ECN2014 MANAGERIAL ECONOMICS

DEPARTMENT OF ECONOMICS & FINANCE, SUBS

LECTURE EIGHT
MANAGERIAL DECISION IN
COMPETITIVE MARKET
 LEARNING OUTCOMES
By the end of this lecture, students should be able:
1. To describe the principle and concepts of A COMPETITIVE MARKET.
2. To demonstrate how the principle of COMPETITIVE MARKET is dealt
with real businesses.
3. To apply analytical and quantitative techniques to facilitate managerial
decision-making in COMPETITIVE BUSINESS ENVIRONMENT.
 THREE CHARACTERISTICS OF
PERFECT COMPETITION

1. Firms are PRICE-TAKERs because each firm produces only a very small
portion of total market or industry output. As a result, its DEMAND
CURVE = MR CURVE and is HORIZONTAL – Perfectly Price Elastic.

2. All firms in the market produce a HOMOGENEOUS or perfectly

STANDARDISED PRODUCT.

3. Entry into and exit from the market is UNRESTRICTED.

 CHARACTERISTICS OF PERFECT
COMPETITION MARKET
Exercise taken from Thomas & Maurice textbook, Applied Problem 10 pp. 444.

Grocery stores and gasoline stations in a large city

would appear to be example of competitive markets:
There are numerous relatively small sellers, each
seller is a price-taker, and the products are quite
similar.
a. How would we argue that these markets are not
competitive?
• Firms are no longer Price-takers when
consumers prefer shop at somewhere nearby
their residential areas in a large city.
• Quality of services provided by each store are
different, but not Standardised or Homogenous.
 CHARACTERISTICS OF PERFECT
COMPETITION MARKET
Exercise taken from Thomas & Maurice textbook, Applied Problem 10 pp. 444.

Grocery stores and gasoline stations in a large city

would appear to be example of competitive markets:
There are numerous relatively small sellers, each
seller is a price-taker, and the products are quite
similar.
b. Could each firm face a demand curve that is not
perfectly elastic based on part (a)?
Each firm’s demand curve is no longer horizontal,
but a downward-sloping price elastic demand
curve.
 CHARACTERISTICS OF PERFECT
COMPETITION MARKET
Exercise taken from Thomas & Maurice textbook, Applied Problem 10 pp. 444.

Grocery stores and gasoline stations in a large city

would appear to be example of competitive markets:
There are numerous relatively small sellers, each
seller is a price-taker, and the products are quite
similar.
c. How profitable do you expect grocery stores and
gasoline stations to be in the long run?
In view of the free entry and exit from the market,
in the long run, those firms making economic
profits will be competed away by entry of new
firms, and only generate normal profits.
 PROFIT MAXIMISATION IN THE SR
Exercise taken from Student Workbook, Homework What will be the
exercises 1 pp. 243.
At P = $12, P=MR, a Price-taker.
To maximise profit, set MR=P=MC firm’s decision to
Consider the cost curves for a price-taking
Profit-maximing Q* = 35, either produce or
firm in the following figure: Making Economic Profit of (P – AC) Q* shut down in the
TFC= AFC*Q = 100’ Total Profit = $70 = ($12 - $10)x35 short run if the
If shut down, loss price is $12 per
TFC of 100 unit? If the price is
$6 per unit? And
dd = MR = AR determine the
firm’s shut down
AC = 9 point.

AFC = 5 At P = $6, to maximise profit,

SHUT DOWN POINT set MR = P = MC = $6
AVC P = AVC MINIMUM POINT Profit-maximing Q** = 20,
Making Economicl Profits of (P – AC) Q*
SHUT DOWN DECISION Total Profit (Loss) = - $60 = ($6 - $9) x 20
If P  AVC, Run Production To continue production with loss
If P < AVC, Shut Down Production
TO SHUT DOWN OR
OPERATE AT A LOSS?
Exercise taken from Thomas & Maurice textbook,
Applied Problem 1 pp. 441.

The MidNight Hour, a local nightclub,

earned $100,000 in Accounting Profit last
year. This year the owner, who had
invested $1 million in the club, decided to
close the club. What can you say about
ECONOMIC PROFIT (and the rate of
return) in the nightclub business?

The owner should make ECONOMIC LOSS.

ACCOUNTING PROFIT < IMPLICIT COSTS,
Could invest in alternative with more than 10% rate of return.
 Exercise taken from Thomas & Maurice textbook, Applied Problem 12 pp. 444.

During the summer of 2009 at the European Union’s headquarters in Brussels,

dairy farmers across Europe protested low milk prices caused by the EU’s move
away from farm crop subsidy programs toward more heavy reliance on market-
determined prices for agricultural products. The Wall Street Journal reported that
TO SHUT the dairy farmers demanded “a fair price for (their) milk, which covers at least
DOWN OR (their) production cost and some profit margin.” The EU Farm Commissioner
responded, “What farmers need to do is produce less.”
OPERATE?
a. Although in economics there is no such thing as a “fair” price, how might
market-determined prices he considered “fair” in an economic sense?
The price is the lowest possible price consumers can pay for the milk which
is also allow farmers earn at least NORMAL PROFITS, the price covers all the
opportunity costs of production, including the farmers’ implicit costs.
 Exercise taken from Thomas & Maurice textbook, Applied Problem 12 pp. 444.
During the summer of 2009 at the European Union’s headquarters in Brussels,
dairy farmers across Europe protested low milk prices caused by the EU’s move
away from farm crop subsidy programs toward more heavy reliance on market-
determined prices for agricultural products. The Wall Street Journal reported that
the dairy farmers demanded “a fair price for (their) milk, which covers at least
TO SHUT (their) production cost and some profit margin.” The EU Farm Commissioner
DOWN OR responded, “What farmers need to do is produce less.”
OPERATE? b. Why don’t dairy farmers take the Commissioner’s advice and just produce
less milk?
In view of competitive market, if each producer produces less. Then, market
price will increase. However, this can’t be sustained in the long run as some
producers tend to increase their production to generate more revenues and
the price will be back to normal..
 PROFIT MAXIMISATION IN THE SR
Exercise taken from Student Workbook, Homework exercises 3 pp. 245.
Sunnyvale Orchards is one of many small, perfectly competitive firms growing apples for the
U.S. market. The forecasted price of apples is $23.60 per crate. The management of Sunnyvale
Orchards estimates its SHORT-RUN AVERAGE VARIABLE COST function to be
𝑨𝑽𝑪 = 20 − 0.04𝑸 + 0.00005𝑸2
where Q is the number of crates of apples produced each week. TOTAL FIXED COST at
Sunnyvale Orchards is $1,200 per week. Determine the firm’s decision on profit-maximising
output (𝑸∗ ) and the amount of profit made ().

To determine profit-maximising output, 𝑸∗ by setting 𝑴𝑹 = 𝑷 = 𝑴𝑪.

𝑷 = 𝑴𝑹 = $𝟐𝟑. 𝟔𝟎
𝑨𝑽𝑪 = 20 − 0.04𝑸 + 0.00005𝑸2
𝑻𝑽𝑪 = 𝑨𝑽𝑪 ∗ 𝑸 = 20𝑸 − 0.04𝑸2 + 0.00005𝑸3
𝑴𝑪 = 𝒅𝑻𝑪Τ𝒅𝑸 = 20 − 0.08𝑸 + 0.00015𝑸2
To find 𝑸∗ by setting 𝑷 = 𝑴𝑪. 0.00015𝑸2 − 0.08𝑸 − 𝟑. 𝟔 = 𝟎
$𝟐𝟑. 𝟔𝟎 = 20 − 0.08𝑸 + 0.00015𝑸2  𝑄 ∗ = 575
𝑨𝑽𝑪 = 20 − 0.04(𝟓𝟕𝟓) + 0.00005(575)2 =13.53; 𝑻𝑽𝑪 = 7,780.
𝑻𝑪 = 𝑻𝑽𝑪 + 𝑻𝑭𝑪 = 8,980. 𝑻𝑹 = 𝑷 ∗ 𝑸 = 13,570. 𝝅 = 𝑻𝑹 − 𝑻𝑪 = 4,590.
 PROFIT MAXIMISATION – INPUT USAGE
Exercise taken from Student Workbook, Homework exercises 2 pp. 244. TVC = wL TR = P*Q  = TR - TC
MC = w/ MP
Ajax Corporation is a price-
taking firm in a competitive
industry that employs only one
variable input, labour, to
produce a product that sells for
$2 per unit. The wage rate is $8
per unit of labour and total fixed
costs are $1,000.
Determine profit-maximising
output and labour employed.
MRP = MP x PGOOD= R/L
ARP = AP x PGOOD = R/L
If MRP > w, L If MR > MC, Q
If MRP < w, L If MR < MC, Q
If MRP = w, L* If MR = MC, Q*
 PROFIT MAXIMISATION IN THE LR
Exercise taken from Student Workbook, Study Problem 6 pp. 228.
A textile firm in a competitive industry employs a
particularly efficient manager to run the operations at its
production facility. In the textile industry, a plant
manager typically makes a salary of $4,500 per month.
The textile firm employing the superior manager faces
the LAC and LMC curves shown in the diagram on the
right. In long-run competitive equilibrium, the price of  = (P – AC)Q*
the product is $9. = $1,500
a. Given the similar cost condition, in the LR
equilibrium, how much economic profit a typical
firm generate?
b. How much economic profit the textile firm with NORMAL PROFIT
superior plant manager could generate if no rent is
paid to the manager? What will be the amount the
superior manager will earn? Explain.
c. If the superior manager run his own textile firm,
what will be the amount of economic profit earned? $6,000
Explain.
 PROFIT MAXIMISATION IN THE SR AND LR
Exercise taken from Thomas & Maurice textbook, Applied Problem 4 pp. 443.

HoneyBee Farms, a medium-size producer of honey, operates in a market that fits

the competitive market definition relatively well. However, honey farmers are
assisted by support prices above the price that would prevail in the absence of
controls. The owner of HoneyBee Farms, as well as some other honey producers,
complain that they can’t make a profit even with these support prices. Explain why.
Explain also why even higher support prices would not help honey farmers in the
long run.

Even with the support price above the market-determined price, honey
producers won’t make profits because, in the absence of controls, the higher
support price will draw new honey producers to join the market.
In addition, the new producers are likely
to have higher marginal costs due to
less productive land, which allows them to
survive in a higher support price.
PROFIT MAXIMISATION
IN THE SR AND LR
Exercise taken from Thomas & Maurice textbook, Applied Problem 6 pp. 443.

If all the assumptions of perfect competition hold, why would

firms in such an industry have little incentive to carry out
technological change or much research and development?
What conditions would encourage research and development
in competitive industries?
If a firm innovates new product or new production
process, any profit would be competed away – the
assumption of HOMOGENEOUS Product in a Competitive
market  Firms have little incentives to engage in R&D.
Only with the condition that firm’s Innovation is protected
from patent right/ intellectual Property Right for a length
of time periods.
 SUMMARY
1. PERFECT COMPETITION is characterised as numerous relatively small sellers
selling homogeneous products in the market and, with free entry and exit from
the market in the long run.
2. A perfectly competitive firm can earn Economic Profit or Economic Loss in the
Short run Equilibrium. As firms are free to enter or exit from an industry in the
long run, all competitive firms only earn Normal Profit in the Long run
equilibrium.
3. Consider the constraint of fixed costs in the short run, a loss-making firm will
shut down its operation if the price charged fails to cover its average variable
costs per unit, and otherwise.
4. In the long run equilibrium, perfectly competitive firms produce each units of
output at the minimum average costs (when 𝑀𝐶 = AC) which is similar to the
price per unit whereby 𝑃 = 𝑀𝑅 = 𝑀𝐶 = 𝐴𝐶𝑀𝐼𝑁 .
 TUTORIAL

APPLIED PROBLEM 2, 7 & 8.