Chapter 8 Econ- Managing in Competitive, Monopolistic, and Monopolistically Competitive Markets

Long-Run and Monopolistic Competition

-In the long run, monopolistically competitive firms produce a level of output such that: 1. P>MC 2. P=ATC> minimum average costs

Multiplant Output Rule

-Let MR(Q) be the marginal revenue of producing a total of Q=Q1+Q2 units of output. Suppose the marginal cost of producing Q1 units of output in plant 1 is MC1(Q1) and that of producing Q2 units in plant 2 is MC2(Q2). the profit-maximizing rule for the two-plant monopolist is to allocate output among the two plants such that: MR(Q)= MC1(Q1) MR(Q)= MC2(Q2) --------> this would cause a break even= max profit

Monopoly:

A market structure in which a single firm serves as an entire market for a good that has no close substitutes -Sole seller of a good in a market that gives that firm greater market power than if it competed against other firms (implications: market demand curve is the monopolist's demand curve) -a monopolist DOES NOT have unlimited market power

Competitive Output Rule ex: The cost function for a firm is C(Q) = 5 + Q^2. If the firm sells output in a perfectly competitive market and other firms in the industry sell output at a price of $20, which price should the manager of this firm charge> What level of output should be produced to maximize profits? How much profit will be earned?

Charge $20 MC= 2Q P=20; 20=2Q Q=10 units will maximize profits Profits= (P x Q) - Cost maximum profits= 20 x 10 - (5 + 10^2) =200-105 max profits =$95

A key different between monopolistically competitive and perfectly competitive markets is that each firm produces a slightly differentiated product

(implications: products are close, but not perfect, substitutes; therefore, firm's demand curve is downward sloping under monopolistic competition.

Implications of Entry Barriers

-A monopolist may earn positive economic profits, which in the presence of barriers to entry prevents other firms from entering the market to reap a portion of those profits. (implications: monopoly profits will continue over time provided the monopoly maintains its market power) -Monopoly power, does not guarantee positive profits

Optimal Advertising Decisions: How much should a firm spend on advertising to maximize profits?

-Depends, in part, on the nature of the industry -The optimal amount of advertising balances the marginal benefits and marginal cost. -Profit Maximizing advertising-to-sales ratio is: (A/R)= (EQ,A/-EQP)

Absence of a Supply Curve

-Firms operating in perfectly competitive markets determine how much output to produce based on price (P=MC) (a supply curve exists in perfectly competitive markets) -A monopolist's market power implies P>MR =MC (there is no supply curve for a monopolist, or in markets served by firms with market power)

Long run Equilibrium

-If firms in monopolistically competitive markets earn short-run -profits, additional firms will enter in the long run to capture some of those profits -losses, some firms will exit the industry in the long run

Monopoly ex: Suppose the inverse demand function for a monopolist's product is given by P = 100 - 2Q and the cost function is C(Q) = 10 + 2Q. Determine the profit-maximizing price, quantity and maximum profits.

-Profit Maximizing: 100-4Q = 2 ----> Q^M= 24.5 -The profit-maximizing price is: P^M= 100 - 2(24.5)= $51 -Maximum profits are: $51 x 24.5 - (10 +2 x 24.5)= $1,190.50

Monopolist Multiplant Decisions producing output at two plants:

-The cost of producing Q1 units at plant 1 is C(Q1), and the cost of producing Q2 at plant 2 is C(Q2). -When the monopolist produces a homogeneous product, the per-unit price consumers are willing to pay for the total output produced at the two plants is P(Q), where Q=Q1+Q2.

Implications of Product Differentiation

-The differentiated nature of products in monopolistically competitive markets implies that firms in these industries must continually convince consumers that their products are better than their competitors.

Perfectly competitive markets are characterized by:

-The interaction between many buyers and sellers that are "small" relative to the market. -Each firm in the market produces a homogeneous (identical product) -Buyers and sellers have perfect information -No transaction costs --Free entry into and exit from the market

An industry is monopolistically competitive if:

-There are many buyers and sellers -Each firm in the industry produces a differentiated product -There is free entry into and exit from the industry

Profit Maximization Rule

-To maximize profits, a monopolistically competitive firm produces where its marginal revenue equals marginal cost -The profit-maximizing price is the maximum price per unit that consumers are willing to pay for the profit-maximizing level of output, Q*, is such that MR (Q*)=MC(Q*) and the profit maximizing price is P* = P (Q*)

The implications of a perfectly competitive market:

-a single market price is determined by the interaction of demand and supply -firms earn zero economic profits in the long run (market equilibrium= firm price)

Short-Run Output Decisions

-the short run is a period of time over which some factors of production are fixed -To maximize short-run profits, managers must take as given the fixed inputs (and fixed costs), and determine how much output to produce by changing the variable inputs

Two strategies monopolistically competitive firms use to persuade consumers:

1. Comparative Advertising 2. Niche Marketing (successful differentiation and branding strategies can make managers brand myopic, resting on the brand's past laurels and in doing so mission opportunities to enhance its brand

*look at graphs (1.short run profit max 8-9,2.short run loss minimization 8-12, 3. the shut down case 8-13)

1. P > ATC when MC = P ----> profit > 0 2. AVC < P < ATC, MC = P -----> profit < 0 < FC, still produce!!! 3. P < AVC, MC= P -----> profit< 0> FC, exit even in short run!!!

Output Rule

A profit-profit maximizing monopolist should produce the output, Q^m, such that marginal revenue equals marginal cost: MR(Q^m) = MC (Q^m)

Pricing Rule

Given the level of output, Q^M, that maximizes profits, the monopoly price is the price on the demand curve corresponding to the Q^M units produced: P^M= P(Q^M)

Long-Run Competitive Equilibrium

In the long run, perfectly competitive firms produce a level of output such that 1. P=MC 2. P= minimum of AC

Short-Run Profit Maximization: Revenue-Cost Approach

MR = P = MC (look at graph 3-7)

The monopolist's marginal revenue function is:

MR= P [1+E/E]; where E is the elasticity of demand for the monopolist's product and P is the price charged -For P > 0, (MR>0 when E < -1) (MR=0 when E = -1) (MR <0 when -1 < E < 0

Marginal Revenue and Linear Demand function

P (Q) = a + bQ; where a > 0 and b <0, the associated marginal revenue is MR (Q) = a + 2bQ

Marginal Revenue ex: Suppose the inverse demand function for a monopolist's product is given by P= 10-2Q. What is the maximum price per unit a monopolist can charge to be able to sell 3 units? what is the marginal revenue when Q=3?

P=10-2(3) The max price the monopolist can charge for 3 units is P= $4. MR (3) = 10 - 2(2)(3) MR (3)= -$2

Deadweight Loss of Monopoly

The consumer and producer surplus that is lost due to the monopolist charging a price in excess of marginal cost

Competitive Firm's Demand

The demand curve for a competitive firm's product is a horizontal line at the market price. this price is the competitive firm's marginal revenue. Profit= (P -ATC) x Q

Short- Run Output Decision

To maximize short-run profits, a perfectly competitive firm should produce in the range of increasing marginal cost where P = MC, provided that P >= AVC. If P < AVC, the firm should shut down its plant to minimize losses

Firm's Short- Run Supply Curve

The short-run supply curve for a perfectly competitive firm is its marginal cost curve above the minimum point on the AVC curve. -Short run marginal supply curve= marginal supply curve

Competitive Output Rule

To maximize profits, a perfectly competitive firm produces the output at which price equals marginal cost in the range over which marginal cost is increasing P= MC(Q)