micro chapter 15

switching costs

- switching costs = are impediments that make it costly for customers to switch to buying from another business

average cost formula

(total costs/quantity) = (fixed costs/quantity) + (variable costs/quantity)

entry deterrence strategies

- convince your rivals that you'll crush them a. build excess capacity so that your rivals expect fierce competition b. financial resources signal that you can survive a costly fight c. brand proliferation can ensure there are no profitable riches for a rival to exploit d. your reputation for fighting can be helpful, too

demand-side strategies

- create customer lock-in - a. switching costs lock in your customers b. reputation and goodwill keep your customers loyal c. network effects mean that your product becomes more useful the more people use it

entry decreases demand and your profits

a. new competitors will enter profitable markets - involves the rational rule for entry b. new competitors will make your market less profitable

price equals average cost

a. your firm's demand curve just touches your average cost curve b. average costs matter because they determine the profitability of the marginal firm c. your long-run profitability depends on barriers to entry

compulsory licenses

can limit competition

price equals average cost -- graphic

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using economic profit to make decisions: an example -- graphic

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short run

the horizon over which the production capacity and the number and type of competitors you face cannot change

accounting profit

the total revenue minus out-of-pocket financial costs

economic profit

- accounts for both explicit financial costs and implicit opportunity costs - the opportunity cost of running a business includes forgone wages and interest

barriers to entry def

- barriers to entry = obstacles that make it difficult for new firms to enter

free entry

- def: pushes economic profits down to zero, in the long run - occurs when there are no factors making it particularly difficult or costly for a business to enter or exit an industry

supply-side stragies

- develop unique cost advantages a. learning by doing mean that experience yields efficiency gains b. the benefits of mass production can keep small firms from being competitive entrants c. research and development can create cost advantages d. relationships with suppliers can get you cheaper inputs e. access to key inputs can freeze out your competitors

regulatory strategies

- government policy - a. patents give you the right to be the only producer b. regulations make it difficult for new businesses to enter your market c. compulsory licenses = can limit competition d. lobbying can create new regulatory barriers

economic profits tend to zero in the long run

- involves free entry

average revenue

- revenue per unit, calculated as total revenue divided by the quantity supplied - average revenue is equal to the price if you charge everyone the same price

the rational rule for exit

- says to exit the market if you expect to earn a negative economic profit, which occurs if price is less than average cost

the rational rule for entry

- says you should enter a market if you expect to earn a positive economic profit, which occurs when price exceeds average cost

long run

- the horizon over which you or your rivals may expand, or contract production capacity and new rivals may enter the market or existing firms may exit

profit margin

- the price less the average cost - this is a per-unit measure - remember that price is equal to the average revenue

marginal vs average cost curves relationships

- when MC > AC, the average increases - when MC < AC, the average decreases - example: GPA

profit margin formula

PM = price - average cost

short run vs long run business decisions

a. economic profit is important for the long-run analysis of firm entry and exit b. long-run analysis is useful for planning purposes, such as planning how much to invest in new plant and equipment for a business expansion

overcoming barriers to entry

a. entrepreneurs need to overcome barriers to entry - use demand-side strategies to combat customer lock-in - use supply-side strategies to overcome cost disadvantages - use regulatory strategies to your advantage - overcome deterrence strategies to fight the big guys

exit increases demand and your profits

a. existing competitors exit unprofitable markets, which helps restore profitability - involves the rational rule for exit b. use the cost-benefit principle to decide whether to enter or exit - if the benefits of entering exceed the costs, then enter the market - if the costs of staying exceed the benefits, then exit the market

barriers to entry

a. firms' ongoing profitability depend on barriers to entry b. how do firms deter entry? - find ways to create customer lock-in (demand-side-strategies) - develop unique cost advantages (supply-side-strategies) - mobilize the government to prevent entry (regulatory strategies) - convince potential entrants that you'll crush them (deterrence strategies)

price equals average cost

a. free entry pushes the price down toward average cost b. free exit pushes the price up toward average cost c. in the long run, with free entry and exit, price equals average cost d. price = average cost

economic profits tend to zero in the long run

a. free exit ensures industries won't remain unprofitable in the long run

average cost

cost per unit, calculated as your firm's total costs (including fixed and variable costs) divided by the quantity produced

explicit costs

these out-of-pocket financial costs

accounting profit formula

total revenue - explicit costs

economic profit formula

total revenue - explicit costs - implicit costs

average revenue formula

total revenue/quantity = price

two perspectives on profit -- graphic

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workday notes -- graphic

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average cost curve -- graphic

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barriers to entry -- graphical summary

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cost advantages generate lasting profits -- graphic

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demand-side strategies -- graphic

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economic profits tend to zero -- graphic

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economic profits tend to zero in the long run -- graphic (involves short run losses)

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economic profits tend to zero in the long run -- graphic (involves short run profits)

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entry and exit shift your firm's demand curve -- graphic

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free entry continues until price equals average cost -- graphic

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marginal vs average cost curves -- graphic

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profit margin graphic

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supply-side strategies -- graphic

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