Production Process and Cost" is a fundamental aspect of managerial economics that focuses on of firms, the degree of product differentiation,
rentiation, barriers to entry and exit, and the extent of
understanding how firms produce goods and services and the costs associated with these
production processes. Here's a detailed overview: Production Process Overview: The production
process refers to the activities and methods employed by firms to transform inputs (such as labor,
capital, and raw materials) into outputs (goods or services). It involves various stages, including
procurement of raw materials, production operations, quality control, and distribution of finished
products.
Factors of Production: The production process relies on the combination of factors of production,
which include: Labor: The human effort involved in producing goods or services. Capital: The
machinery, equipment, and infrastructure used in production. Land: Natural resources such as land,
water, and minerals. Entrepreneurship: The managerial skills and innovation required to organize
and coordinate the production process.
Production Function: The production function represents the relationship between inputs and
outputs in the production process. It shows how the quantity of output depends on the quantities of
inputs used, typically represented as Q = f(L, K), where Q is output, L is labor, and K is capital.
Managers analyze the production function to determine the optimal combination of inputs to
maximize output while minimizing costs. Cost Concepts: Various cost concepts are essential in
understanding the economics of production, including: Total Cost (TC): The sum of all costs
incurred in the production process, including fixed costs and variable costs. Fixed Costs (FC):
Costs that remain constant regardless of the level of output, such as rent, depreciation, and
insurance. Variable Costs (VC): Costs that vary with the level of output, such as raw materials,
labor, and utilities. Marginal Cost (MC): The additional cost incurred by producing one more unit
of output. Average Total Cost (ATC): The total cost per unit of output, calculated as TC divided by
the quantity of output (Q).
Cost Curves: Cost curves graphically represent the relationship between costs and the level of
output. Key cost curves include: Total Cost Curve: Shows how total cost changes with the level of
output. Average Total Cost Curve: Shows the average total cost per unit of output. Marginal Cost
Curve: Shows how marginal cost changes with the level of output.These curves help managers
make decisions regarding production levels, pricing strategies, and cost minimization.
Economies of Scale and Diseconomies of Scale: Economies of Scale occur when a firm
experiences cost savings as it increases the scale of production, typically due to efficiencies in
production processes, bulk purchasing, and specialization. Diseconomies of Scale occur when a
firm experiences an increase in average costs as production levels rise, often due to coordination
problems, communication challenges, and diminishing returns to scale.
Cost Minimization and Profit Maximization: Managers aim to minimize costs while maximizing
profits by optimizing the production process. They use cost analysis techniques to identify cost-
saving opportunities, improve efficiency, and allocate resources effectively. Understanding the
production process and costs is essential for managers to make informed decisions regarding
production levels, pricing strategies, investment decisions, and overall business strategy. By
analyzing production processes and costs, managers can improve operational efficiency, enhance
competitiveness, and achieve long-term profitability
The nature of an industry refers to its characteristics, dynamics, and overall structure, which
influence how firms within the industry operate and compete. Market Structure: Market structure
refers to the number and size distribution of firms in an industry and the degree of competition
among them.
Common types of market structures include: Perfect Competition: Many small firms producing
identical products with no market power. Monopoly: A single firm controls the entire market with
significant barriers to entry. Oligopoly: A few large firms dominate the market, leading to
interdependence and strategic interactions. Monopolistic Competition: Many firms offer
differentiated products, allowing some degree of market power through branding and product
differentiation.
The market structure influences pricing behavior, entry barriers, innovation, and overall market
performance. Entry and Exit Barriers: Entry barriers are factors that make it difficult for new firms
to enter an industry, such as high capital requirements, economies of scale, government
regulations, and patents. Exit barriers are factors that make it difficult for firms to leave an
industry, such as specialized assets, contractual obligations, and emotional attachment to the
business. High entry barriers can lead to monopolistic or oligopolistic market structures, while low
entry barriers can result in more competitive markets with easier entry for new firms.
Product Differentiation: Product differentiation refers to the extent to which firms within an
industry offer products or services that are perceived as unique or distinct by consumers.
Differentiation strategies include branding, advertising, product features, quality, and customer
service. Industries with high levels of product differentiation tend to have monopolistic or
monopolistically competitive market structures, allowing firms to have some degree of market
power.
Technology and Innovation: Technological advancements and innovation play a significant role in
shaping the nature of industries. Industries characterized by rapid technological change often
experience disruptive innovations, shifts in consumer preferences, and changes in market
dynamics. Innovation can create new markets, disrupt existing industries, and drive competitive
advantage for firms that adapt quickly to technological changes.
Regulatory Environment: Government regulations and policies can significantly impact the nature
of industries by influencing market structure, competition, entry barriers, and consumer protection.
Regulatory frameworks vary across industries and countries and may include antitrust laws,
environmental regulations, safety standards, and intellectual property laws. Regulations can affect
industry consolidation, pricing behavior, innovation incentives, and market entry strategies.
Globalization and International Competition: Globalization has led to increased competition
among firms from different countries and expanded market opportunities for businesses. Industries
are increasingly interconnected and face competition from both domestic and international rivals.
Globalization can drive industry consolidation, facilitate technology transfer, and influence supply
chain dynamics.
Understanding the nature of an industry is crucial for firms to develop effective strategies,
anticipate competitive threats, identify growth opportunities, and navigate regulatory challenges.
By analyzing industry characteristics and dynamics, firms can position themselves strategically to
succeed in their respective markets.
Market Structures:
Market structure refers to the characteristics of a market that influence the behavior of firms
operating within it. The key elements of market structure include the number and size distribution
information transparency. Common types of market structures include perfect competition,
monopoly, monopolistic competition, and oligopoly. Each market structure has distinct features
that affect firms' pricing strategies, production decisions, innovation incentives, and overall
performance.
SCP Approach: The SCP framework suggests that market structure influences firm conduct, which
in turn affects market performance. The three components of the SCP approach are as follows:
Structure: Refers to the characteristics of the market, including the number and size distribution of
firms, product differentiation, entry and exit barriers, and concentration ratios. Conduct: Refers to
the behavior of firms within the market, including pricing strategies, advertising and promotion,
research and development efforts, and collusion. Performance: Refers to the outcomes or results of
the market, including measures such as profitability, efficiency, innovation, consumer welfare, and
market dynamics.
According to the SCP approach, changes in market structure can lead to changes in firm conduct,
which subsequently affect market performance. For example, in a monopolistically competitive
market, firms may engage in non-price competition through product differentiation and advertising
to gain market share.
Application of SCP Approach: The SCP approach is commonly used by economists, policymakers,
and antitrust authorities to assess market competition and evaluate the effects of mergers,
acquisitions, and anticompetitive practices. By understanding how changes in market structure
influence firm behavior and market outcomes, policymakers can design and implement regulations
and competition policies to promote consumer welfare and ensure efficient market functioning. In
summary, the SCP approach provides a framework for analyzing how market structure influences
firm conduct and market performance. By examining the interplay between market structure,
conduct, and performance, economists and policymakers can better understand market dynamics
and make informed decisions to promote competition and consumer welfare
Perfect Competition: In perfect competition, there are many small firms producing identical or
homogeneous products. Characteristics of perfect competition include: Many buyers and sellers:
No single buyer or seller can influence the market price. Homogeneous products: All firms
produce identical products that are perfect substitutes for each other. Easy entry and exit: Firms
can freely enter or exit the market without facing barriers. Perfect information: Buyers and sellers
have complete knowledge about prices, costs, and product quality. No market power: Individual
firms have no control over the market price and are price takers. Examples of industries that
approximate perfect competition include agricultural markets (e.g., wheat, corn), commodity
markets, and stock exchanges for standardized goods.
Monopolistic Competition: Monopolistic competition is characterized by many firms producing
differentiated products that are similar but not identical. Characteristics of monopolistic
competition include: Many buyers and sellers: There are numerous firms competing for market
share. Differentiated products: Each firm offers products with unique features or branding to
distinguish them from competitors. Some degree of market power: Firms have some control over
the prices of their products due to product differentiation. Easy entry and exit: Firms can enter or
exit the market relatively freely, although product differentiation may create some barriers.
Imperfect information: Consumers may have limited knowledge about the differences in product
quality and features. Examples of industries characterized by monopolistic competition include
restaurants, clothing retail, and personal care products.
Monopoly: In a monopoly, there is a single seller or producer dominating the entire market.
Characteristics of monopoly include: Single seller: A single firm controls the entire market and has
no direct competitors. Unique product: The monopolist produces a unique product with no close
substitutes. Significant barriers to entry: Barriers such as patents, economies of scale, or
government regulations prevent new firms from entering the market. Market power: The
monopolist has considerable control over the market price and can influence it through production
decisions. Imperfect information: Consumers may have limited alternatives and may be less
informed about product choices. Examples of monopolies include public utilities (e.g., water
supply, electricity), patented pharmaceutical drugs, and local cable providers in some areas.
Each of these market structures has distinct characteristics that affect pricing behavior, efficiency,
consumer welfare, and market outcomes. Understanding these market structures helps economists,
policymakers, and businesses aTotal Cost (TC):
Total Cost is the sum of all costs incurred by a firm in the production process. Formula: TC =
Fixed Costs (FC) + Variable Costs (VC)
Average Total Cost (ATC or AC): Average Total Cost is the total cost per unit of output
produced. Formula: ATC = TC / Q, where Q is the quantity of output.
Average Fixed Cost (AFC): Average Fixed Cost is the fixed cost per unit of output produced.
Formula: AFC = FC / Q, where Q is the quantity of output.
Average Variable Cost (AVC): Average Variable Cost is the variable cost per unit of output
produced. Formula: AVC = VC / Q, where Q is the quantity of output.
Marginal Cost (MC): Marginal Cost is the additional cost incurred by producing one more unit of
output. Formula: MC = ΔTC / ΔQ, where ΔTC is the change in total cost and ΔQ is the change in
quantity.
Total Fixed Cost (TFC): Total Fixed Cost is the sum of all fixed costs incurred by a firm in the
production process. Formula: TFC = FC
Total Variable Cost (TVC): Total Variable Cost is the sum of all variable costs incurred by a firm
in the production process. Formula: TVC = VCnalyze competition, market dynamics, and
regulatory policies.
When a firm decreases the price of its product, the change in total revenue depends on the price
elasticity of demand. If the demand for the product is elastic, a decrease in price will lead to an
increase in total revenue because the increase in quantity sold will outweigh the decrease in price.
Conversely, if the demand is inelastic, a decrease in price will lead to a decrease in total revenue
because the increase in quantity sold will not be sufficient to offset the decrease in price.
Therefore, the statement is incorrect as it oversimplifies the relationship between price changes
and total revenue.
Vertical integration involves the expansion of a firm into different stages of the production
process or distribution chain. While it offers several potential advantages such as increased control
over inputs or distribution channels, one significant disadvantage is that it may lead to firms
moving away from specialization in what they do best. By integrating vertically, a firm may need
to divert resources and attention away from its core competencies to manage activities in other
stages of production or distribution. This can lead to inefficiencies and a loss of focus on the
activities that the firm excels at, potentially reducing overall performance and competitiveness.

1. A firm sells its product in a competitive market where all firms charge a price of Rp 40,000 per
unit. The firm’s total costs are given as below: C(Q) = 2,805 + 122 Q + Q2 a. How much output
should the firm produce in order to maximize profit? b. What is the difference between production
(and cost) in the short-run and the long-run? c. In what sense competitive market is an ideal
market structure?

To find the profit-maximizing output level for the firm, we need to determine the level of output
where marginal revenue (MR) equals marginal cost (MC). a. To maximize profit, the firm should
produce where MR = MC. In a competitive market, the price is equal to marginal revenue (P =
MR), so we set the price equal to the marginal cost (P = MC).

Therefore, the firm should

produce 19,939 units to maximize
profit.

b. The difference between the

short-run and the long-run in
terms of production and cost lies
in the flexibility of inputs. In the
short run, some inputs are fixed
(e.g., capital), while others are
variable (e.g., labor). This means
that the firm can adjust its output
by varying the variable inputs, but
it cannot adjust its fixed inputs.

In the long run, all inputs are variable, and the firm can adjust both its variable and fixed inputs.
This allows the firm to optimize its production process and minimize costs more effectively in the
long run compared to the short run.

c. A competitive market is considered an ideal market structure for several reasons: There are
many buyers and sellers, none of whom can influence the market price individually. Firms produce
homogeneous (identical) products, meaning consumers can easily substitute one firm's product for
another. There are no barriers to entry or exit, allowing new firms to enter the market easily and
ensuring that inefficient firms can exit. There is complete information transparency, with buyers
and sellers having perfect knowledge of prices and products. The market reaches an equilibrium
where supply equals demand, maximizing total welfare (consumer and producer surplus). These
characteristics ensure efficiency in resource allocation, promote innovation and competition, and 4. A consumer shares her income 950 between the consumption of product X and product Y. The
result in the most efficient outcomes for both consumers and producers. relevant market prices are Px = 12 and Py = 15. a. Write the equation for the consumer’s budget
line. What is the MRS between goods X and Y?. b. Show graphically how the consumer’s choice
2. Answer the following questions: a. Explain the essence of the economies of scale and changes when the price of good X increases to 20. c. What is the essence of the discussion about
opportunity cost. Give two actual examples of each concept. b. By using formula below, explain substitution and income effect?
the concept of economies of scope: TC(Qx, Qy) – TC (0, Qy) < TC(Qx, 0) – TC(0, 0) c. Show the
difference between sunk cost and fixed cost with one concrete example. b. When the price of
good X increases to 20,
a. Economies of scale refer to the cost advantages that a firm can achieve by increasing its level of the consumer's budget
production. As production increases, the average cost per unit of output decreases due to factors line will change. This
such as specialization, efficient use of resources, and spreading of fixed costs over a larger output. change reflects the new
Example 1: Manufacturing Industry - A manufacturing company may experience economies of constraint the consumer
scale when it increases its production volume. For instance, the company may benefit from faces due to the higher
purchasing raw materials in bulk at lower prices, utilizing specialized machinery more efficiently, price of good X.
and spreading fixed costs (such as rent for factory space) across a larger number of units produced. Graphically, this change
can be shown by drawing
Opportunity cost represents the cost of choosing one alternative over another, or the value of the a new budget line with a
next best alternative foregone when a decision is made. It reflects the benefits that could have been steeper slope. This
gained from an alternative use of the same resources. Example 2: Education - Pursuing a college indicates that the
degree involves an opportunity cost in terms of the income that could have been earned during the consumer can now afford
years spent studying. For instance, if a student decides to attend university instead of working full- fewer units of good X for
time, the opportunity cost is the income they could have earned during those years. the same amount of good
Y, given the fixed income
b. The concept of economies of scope refers to the cost advantages that a firm can achieve by and the new price ratio.
producing a variety of goods or services together rather than separately. It occurs when the
combined production of multiple products is less costly than producing each product c. The discussion about
independently. The formula provided compares the total cost of producing two goods together (Qx substitution and income effects is essential in understanding consumer behavior when faced with a
and Qy) with the total cost of producing each good separately (Qx and 0, and 0 and Qy). If the change in prices. Substitution effect: This refers to the change in the quantity demanded of one
total cost of producing both goods together is less than the sum of the costs of producing each good relative to a change in the price of another good, while keeping the consumer's utility
good separately, economies of scope exist. constant. When the price of one good decreases (or increases), consumers may substitute it for
other goods, leading to a change in the relative consumption of goods. Income effect: This refers to
c. Sunk cost refers to a cost that has already been incurred and cannot be recovered. It is a cost the change in the quantity demanded of a good due to a change in real income resulting from a
that has been spent and is irretrievable regardless of any future decisions. Sunk costs should not be change in the price of that good. When the price of a good decreases (or increases), consumers'
considered when making decisions about the future because they cannot be changed. Example: real purchasing power increases (or decreases), leading to a change in the quantity demanded of
Suppose a company invests $10,000 in a marketing campaign for a product, but after the campaign that good. The income effect can amplify or offset the substitution effect depending on whether the
has started, it becomes evident that the product is not performing well in the market. The $10,000 good is normal or inferior.
spent on the marketing campaign is a sunk cost because it has already been spent and cannot be
recovered, regardless of whether the company decides to continue or discontinue the product. 5. A company estimates demand and cost functions of one of its product. The result are as follows:
Fixed cost, on the other hand, refers to costs that do not vary with the level of production or sales.
These costs remain constant over a specific period regardless of changes in the output or activity QD = 18,110 – 2.4 P + 0.78 Y + 0.18 A | TC = 3,130 + 2 Q + Q2 . Given P is the price, Y is the per
level of the business. Example: Rent for a retail store is a fixed cost because it remains constant capita income, A is the advertising expense of the firm, TC is the total cost, and Q is the output.
regardless of how many products are sold in the store. Whether the store sells one product or one Using these findings, analyze the following cases: a. If per capita income is 5,000 and advertising
hundred products, the rent expense remains the same. spending is 4,000, then calculate profit/loss of the company [Hint: MR = MC]. b. Can the above
pricing be expressed as price distortion? c. Explain the meaning of market mechanism and market
3. Based on estimates below, write an equation that summarizes the demand for the firm’s product, failure. Are these two concepts contradictory?
and answer the following questions: a. Comment on how well the regression line fits the data. b. If
P=30, and M=43, determine the own price, income, and other price elasticity of demand, and state
whether demand is elastic, inelastic, or unitary elastic. c. Show the quantity and price that
maximizes revenue. Let's assume that the demand equation for the firm's product can be estimated
using linear regression as:
 Finally, we find the Complementary goods are those goods that are typically consumed together because the use of
value of P that one good enhances the use of the other. For example, peanut butter and jelly are complementary
maximizes profit by goods because they are often used together to make sandwiches.
setting marginal
revenue (MR) equal to When the price of one complementary good decreases, it usually leads to an increase in the
marginal cost (MC), demand for the other complementary good. This is because consumers are more likely to buy more
and solve for P. of both goods when the price of one of the goods decreases, as it becomes more affordable to
consume both goods together.
b. Price distortion
occurs when the The four-firm concentration ratio is one measure of market structure. If the ratio equals one,
market price does not the industry is a monopoly or oligopoly; if it is zero, the industry is competitive. Another measure
reflect the true costs of market structure is the Herfindahl-Hirschman index (HHI), which can range from 10,000 for a
and benefits of monopoly to zero for a perfectly competitive industry. It explains how the four-firm concentration
production and ratio indicates the dominance of large firms in an industry, with a ratio of one suggesting a
consumption. In this monopoly or oligopoly, while zero suggests perfect competition. Additionally, it mentions the HHI
case, if the price set by as another measure that ranges from 10,000 for a monopoly to zero for perfect competition.
the company does not
align with the In a market characterized by monopolistic competition, there are many firms and consumers,
equilibrium price just as in perfect competition. Thus, concentration measures are between zero to one. Unlike in
determined by the perfect competition, however, each firm produces a product that is slightly different from the
market forces of supply products produced by other firms. In an oligopolistic market, a few large firms tend to dominate
and demand, it can be the market. Firms in highly concentrated industries. When one firm in an oligopolistic market
considered a form of changes its price or marketing strategy, its own profits are not affected, but the profits of the other
price distortion. firms in the industry are affected. It highlights that in monopolistic competition, there are many
firms and consumers, similar to perfect competition, but each firm produces a slightly
c. The market mechanism refers to the process by which the forces of supply and demand interact differentiated product. In contrast, oligopoly features a few large firms dominating the market, and
to determine prices and allocate resources in a market economy. Market failure occurs when the when one firm changes its price or strategy, it affects the profits of other firms in the industry.
market mechanism fails to allocate resources efficiently, leading to an inefficient allocation of
goods and services. The price elasticity of demand is typically calculated as the percentage change in quantity
demanded divided by the percentage change in price. This formula helps to measure the
These two concepts are not necessarily contradictory. Market mechanisms can be highly efficient responsiveness of quantity demanded to changes price.
in many cases, leading to the optimal allocation of resources. However, there are situations where
market failures occur due to various reasons such as externalities, market power, incomplete When the income elasticity of a good is greater than 1, it is considered a luxury good. This
information, and public goods. In such cases, interventions may be necessary to correct the market means that as income increases, the demand for wine increases at a proportionally higher rate.
failures and ensure a more efficient allocation of resources. Therefore, while market mechanisms Luxury goods are those for which demand increases more than proportionally as income rises,
are generally effective, they are not infallible and can lead to market failures in certain indicating that consumers allocate a larger portion of their incometo these goods as they become
circumstances. wealthier.

Suppose market demand and supply are given by Qd = 100 − 2P and Qs = 5 + 3P. If a price
ceiling of $15 is imposed:
Economies of scale refer to the phenomenon where the average cost of production decreases as
the level of output increases. This decrease in average cost occurs due to factors such as
specialization of labor, efficient use of capital, bulk purchasing discounts, and spreading of fixed
costs over a larger output. As a result, per-unit costs decrease, leading to greater efficiency and
profitability for the firm. Therefore, option A is the characteristic of economies of scale

Short-run Economies of Scale: Short-run economies of scale occur when a firm experiences cost
savings due to increased production within a limited time frame while some factors of production
remain fixed. In the short run, certain inputs, such as capital equipment and factory size, may be
fixed, while others, such as labor and raw materials, can be varied. Short-run economies of scale
typically result from improved utilization of existing resources, specialization of labor, better
coordination of production processes, and spreading of fixed costs over a larger output. Examples
of short-run economies of scale include increasing the number of shifts worked in a factory,
improving production scheduling to reduce idle time, and achieving higher levels of automation.

Long-run Economies of Scale: Long-run economies of scale occur when a firm experiences cost
savings due to increased production over a more extended period, during which all factors of
production can be varied. In the long run, firms have the flexibility to adjust their production levels
by changing the quantities of all inputs, including capital equipment, labor, and raw materials.
Long-run economies of scale often result from investments in new technologies, larger-scale
production facilities, improvements in management practices, and specialization of production
processes. Examples of long-run economies of scale include building larger factories to benefit
from greater production volumes, investing in state-of-the-art machinery to improve efficiency,
and implementing supply chain optimizations to reduce costs.

Short-run Economies of Scope: Short-run economies of scope occur when a firm experiences
cost savings by producing multiple products simultaneously within a limited time frame while
some factors of production remain fixed. In the short run, firms may have constraints on their
ability to adjust their production processes or invest in new technologies, limiting their ability to
fully exploit economies of scope. Short-run economies of scope typically result from shared
resources, complementary production processes, and joint marketing efforts across different
product lines. Examples of short-run economies of scope include a bakery producing various types
of bread using the same oven, a software company offering multiple software products using the
same development team, or a hotel providing both lodging and dining services using shared
facilities.

Long-run Economies of Scope: Long-run economies of scope occur when a firm experiences cost
savings by producing multiple products together over a more extended period, during which all
factors of production can be varied. In the long run, firms have more flexibility to invest in
specialized equipment, develop cross-functional teams, and optimize their production processes to
achieve economies of scope. Long-run economies of scope often result from investments in
research and development, innovation, and diversification strategies that allow firms to leverage
their resources and capabilities across multiple product lines. Examples of long-run economies of
scope include a technology company developing a suite of software products that share common
underlying technology, a diversified conglomerate benefiting from cross-selling opportunities
among its various business units, or a food manufacturer producing multiple product lines using
the same production facilities and distribution networks.
 - Focus on Value Proposition: Instead of engaging in price wars, the regional airline should
focus on enhancing its value proposition through improved service quality, customer
experience, route expansion, and operational efficiency. By offering superior value to
customers, the airline can differentiate itself in the market and attract passengers based on
quality rather than solely on price.
- Collaborative Solutions: Rather than seeking to eliminate competition, the regional airline
could explore opportunities for collaboration or consolidation within the industry. This could
involve partnerships with other airlines, joint ventures, or strategic alliances that benefit all
parties involved while preserving healthy competition.

In conclusion, while the temptation to exploit a competitor's financial difficulties may exist, it is
essential for the regional airline to prioritize ethical conduct, long-term sustainability, and
customer satisfaction. Instead of focusing on undermining competitors, the airline should
concentrate on enhancing its own competitiveness and delivering value to its customers in a
responsible manner.

Bagel and Butter just open in Indonesia offers a frequent buyer program whereby a consumer
receives a stamp each time she purchases one dozen bagels for Rp 60.000. After a consumer
accrues 10 stamps, she receives one dozen bagels free. This offer is an unlimited offer, valid
throughout the year. The manager knows her products are normal goods. Given this information,
a. Comment on how well the regression line fits the data. b. If P=30, and M=43, determine the own
construct the budget set for a consumer who has Rp 1.200.000 to spend on bagels and other goods
price, income, and othe price elasticity of demand, and state whether demand is elastic, inelastic,
throughout the year. Does Einstein’s frequent buyer program have the same effect on the
or unitary elastic. c. Show the quantity and price that maximizes revenue. Answers:
consumption of its bagels that would occur if it simply lowered the price of one dozen bagels by 3
percent? Explain.
a. To comment on how well the regression line fits the data, we can look at the R-squared value. In
the provided regression output, the R-squared value is very high, approximately 0.9992. This
To construct the budget set for a consumer who has Rp 1,200,000 to spend on bagels and other
indicates that about 99.92% of the variation in the dependent variable (presumably quantity
goods throughout the year, we need to consider two scenarios:
demanded or a similar metric) is explained by the independent variables (own price, income, and
other price) included in the regression model. Generally, an R-squared value close to 1 suggests
1. Using the Frequent Buyer Program: Under this program, the consumer receives one stamp
that the regression line fits the data very well.
for every purchase of one dozen bagels at Rp 60,000. After accumulating 10 stamps, the
consumer receives one dozen bagels for free. Since the offer is unlimited throughout the
b. answer: year, the consumer can potentially receive multiple free dozens of bagels.
2. Lowering the Price by 3 Percent: In this scenario, we'll calculate the price of one dozen
c. To find the quantity and price that
bagels after reducing the price by 3 percent. Then, we'll determine how many dozens of
maximize revenue, you can use the total
bagels the consumer can
revenue (TR) formula: TR = P * Q.
purchase with the given
Differentiate TR with respect to Q and
budget.
set the derivative equal to zero to find
the quantity that maximizes revenue. Let's calculate the budget sets for
Then, use this quantity to find the both scenarios:
corresponding price using the demand
equation. 1.Using the Frequent Buyer
Program: Price per dozen
Search Goods: Search goods are bagels = Rp 60,000.
products whose quality or characteristics Number of dozens of
can be easily evaluated before purchase. bagels to purchase with Rp
Consumers can assess these goods based 1,200,000 = Rp 1,200,000 /
on available information before making Rp 60,000 = 20 dozens. Since every 10 stamps yield one free dozen, the consumer
a decision. Examples include electronics, effectively purchases 20 dozens but receives 2 dozens for free. So, the consumer gets 22
books, clothing, and groceries. For dozens of bagels.
instance, a book is a search good 2. Lowering the Price by 3 Percent: Reduced price per dozen bagels = Rp 60,000 * (1 - 0.03) =
because consumers can examine its title, Rp 58,200. Number of dozens of bagels to purchase with Rp 1,200,000 = Rp 1,200,000 / Rp
author, synopsis, and reviews before 58,200 ≈ 20.62 dozens. The consumer can't purchase a fraction of a dozen, so she can buy
deciding to purchase it. only 20 dozens of bagels.
Experience Goods: Experience goods are products whose quality or characteristics can only be Comparison: The Frequent Buyer Program allows the consumer to purchase 22 dozens of bagels
fully evaluated after consumption or use. Consumers cannot fully assess these goods' quality with the given budget, while simply lowering the price by 3 percent enables the purchase of only
beforehand, and their evaluation relies on personal experience. Examples include restaurants, 20 dozens. Therefore, the Frequent Buyer Program has a slightly greater effect on the consumption
movies, haircuts, and vacations. For example, a haircut is an experience good because its quality is of bagels compared to simply lowering the price by 3 percent. This is because the program offers
fully known only after the service is received and the hair is styled. additional incentives (free dozens) that effectively reduce the average price per dozen even further,
b. If there's increasingly asymmetric information and the product being offered is a search good, as encouraging more purchases.
a manager, you would likely invest in providing more information about the product to reduce
information asymmetry. This could include detailed product descriptions, specifications, customer There is an industry operating in perfect competition market conditions. When there is a massive
reviews, warranties, and guarantees. Additionally, setting competitive prices based on market horizontal merger, the industrial situation changes to become a monopoly market. The merger
research and comparative analysis can help attract customers who are looking for value and resulted in a decrease in Marginal Cost from 100 per unit to 80 per unit. The demand curve facing
quality. by Industry is Q = 600-2P.

c.With the existence of e-commerce platforms where goods receive reviews from buyers and With the above information, calculate: a. The level of outputs and prices, before and after the
stores, the impact on asymmetric information and search costs can be significant. As a result, in merger. b. The differences in the deadweight loss because of the decrease in marginal cost. How
setting prices, you might consider the following actions: Adjust prices based on the quality and will the merger affect society? Provide interpretation of these results.
quantity of positive reviews. Higher-rated products may command premium prices. Offer
discounts or promotions to incentivize customers to leave reviews, thereby increasing the pool of Differences in Deadweight
information available to potential buyers. Implement dynamic pricing strategies that take into Loss:
account real-time changes in demand, competitor pricing, and customer feedback. Invest in
customer service and support channels to address any concerns or questions potential buyers may Deadweight loss (DWL) occurs
have, further reducing information asymmetry and search costs. Utilize pricing analytics tools to when the quantity produced is
analyze customer behavior, preferences, and market trends to optimize pricing strategies for less than the socially optimal
maximum profitability and competitiveness. level. In this case, the
reduction in marginal cost
While it might seem advantageous for the regional airline to lower its airfares to expedite the leads to a higher equilibrium
exit of its competitor from the market, this approach raises several ethical and strategic output level in the monopoly
considerations. market compared to perfect
competition. The deadweight
- Maintaining Market Integrity: Engaging in predatory pricing practices, which involve loss can be calculated as the
intentionally lowering prices to drive competitors out of business, can harm market integrity area of the triangle formed
and lead to anti-competitive behavior. Such actions could result in regulatory scrutiny and between the demand curve and
damage the reputation of the airline. the marginal cost curve, where
- Long-Term Viability: While the exit of a competitor might provide short-term benefits, it the quantity produced changes
does not guarantee long-term success for the regional airline. Operating in a market with due to the merger.
weak or no competition might lead to complacency and inhibit innovation. Additionally,
once the competitor exits, the regional airline might face challenges in raising prices back to Before the merger, DWL in
profitable levels. perfect competition: Calculate
- Customer Perception: Drastically lowering airfares may signal to customers a lack of the area between the demand
confidence in the value of the airline's services. It could lead to perceptions of instability or curve and MC at the output
desperation, potentially eroding customer trust and loyalty. level of 100 units and price of
Rp 250 per unit. After the
merger, DWL in monopoly: Calculate the area between the demand curve and MC at the output
level of 130 units and price of Rp 235 per unit.

The difference in DWL reflects the efficiency loss due to the decrease in marginal cost and the
shift from perfect competition to monopoly. This merger likely results in a transfer of surplus from
consumers to the monopolist and decreases overall societal welfare.

The interpretation of these results is that while the merger may benefit the merging firms by
increasing their profits, it is likely to harm society as a whole due to the reduction in consumer
surplus and the increase in deadweight loss. Consumers are likely to face higher prices and
reduced choice as a result of the monopoly power gained through the merger. Additionally, the
decrease in deadweight loss indicates a loss of efficiency in resource allocation, as the monopolist
produces less than the socially optimal level of output. Overall, the merger is expected to have
negative consequences for consumers and societal welfare.

A perfectly competitive market consists of 100 firms, each with a total cost function of TC = 10y2
+ 100 and a marginal cost function of MC = 30y. The market demand function is Q= 800 – 6P. a. If
the market price is $90.00, how much will the firm produce and what will be its economic profits?
b. Determine the market equilibrium price and quantity. c. Why firm in the perfect completion
market will earn zero economic profit in short-run and long-run

So, the market equilibrium quantity is approximately 300 units.

c. In a perfectly competitive market, firms earn zero economic profit in both the short run and the
long run due to the following reasons: In the short run, firms may earn positive or negative
economic profits. However, in the long run, firms can enter or exit the market freely. If firms in the
industry are earning positive economic profits, new firms will enter the market, increasing
competition and driving down prices until economic profits are driven to zero. Similarly, if firms
are experiencing losses, some firms will exit the market, reducing competition and allowing the
remaining firms to earn positive economic profits until economic profits are also driven to zero.
This process of entry and exit continues until firms in the market are earning zero economic profit
at the equilibrium price and quantity. At this point, each firm earns enough revenue to cover its
explicit and implicit costs, resulting in zero economic profit in the long run.

Definition of Market Structure:

Market structure refers to the characteristics and organization of a market, including the number of
firms, their relative sizes, the degree of product differentiation, the ease of entry and exit, and the
extent of control firms have over pricing. It describes the competitive environment in which firms
operate within an industry. Importance of Understanding Market Structure for Business Decision
Making:

Pricing Strategy: Knowledge of market structure helps firms determine appropriate pricing
strategies. For example, in a perfectly competitive market, firms must accept the market price,
whereas in a monopolistic market, firms have more control over pricing. Market Entry and Exit:
Understanding market structure influences decisions regarding market entry and exit. In highly
concentrated markets, barriers to entry may be high, while in competitive markets, entry may be
easier.

Competitive Strategy: Different market structures require different competitive strategies. For
instance, firms in monopolistically competitive markets may focus on product differentiation,
while those in oligopolistic markets may engage in strategic pricing and non-price competition.

Regulatory Compliance: Regulatory agencies often consider market structure when assessing
competition and enforcing antitrust laws. Firms must understand the regulatory environment in
which they operate and comply with relevant laws.

b. Calculation of CR4 and HHI:

CR4 (Four-Firm Concentration Ratio): Sum of the market shares of the four largest firms in the
industry. HHI (Herfindahl-Hirschman Index): Sum of the squares of the market shares of all firms
in the industry. Let's calculate CR4 and HHI for each industry:

Industry A:

CR4 = 30 + 18 + 25 + 12 = 85

HHI = (30^2 + 18^2 + 25^2 + 12^2 + 7^2 + 8^2 + 7^2 + 18^2 + 16^2 + 8^2) = 3178

Industry B:

CR4 = 5 + 7 + 11 + 14 = 37

HHI = (5^2 + 7^2 + 11^2 + 14^2 + 4^2 + 10^2) = 510

Comparison: Industry A has a higher CR4 (85) and HHI (3178), indicating a higher concentration
level compared to Industry B, which has a CR4 of 37 and an HHI of 510. Based on these
concentration measures, Industry A is likely to have a more concentrated market structure than
Industry B. In Industry A, a few large firms dominate the market, potentially leading to higher
barriers to entry, reduced competition, and greater market power for the dominant firms.
Conversely, Industry B appears to have a more competitive market structure, with a greater
number of smaller firms sharing the market.

Study Case Nissan: