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Maximizing Profit:Maximizing Profit:
Profit = Total Revenue - Total Cost
Total Revenue (TR) = P × Q
Average Revenue (AR) = TR÷Q = PQ
QP
Chapter 9:Chapter 9:
Marginal Revenue: Marginal Revenue:
It measures the change in total revenue generated by one additional unit of goods or services.
Q
TRMR
Weekly Revenue and Cost Data Weekly Revenue and Cost Data
for a Gold Miner for a Gold Miner
Price of Gold = $600 / oz
Weekly Output
Weekly TR
Weekly TC
Weekly Profit
0 0 570 -5701 600 810 -2102 1200 1000 2003 1800 1240 5604 2400 1530 8705 3000 1920 10806 3600 2410 11907 4200 3000 12008 4800 3690 11109 5400 4480 920
Weekly Output
Weekly TR MR
Weekly TC MC
Weekly Profit
0 0 0 570 -5701 600 600 810 240 -2102 1200 600 1000 190 2003 1800 600 1240 240 5604 2400 600 1530 290 8705 3000 600 1920 390 10806 3600 600 2410 490 11907 4200 600 3000 590 12008 4800 600 3690 690 11109 5400 600 4480 790 920
MC
PP = MR
q
MRMC
0 Output
MC
ATCAVC
0
Pa
q
Fig. AFig. A
c b
1 2 3 4 5 6 7 8 9 10
1
2
3
4
5
7
89
10
6
MCATC
AVC
MC
ATCAVC
0
P a
q
b
Fig. CFig. C
c
mn
MC
ATCAVC
q0
P a
b
Fig. BFig. B
c
1 2 3 4 5 6 7 8 9 10
1
2
3
4
5
7
89
10
6
MCATC
AVC
1 2 3 4 5 6 7 8 9 10
1
2
3
4
5
7
89
10
6
MCATC
AVC
Chapter 10: Chapter 10: Indentifying Indentifying Markets and Market Markets and Market StructureStructure
Chapter 10: Chapter 10: Indentifying Indentifying Markets and Market Markets and Market StructureStructure
Characteristics of Perfect Competition:Characteristics of Perfect Competition:
Numerous small firms and customers. Firms have insignificant market share.
Homogeneity of Product. Firms produce perfect substitutes.
Freedom of Entry and Exit.
Perfect Information.
Demand Facing a Typical Firm in Perfect CompetitionDemand Facing a Typical Firm in Perfect Competition
D
S
Industry A representative Firm
Q Q0 0Q0
P0
P = MR
P0
MC
ATC AVC
0
Pa
q
Fig. AFig. A
c b
Normal Profit:Normal Profit: The entrepreneur’s opportunity cost. It is equal to or greater than the maximum income an entrepreneur could have received employing his or her resources elsewhere. Normal Profit is included in the firm’s costs.
Economic Profit: Profit that an entrepreneur makes over the Normal Profit.
P=20 MR=MC, at Q=2000
Total Explicit Cost = 10,000
Opportunity Cost = 22,000
TC = Total (Economic) Cost =Explicit Cost + Implicit Cost
Economic Profit = TR -TC
TR = P x Q = 20(2000) = 40,000
TR –TC =
Accounting Profit=30,000
- 22,000=8,000
Economic Profit = 40,000 -10,000
Exercises:Exercises:
AVC
ATC
18
7
15
0
MC
Exercises:Exercises:
AVC
ATC
0
MC
16
13
12
4
Long Run Equilibrium under Perfect CompetitionLong Run Equilibrium under Perfect Competition
Industry Representative Firm
0 0
D S0
P0
P0
Q0
a
q0
bc
S*
P*
Q* q*
Monopoly:Monopoly:
This is a situation where a single producer (firm) is the sole producer of a good that has no close substitutes.
Sources of Monopoly: The firm may control the entire supply of raw
materials required to produce that output.
The firm may have a patent or copyright.
The case of “Natural MonopolyNatural Monopoly”. Economies of Scale may permit only one firm to be efficient in the market.
DATC
0
P
Q40
2
20
2.25
1.5
Natural MonopolyNatural Monopoly
Sources of Monopoly: The firm may control the entire supply of raw
materials required to produce that output.
The firm may have a patent or copyright.
The case of “Natural MonopolyNatural Monopoly”. Economies of Scale may permit only one firm to be efficient in the market.
The case of Government Franchises.
Through Mergers and Acquisitions.
Characteristics of Monopoly:
A single seller: A single firm produces all industry output. The monopoly is the
industry. Entry into the industry is totally blocked.
Imperfect dissemination of information: Cost, price, and product quality information are withheld from uninformed buyers.
2 3
7
8
TR2= AR2=8=P
TR3= AR3=7=P
MR3=
0
D or AR
MR
8(2)=16
7(3)=21
TR3-TR2=21-16=5
Pri
ce
Quantity
ATC
AVCMC
MR D
P
Q0
bc
a
Quantity
Pri
ce
ATC
AVC
MR=MC
P
1 2 3 4 5 6 7 8 9 10
1
2
3
4
5
7
89
10
6
MCATC
AVC
Q
$
0
6.5
MR D
ATC
AVC
MC
MR D
Q0
a
Quantity
Pri
ce
P
cb
ATC
AVC
MC
MR D
0
a
Q
P
Quantity
Price
cb
nm
Find the Profit maximizing output from the following information.
Demand Information Cost Information
P Q
12 0
11 1
10 2
9 3
8 4
7 5
Q TC
0 5
1 7
2 10
3 14
4 19
5 25
TR
0
11
20
27
32
35
MR
--
11
9
7
5
3
MC
--
2
3
4
5
6
Profit = TR – TC =
32 – 19 = 13
Monopolistic Competition:Monopolistic Competition:
It is a form of market organization in which there are many sellers of a heterogeneous or differentiated product, and entry into and exit from the industry are rather easy in the long run.
Differentiated Product:Differentiated Product:
Products which are similar but not identical and satisfy the same basic need.
Characteristics:Characteristics:
Large number of buyers and sellers.
Product Heterogeneity.
Free Entry and Exit.
Perfect dissemination of information.
36
The Market Structure SpectrumThe Market Structure Spectrum
37
The Demand Curve for Coca-Cola: The Demand Curve for Coca-Cola: Before and After Substitutes Appear on the MarketBefore and After Substitutes Appear on the Market
e = -1 e = - . 47e = - 3
MC
MR
D
P
q0
a
b c
Quantity
Price
sr
q1
D1
MR1
P
q0
a
Quantity
Price
D2MR2
MC
40
The Effect of Advertising The Effect of Advertising on the Firm’s Demand Curveon the Firm’s Demand Curve
Oligopoly:Oligopoly:
This is a form of market organization in which there are few sellers of a homogeneous or differentiated product. Unlike the other forms of market structure that we have discussed, a firm in Oligopoly makes pricing and marketing decision in light of the expected response by rivalsrivals.
Characteristics of Oligopoly:Characteristics of Oligopoly:
Few Sellers:Few Sellers: A handful of firms produce the bulk of industry output.
Homogeneous or unique product:Homogeneous or unique product: If product is homogeneous, then we have “Pure Oligopoly”. If product is differentiated, then we have “Differentiated Oligopoly”.
Blockaded Entry and Exit:Blockaded Entry and Exit: Firms are heavily restricted from entering the industry.
Imperfect Dissemination of Information:Imperfect Dissemination of Information:
What are some examples of What are some examples of Oligopoly?Oligopoly?
AutomobilesSteelSoupCerealsGasoline
Measure of Market Concentration:Measure of Market Concentration:
4 Firm Concentration Ratios: 4 Firm Concentration Ratios:
This is the percentage of total industry sales of the 4 largest firms in the industry.
Firm A = 20%
Firm D = 2%
Firm C = 6%
Firm G = 3%
Firm F = 35%
Firm J = 11%
Firm H = 7% Firm I = 3%
Firm E = 8%
Firm B = 5%
What is an example of a high What is an example of a high concentration ratio?concentration ratio?
Out of 151 firms in the aircraft industry the leading 4 constitutes 79% of total sales
What is the Herfindahl-What is the Herfindahl-Hirschman Index (HHI)?Hirschman Index (HHI)?
A measure of industry concentration, calculated as the sum of the squares of the market shares held by each firm in the industry
The Herfindahl-Hirschman Index:The Herfindahl-Hirschman Index:
........SSSSHHI 24
23
22
21
Firm A = 20%
Firm D = 2%
Firm C = 6%
Firm G = 3%
Firm F = 35%
Firm J = 11%Firm H = 7%Firm I = 3%
Firm E = 8%
Firm B = 5%
HHI = 202 + 52 + 62 + 22 + 82 + 352 + 32
+ 72 + 32 + 112
HHI = 400 + 25 + 36 + 4 + 64 + 1225 + 9 + 49 + 9 + 121 = 1942In this case 1,000 < HHI < 10,000
What is a Balanced Oligopoly?What is a Balanced Oligopoly?
An oligopoly in which the sales of the leading firms are distributed fairly evenly among them
What is an Unbalanced Oligopoly?What is an Unbalanced Oligopoly?
An oligopoly in which the sales of the leading firms are distributed unevenly among them
Balanced and Unbalanced OligopolyBalanced and Unbalanced Oligopoly
Concentrating the Concentration:Concentrating the Concentration:
Horizontal Mergers
Vertical Mergers
Conglomerate Mergers
A merger between firms producing the same good in the same industry
A merger between firms that have a supplier - purchaser relationship
A merger between firms in unrelated industries
What is Collusion?What is Collusion?
The practice of firms to negotiate price and market decisions that limit competition
What is a Cartel?What is a Cartel?A group of firms that collude to
limit competition in a market by negotiating and accepting agreed-upon price and market shares
How do firms in an unbalanced How do firms in an unbalanced Oligopoly set price?Oligopoly set price?
Most often they practice price leadership
What is Price Leadership?What is Price Leadership?
A firm whose price decisions are tacitly accepted and followed by other firms in the industry
D
MCF
0 Quantity
Price,
MC
DLMR
MC
QL QF
Price Leadership:Price Leadership:
P
Imagine 3 identical firms, A, B, and C in Imagine 3 identical firms, A, B, and C in an industry. What happens If an industry. What happens If AA raises raises price?price?
B and C will not raise their prices
Imagine 3 identical firms in an industry Imagine 3 identical firms in an industry A, B, C what happens If A, B, C what happens If AA lowers price? lowers price?
B and C will lower their prices
The Kinked Demand Curve Model:The Kinked Demand Curve Model:
Price
Quantity0
P
Q
The Kinked Demand Curve Model:The Kinked Demand Curve Model:
P
Q
Price
Quantity0
P
Q0 Quantity
Price
P
Q0 Quantity
Price
Brand Multiplication:Brand Multiplication:
Variations of essentially one good that a firm produces to increase its market share.
Firm’s Market Share = (Number of Brands) x Firm’s Market Share = (Number of Brands) x (Brand’s (Brand’s Market Share)Market Share)
Price Discrimination :Price Discrimination :
The practice of offering a specific good or service at different prices to different segments of the market.
q1
Centralized Cartels:Centralized Cartels:
q2 Q
PP
MC
P
0 0 0
MR
MC1MC2
D