japanese corns sold
along Katipunan Avenue in Quezon
City.
o Notice that the corn sold by one seller is
the same corn sold by another seller.
o No single seller can claim that his/her
Japanese corn is different from the
others.
o It is also probable that they came from
one source.
o In the same way, eggplants sold at a
nearby talipapa have almost the same
price; although some dealers might give
discounts or some freebies, the selling
price is still nearly the same.

o In the Philippines, Manila Electric

MONOPOLY
o Monopoly: is the market where there is
only one seller that represents the whole
industry.
o A monopolist is a “price maker” and
profit maximizer since he/she has the
power over the market prices.
o In a monopoly, there is only one good
or service with no close substitutes so
the consumers have no choice but to
patronize that product or service.
Company (MERALCO) first submits a
proposal for an increase in electricity
price to government agencies (e.g.,
Energy Regulatory Board).
o Then, the public sector is informed of
such increase, and consultations are
made before implementing the increase.
o Other public policies include
nationalization, regulation, and
deregulation.
o There are cases in a monopoly where
the same good or service is offered to
different customers at different selling
prices.
o This practice is called Price
Discrimination.
 o MERALCO gives different rates for
business establishments and for ordinary
households.
o The same is true for Metropolitan
Waterworks and Sewerage System
(MWSS) and Maynilad Water Services,
Inc. (Maynilad).
o Lastly, different rates are applied to
consumers depending on their amount
of consumption.
OLIGOPOLY
o Oligopoly: There is more than one
seller but remain to be few so that a
considerable degree of market power is
exercised.
o In this respect, the few players can
coordinate prices and production. This
is known as cartel.
Types of Oligopoly
(1) The players are the same or
there are no disparities
between them.
(2) There is no dominant player
among several players.
(3) There are only two players.
(2) Oligopoly in a perfect collusion, where
there is a dominant player and products
are differentiated.
(1) Competitors or
“players” in this kind
of structure collude.
(2) They play either as
one team or as
different teams.
(3) There are few sellers
that prefer to make
alliances than to
compete.
(2) In a duopoly, where there are two sellers, it is
best if they work together rather than to compete
with each other.
(4) They can also
cooperate, but
pretend to compete
with each other.
 Let us say that all three players stores
supplies of fuel on January 1, 2016. All
of them bought and filled up their
depots fully.
 On January 30, 2016, the prices of fuel
in the world market increased by USD
10 per barrel.
 Player C will increase its price on the
day it refills its depot.
 Players A and B have 15 and 30 days
worth of fuel in storage, respectively.
 But do they increase their prices on the
same day? Yes, delaying the increase
will not help Players B and A because it
is more profitable to increase the day
the first player, C, increases its price.
 Also, when there is a decrease in the oil
prices in the world market, the smallest
player will not decrease its price after
30 days but will wait for 30 days more
before selling in the new price.
 In this example, the smallest player
benefited more than the two other
players.
MONOPILISTIC COMPETITION
 This kind of market structure refers to
many firms selling differentiated
products.
 This means that products of the same
industry seem to be different but they
are actually not.
 Hair shampoos are an example.
 The different kinds of shampoos sold in
the market – with various compositions
for specific target consumers –
essentially function as personal hair care
products.
 Our personal preference for certain
brands may have a strong influence over
us.
 Sometimes, we even use brand names as
generic terms.
 An example is using the name Xerox to
mean photocopy.
 Another example is Frigidaire, an old
brand of refrigerator, use to mean
refrigerators in general.
 In this market structure, consumer’s
loyalty is experienced by the seller,
when certain consumers prefer their
brand over others.
THE MONOPOLY MARKET
Advantages of Monopolies
 Avoids duplication and wastage of
resources. If there is only one (1)
business creating a certain product,
production costs for that industry
will be low. Therefore, resources
can be used efficiently to make only
one (1) product.
 Economies of scale. Economies of
scale refer to savings in cost when
there is an increase in production.
As the monopolistic firm creates
more products, it will save more in
terms of production costs. Recall
from the previous lesson that the
ideal price of a product is equal to its
average cost. The lower the average
cost, the lower the prices would be.
 Research and development. Since
monopolies are the only source of a
particular product, their demand is
high. To maintain this level of
demand, monopolies set aside a
certain part of their income to
develop methods and maintain their
status.
 Price discriminations. Since
monopolies encompass many types
of market, they are able to offer
discounts to groups such as students
and other lower-income earners.
 Monopolies are a source of
revenue for the government. The
government charges a certain rate of
income tax from business firms.
Since monopolies have high profits,
it follows that the income tax that
the government gets from them is
also high.

Disadvantages of Monopolies
 Poor level of service. There is a lot
of demand that monopolies must
respond to. Since they have limits on
their human resources, the level of
service may not be as ideal as those
of competitive markets.
 High prices. Consumers may be
charged high prices for the low
quality of goods and services. Recall
that monopolies have the power to
set and control prices. Therefore,
even if the customers would protest,
since they are the only one who can
provide the product or service, the
customers are forced to pay anyway.
 Poor quality. Lack of competition
may result to poor quality. Although
some monopolies use their profits to
develop their products, there are
other monopolies who do not bother
with this effort, since they will
always have customers whether their
products are of good quality or not.
TYPES of MONOPOLIES
Government-Created Monopolies
• This is a form of monopoly where a
government grants an exclusive
privilege to a private individual or a
firm to be the sole provider of a good
or service. Potential competitors are
excluded from the market by laws or
regulations. Kings, for example, once
granted exclusive business licenses to
their friends and allies.
• The patent and copyright laws are two
(2) important examples of how
government creates a monopoly to
serve the public interest. When a
pharmaceutical company discovers a
new drug, it can apply to the
government for a patent. If the
government deems the drug to be truly
original, it approves the patent, which
gives the company the exclusive right
to manufacture and sell the drug for a
certain number of years.
Natural Monopolies
• An industry is a natural monopoly
when a single firm can supply a good
or service to an entire market at a
lower cost than two (2) or more firms
could. An example of a natural
monopoly is the distribution of water.
To provide water to residents of a
town, a firm must build a network of
pipes throughout the town. If two (2)
or more firms were to compete in the
provisions of this service, each firm
would have to pay the fixed cost of
building a network. Thus, the average
total cost of water is lowest if a single
firm serves the entire market.
• When a firm is a natural monopoly, it
is less concerned about new entrants
affecting its monopoly power.
Normally, a firm has trouble
maintaining a monopoly position
without ownership of a key resource
or protection from the government.
The monopolist’s profit attracts
entrants into the market, and these
entrants make the market more
competitive.
• By contrast, entering a market in
which another firm has a natural
monopoly is unattractive. Would-be
entrants know that they cannot achieve
the same low cost that the monopolist
enjoys because, after entry, each firm
would have a smaller piece of the
market.
Demand Curves for Competitive Firms and
Monopolies
 In profit maximization by
competitive firms, the demand can
be drawn in a horizontal line.
Because a competitive firm can sell
as much or as little as it wants at this
price, the competitive firm faces a
horizontal demand curve. In effect,
because the competitive firm sells a
product with many perfect
substitutes, the demand curve that
any firm faces is perfectly elastic.
This means that in a perfectly
competitive market, buyer demand
remains unaffected because there are
many substitutes for the product.
Even if a firm would raise prices, the
market’s demand would still remain
the same because buyers would
simply go to other producers of the
same product.
 By contrast, because a monopoly is
the sole producer in its market, the
demand goes down as quantity
produced goes up.
  The market demand curve provides a
constraint on a monopoly’s ability to
profit from its market power. A
monopolist would prefer, if it were
possible, to charge a high price and
sell a large quantity at that high
price. The market demand curve
makes that outcome impossible. In
particular, the market demand curve
describes the combinations of price
and quantity that are available to a
monopoly firm. By adjusting the
quantity produced (or equivalently,
the price charged), the monopolist
can choose any point on the demand
curve, but it cannot choose a point
off the demand curve.
 For a competitive firm, P = MR.
Every unit that the firm sells, it sells
at the going market price. The
competitive firm is a small part of
the overall market, and its behavior
has no effect on the overall market
price. So the incremental or
marginal revenue for each new unit
sold is simply the price. For a
monopolist, however, the
monopolist is the market. If the firm
decides to double its output, the
market output will double. The only
way the firm will be able to sell
more is to lower its price.
P – Price, MR – Marginal Revenue
A Monopoly’s Revenue
 Marginal revenue for monopolies is
very different from marginal
revenue for competitive firms. When
a monopoly increases the amount it
sells, it has two (2) effects on total
revenue. Total revenue can be
expressed as price multiplied by
quantity (P x Q).
o The output effect: More output
is sold, so Q is higher.
o The price effect: To sell more,
the price must decrease, so P is
lower.
 Monopolies have higher marginal
costs compared to competitive
markets because their product is
unique and would therefore require
materials or supplies that are not
readily available in the market.
Inefficiency in Pricing for Monopolies
 A monopoly does not have a supply
curve. In a monopoly, the firm is the
only supplier of the good, so it has
the freedom to set how much it
would supply at the same time that it
chooses the price of its goods.
Instead, the average cost curve is
used to analyze how a monopoly
maximizes its profit.
 The demand curve shows how the
quantity affects the price of the
good. The marginal revenue curve
shows how the firm’s revenue
changes when the quantity increases
by one (1) unit. When a monopoly
increases production by one (1) unit,
it must reduce the price it charges
for every unit it sells, and this cut in
price reduces revenue on the units it
was already selling. As a result, a
monopoly’s marginal revenue is less
than its price.
 If the monopolist firm produces at a
quantity where marginal cost (MC)
is less than marginal revenue (MR),
the firm can still increase profit by
producing more units.
 A similar thing happens if MC >
MR. If the firm produces at this
quantity, the costs of producing an
additional unit exceed the additional
revenue from selling the unit.
Therefore, the firm will be able to
raise profit by reducing production.
 In the end, the firm will adjust its
level of production until the quantity
reaches the point where MC = MR.
 A monopoly maximizes profit by
choosing the quantity at which MR =
MC.
 Recall that competitive firms also
choose the quantity of output at
which marginal revenue equals
marginal cost. In following this rule
for profit maximization, competitive
firms and monopolies are alike. But
there is also an important difference
between these types of firms -- the
marginal revenue of a monopoly is
less than its price. That is:
o For a competitive firm: P = MR
= MC
o For a monopoly firm: P > MR =
MC
 A social planner cares not only
 about the profit earned by the firm’s
owners but also about the benefits
received by the firm’s consumers.
The planner tries to maximize total
surplus, which equals producer
surplus plus consumer surplus. It
wants the price where demand and
average total cost intersect.
 A monopolist, on the other hand,
would want to charge a price where
MR = MC, and corresponds to the
demand.
A deadweight loss occurs when the
supply and demand are not in
equilibrium. A monopolist charges a
price above the marginal cost, so not
all consumers who value the good at
more than its cost will buy it. The
deadweight loss is represented by
the area of the triangle between the
demand curve (which reflects the
value of the good to the consumers)
and the marginal cost curve (which
reflects the costs of the monopoly
producer).
MANAGING MONOPOLIES
Making Monopolized Industries More
Competitive
• If two (2) big companies in the same
industry were to merge, the deal
would be closely examined by the
government before it went into effect.
The government authorities may
decide that a merger between these
two (2) large companies would make
the market substantially less
competitive and, as a result, would
reduce the economic well-being of the
country as a whole.
• If so, the government would challenge
the merger in court, and if the judge
agreed, the two companies would not
be allowed to merge.
Regulating the Behavior of Monopolies
• This solution is common in the case of
natural monopolies, such as water and
electric companies. These companies
are not allowed to charge any price
they want. Instead, government
agencies regulate their prices.
• What price should the government set
for a natural monopoly? Regulators
can respond to this problem in various
ways, each with corresponding
drawbacks.
o Subsidizing the monopolist –
In essence, the government
picks up the losses inherent
in marginal-cost pricing. Yet
to pay for the subsidy, the
government needs to raise
money through taxation.
o Allowing the monopolist to
charge a price higher than
marginal cost – If the
regulated price equals
average total cost, the
monopolist earns exactly
zero economic profit. Yet
average-cost pricing leads to
deadweight losses because
the monopolist’s price no
longer reflects the marginal
cost of producing the good.
Turning Private Monopolies into Public
Enterprises
• Rather than regulating a natural
monopoly that is run by a private firm,
the government can run the monopoly
itself. This solution is common in
many European countries, where the
government owns and operates
utilities such as telephone, water, and
electric companies.
Doing Nothing
• Each of the foregoing policies aimed
at reducing the problem of monopoly
has drawbacks. As a result, some
economists argue that it is often best
for the government not to try to
remedy the inefficiencies of monopoly
pricing.
• Determining the proper role of the
government in the economy requires
judgments about politics as well as
economics.
PRICE DISCRIMINATION
First-Degree Price Discrimination
• It means that the monopolist sells
different units of output for different
prices and these prices may differ
from person to person. This is
sometimes known as the case of
perfect price discrimination. Bidding
 for goods is a practice that shows have brought the highest quantity
perfect price discrimination. would pay the highest price. However,
• In monopolies, the price is ideally the the monopolist can offer bulk
point where marginal costs and discounts, which also correspond to
demand would intersect. However, in the quantity bought.
perfect price discrimination, there are
consumers who would be willing to go
beyond this price, creating a surplus in
profit for the monopoly firm. The
price that the consumer chooses to pay
in a first-degree price discrimination
system is called the reservation price. Third-Degree Price Discrimination
• A producer who is able to perfectly • It occurs when the monopolist sells
price discriminate will sell each unit output to different people for different
of the good at the highest price it will prices, but every unit of output sold to
command, that is, at each consumer’s a given person sells for the same price.
reservation price. Since each unit is This is the most common form of
sold to each consumer at his or her price discrimination, and examples
reservation price for that unit, there is include senior citizens’ discounts,
no consumers’ surplus generated in student discounts, and so on.
this market; the entire surplus goes to • The main issue in this kind of price
the producer. discrimination would be how the
• The triangular shaded area indicates monopolist decides on the optimal
the producer’s surplus accruing to the price to charge for each market.
monopolist. Since the producer gets • Market 1 would correspond to the
the entire surplus in the market, it normal consumers of the monopoly, or
wants to make sure that the surplus is those who are willing to pay without a
as large as possible. Put another way, discount. Their demand curves are
the producer’s goal is to maximize its steeper. Market 2 represents those
profits (producer’s surplus) subject to people who are more affected by
the constraint that the consumers are prices of the products. Therefore, their
just willing to purchase the good. demand curve is flatter, or more
elastic than Market 1.
Second-Degree Price Discrimination
• Note that the market with the higher
• It means that the monopolist sells
price must have the lower elasticity of
different units of output for different
demand. Upon reflection, this is quite
prices, but every individual who buys
sensible. An elastic demand is a price-
the same amount of the good pays the
sensitive demand. A firm that price
same price. Thus, prices differ across
discriminates will therefore set a low
the units of the good, but not across
price for the price-sensitive group and
people. The most common example of
a high price for the group that is
this is bulk discounts.
relatively price insensitive. In this
• Second-degree price discrimination is
way, it maximizes its overall profits.
also known as the case of non-linear
pricing since it means that the price
per unit of output is not constant but
depends on how much you buy. In
perfect price discrimination, the firm
knows exactly how much a customer
is willing to pay. In second and third-
degree price discriminations, the firm
has no way of knowing this
information. Furthermore, since there
are many buyers in the market, the
monopoly firm must be able to
distinguish those buyers who are
willing to buy more compared to those
who only want less of the product.
• As the graph shows, there are different
“blocks” or price ranges that a
customer can choose from. Those who