Microeconomics of Product Markets

8/21/2019 Microeconomics of Product Markets

1/110

MICROECONOMICS OFPRODUCT MARKETS

Elasticity, Consumer Surplus, andProducer Surplus

Reference: McConnell, Campbell R. Economics: principles, problems, andpolicies / Campbell R. McConnell, Stanley L. Brue,

Sean M. Flynn. 18th ed. p. cm. (The McGraw-Hill series in economics)


2/110

Price Elasticity of Demand

Measuring responsiveness toprice changes

Elastic demandLarge change in quantitypurchased for given price change

Inelastic demandSmall change in quantitypurchased for given price change


3/110

Price Elasticity of Demand

Price-elasticity coefficientand formula

Percentage Change in Quantity

Demanded of Product X

Percentage Change in Price

of Product X

Ed =

6-3


4/110

Interpretations of Elasticity

Elastic Demand

Inelastic Demand

Unit Elasticity

Ed=.04

.02= 2

Ed

=.01

.02

= .5

Ed=

.02

.02 = 1 6-4


5/110

The Total Revenue Test

Total Revenue = TR = PxQInelastic demand

P and TR change in same direction

Elastic demandP and TR change in oppositedirection

6-5


6/110

$3

2

1

0 10 20 30 40 Q

P

Lower price and elastic demandBlue gain exceeds gold loss

a

b

D1


6-6


7/110

$4

3

2

1

0 10 20Q

P

Lower price and inelastic demandGold loss exceeds blue gain

c

d

D2


6-7


8/110

$3

2

1

0 10 20 30 Q

P

Lower price and unit-elastic demandBlue gain equals yellow loss

e

f

D3


6-8


9/110

]]]

]]]]

Elasticity on a LinearDemand Curve

1

2

3

4

5

6

7

8

$8

7

6

5

4

3

2

1

5.00

2.60

1.57

1.00

0.64

0.38

0.20

$8,000

14,000

18,000

20,000

20,000

18,000

14,000

8,000

Elastic

Elastic

Elastic

Unit Elastic

Inelastic

Inelastic

Inelastic

(1)Total Quantity of

Tickets DemandedPer Week, Thousands

(2)Price Per Ticket

(3)Elasticity

Coefficient (Ed)

(4)Total Revenue

(1) X (2)

(5)Total-Revenue

Test

]]]

]]]]

6-9


10/110

Elasticity and the TR Curve

0 1 2 3 4 5 6 7 8

0 1 2 3 4 5 6 7 8

Quantity Demanded

Quantity Demanded

Price

TotalReve

nue

(Thousandsof

Dollars)

$201816

1412108642

$87

6

5

4

3

2

1

a

b

c

d

e

fg

h

Elastic

Ed> 1Unit Elastic

Ed= 1

InelasticEd< 1

D

TR

6-10


11/110

Determinants of Elasticity

SubstitutabilityMore substitutes, more elasticdemand

Proportion of incomePrice relative to income

Luxuries versus necessities

Luxuries are more elasticTimeMore elastic in the long run

6-11


12/110

Price Elasticity of Supply


Supplied of Product XPercentage Change in Price

of Product X

Es =

Responsiveness to price

changes by producers

6-12


13/110

Price Elasticity of SupplyMarket periodPerfectly inelastic supply

Short runFixed plant size

Long runAdjustable plant size

Supply more elastic

6-13


14/110

P

Q


The Market Period

Perfectly inelastic supply

D1 D2

Sm

Q0

Pm

P0

GreatestPriceImpact

6-14


15/110


The Short Run

Inelastic supply

P

Q

D1 D2

Ss

Q0

PsP0

Qs

LowerPriceImpact

6-15


16/110


The Long Run

Elastic supply

P

Q

D1 D2

Sl

Q0

PlP0

Ql

LeastPriceImpact

6-16


17/110

Cross Elasticity of Demand

Responsiveness of sales to

change in price of another good


Demanded of Product

XPercentage Change in Price

of ProductY

Exy =

6-17


18/110

Cross Elasticity of Demand

Substitute goodsPositive sign

The larger the positive cross-elasticity coefficient, the greater is thesubstitutability between the two products.

Complementary goodsNegative sign

The larger the negative cross elasticity coefficient, the greater is thecomplementarity between the two goods.

Independent goodsZero

6-18


19/110

Income Elasticity of Demand

Responsiveness of sales tochange in income

Normal goodspositive signInferior goodsnegative sign

Percentage Change in QuantityDemanded

Percentage Change in IncomeEi =

6-19


20/110

Consumer Surplus

D

Price

(PerBag)

P1

Q1

Quantity (Bags)

ConsumerSurplus

EquilibriumPrice = $8

6-20


21/110

Producer Surplus

S

Price

(PerBag)

P1

Q1

Quantity (Bags)

ProducerSurplus Equilibrium

Price = $8

6-21


22/110

Efficiency Revisited

Productive and allocative efficiency

D

S

Pr

ice

(PerBag)

P1

Q1

Quantity (Bags)

ConsumerSurplus

ProducerSurplus

EquilibriumPrice = $8

6-22


23/110

Efficiency Loss

Deadweight loss

D

S

Pr

ice

(PerBag)

P1

Q1

Quantity (Bags)

EfficiencyLosses

Q2 Q3

6-23


24/110

Elasticity and Pricing Power

Competitive marketsNo pricing power

Firms with market powerCharge different prices

Differences in group elasticitiesBusiness (i) vs. leisure travelers (e)

Discounting for children

College tuition

6-24


25/110


Consumer Behavior


26/110

Utility

Diminishing marginal utility (states that beyond a certain quantity, additional units of a specific

good will yield declining amounts of extra satisfaction to a consumer)

Satisfaction obtained from

consumptionThree characteristics

Differs from usefulness

Subjective

Difficult to quantify

7-26


27/110

Utility

Total utilityTotal satisfaction from a specificquantity

Marginal utilityExtra satisfaction from anadditional unit

Law of diminishing marginal

utilityExplains downward slopingdemand

7-27


28/110

Utility Graphically

0

10

20

30

10

86420

-2

1 2 3 4 5 6 7

1 2 3 4 5 6 7

Tota

lUtility(Utils)

MarginalUtility(Utils)

(1)Tacos

ConsumedPer Meal

(2)Total

Utility,Utils

(3)Marginal

Utility,Utils

0

12

3

4

5

6

7

0

1018

24

28

30

30

28

]]]]]

]]

10

8

6

4

2

0-2

TU

MU

Total Utility

Marginal Utility

Units Consumed Per Meal

Units Consumed Per Meal

7-28


29/110

Theory of Consumer Behavior

Key dimensions of the consumerproblem

Rational behavior

Preferences

Budget constraint

Prices

7-29


30/110

Theory of Consumer Behavior

Find utility maximizingcombination of goods

Utility maximizing rule

Allocate income

Last dollar spent on each good

yields same marginal utilityMarginal utility per dollar

7-30


31/110

Algebraic Generalization

MU of product A

price of A

MU of product B

price of B=

8 Utils

$1

16 Utils

$2=

Optimum AchievedMoney incomeis allocated so that the last dollar spent on

each product yields the same extra or

marginal utility 7-31


32/110

P

riceofProdu

ctB

0

1

2

4 6

Quantity Demanded of B

Deriving the Demand Curve

$2

1

4

6

Price Per

Unit of B

Quantity

Demanded

DBIncome Effects

Substitution Effects7-32


33/110

Applications and Extensions

New products increase utilityiPods

The diamond-water paradoxThe value of time

Medical care purchasesCash and noncash gifts

7-33


34/110


The Costs of Production


35/110

Economic Costs

Equal to opportunity costsExplicit + implicit costs

Explicit costsMonetary payments

Implicit costsValue of next best useSelf-owned resources

Self-employed resources

8-35


36/110

Profit

Accounting profit

Total revenue less explicit cost

Normal profitEqual to implicit cost

Economic or pure profit

Total revenue less economic cost

8-36


37/110

Profits Compared

EconomicProfit

AccountingCosts (Explicit

Costs Only)

AccountingProfit

ExplicitCosts

Implicit Costs(Including a

Normal Profit)

Economic

(O

pportunity)

Costs

TotalRevenue

Economic Accounting

8-37


38/110

Short and Long RunThe short runFixed plant capacity

Variable intensity of plant use

Variable output

The long runVariable plant capacity

Firms enter and exit

8-38


39/110

Production Relationships

Total product (TP)Marginal product (MP)

Average product (AP)

Average Product Total ProductUnits of Labor

=

Marginal ProductChange in Total Product

Change in Labor Input=

8-39


40/110

Law of Diminishing Returns

Fixed technology

Add variable resource to fixedresource

Marginal product will decline

Beyond some point

Rationale

8-40


41/110

Industry Structure

Minimum efficient scale (MES)Natural monopoly

Applications and illustrations

Price of cornSuccessful start-up firms

The Verson stamping machine

The daily newspaperAircraft and concrete plants

8-41


42/110

Sunk Costs

Irrelevant in decision makingCannot be recovered

Do not affect marginal

benefit and marginal costFirm example:R&D costs

8-42


43/110


Pure Competition


44/110

Four Market Models

Pure competitionPure monopoly

Monopolistic competition

Oligopoly

Market Structure Continuum

PureCompetition

MonopolisticCompetition Oligopoly

PureMonopoly

Imperfect Competition

9-44

M k t M d l


45/110

Characteristic

Market Model

Pure CompetitionMonopolistic

CompetitionOligopoly Pure Monopoly

Number of firms A very large number Many Few One

Type of product Standardized DifferentiatedStandardized or

differentiated

Unique; no close

substitute

Control over price NoneSome, but within rather

narrow limits

Limited by mutual

interdependence;

considerable with

collusion

Considerable

Condition of entry

Very easy, no obstacle

Relatively easy

Significant obstacles

Blocked

Nonprice

competition

None

Considerable emphasis

on advertising, brand

names, trademarks

Typically a great deal,

particularly with

product differentiation

Mostly public relations

advertising

Examples AgricultureRetail trade, dresses,

shoes

Steel, automobiles,

farm implements, many

household appliances

Local utilities


46/110

Pure Competition

Very large numbersStandardized product (identical)

Price takers

Free entry and exit

Perfectly elastic demand

Average revenueMarginal revenue

Price9-46


47/110

Profit Maximization

Two approachesTotal revenue and total cost

approach

Produce where TR-TC is greatest

Marginal revenue and marginal

cost approachProduce where MR=MC

9-47


48/110

Total Revenue Total Cost Approach

(1)Total Product(Output) (Q)

(2)Total FixedCost (TFC)

(3)Total Variable

Cost (TVC)

(4)Total Cost

(TC)

(5)Total Revenue

(TR)

(6)Profit (+)

or Loss (-)

Price = $131

012345

6789

10

$100100100100100100

100100100100100

$090170240300370

450540650780930

$100190270340400470

550640750880

1030

$0131262393524655

786917

104811791310

$-100-59

-8+53

+124+185

+236+277+298+299+280

Now Lets Graph The ResultsDo You See Profit Maximization? 9-48


49/110

10 2 3 4 5 6 7 8 9 10 11 12 13 14

10 2 3 4 5 6 7 8 9 10 11 12 13 14

$1800

17001600

1500

1400

1300

1200

1100

1000

900

800

700

600

500

400

300

200

100

$500

400

300

200

100

TotalRevenue

andTotalCost

TotalEconomic

Profit

Quantity Demanded (Sold)

Quantity Demanded (Sold)

Total Revenue, (TR)

Break-Even Point(Normal Profit)

Break-Even Point(Normal Profit)

MaximumEconomic

Profit

$299

Total EconomicProfit

$299

P=$131

Total Cost,

(TC)

Total Revenue Total Cost Approach

9-49

Marginal Revenue Marginal Cost


50/110

Marginal Revenue Marginal CostApproach

(1)Total

Product(Output)

(2)Average

FixedCost(AFC)

(3)AverageVariable

Cost(AVC)

(4)Average

TotalCost(ATC)

(6)MarginalRevenue

(MR)

(7)Profit (+)

or Loss (-)

012345

6789

10

$100.0050.0033.3325.0020.00

16.6714.2912.5011.1110.00

$90.0085.0080.0075.0074.00

75.0077.1481.2586.6793.00

$190.00135.00113.33100.0094.00

91.6791.4393.7597.78

103.00

$131131131131131

131131131131131

$-100-59-8

+53+124+185

+236+277+298+299+280

No Surp rise - Now Lets Graph ItDo You See Profit Maximization Now?

(5)Marginal

Cost(MC)

$9080706070

8090

110130150

9-50

Marginal Revenue Marginal Cost


51/110

C

ostandReven

ue

$200

150

100

50

01 2 3 4 5 6 7 8 9 10

Output

Econom ic Prof it MR = P

MCMR = MC

AVC

ATC

P=$131

A=$97.78

Marginal Revenue Marginal CostApproach

9-51


52/110

Short Run Profit MaximizationProduce where MR (=P) = MC

Suffer loss, still produce?

Yes if loss is less than fixed costCover variable cost

Shut down if loss greater than fixedcost

Produce if P > min AVC

9-52


53/110

Lower the Price to $81 and

Observe the Resul ts!

C

ostandReven

ue

$200

150

100

50

01 2 3 4 5 6 7 8 9 10

Output

Loss

Short Run Loss Minimizing Case

MR = P

MC

AVC

ATC

P=$81

A=$91.67

V= $75

9-53


54/110

Lower the Price Further to

$71 and Observe the Resu lts!

CostandReven

ue

$200

150

100

50

01 2 3 4 5 6 7 8 9 10

Output

Short Run Shut Down Case

MR = P

MC

AVC

ATC

P=$71

Short-RunShut Down PointP < Minimum AVC

$71 < $74

V= $74

9-54


55/110

Long Run Profit Maximization

AssumptionsEntry and exit only

Identical costs

Constant-cost industry

Goal of the analysis

In the long run, P = min ATCEntry eliminates profits

Exit eliminates losses9-55


56/110

Single Firm Industryp P

p P0 0100 90,00080,000 100,000

Entry Eliminates ProfitsATC

MR

MC

$60

50

40

D1

S1

An increase in demand temporarily raises priceHigher prices draw in new competitors

Increased supply returns price to equilibrium

D2

$60

50

40

S2

9-56


57/110

Single Firm Industryp P

p P0 0100 90,00080,000 100,000

Exit Eliminates LossesATC

MR

MC

$60

50

40

D3

S3

A decrease in demand temporarily lowers priceLower prices drive away some competitors

Decreased supply returns price to equilibrium

D1

$60

50

40

S1

9-57


58/110

Long Run Supply

Constant cost industryEntry/exit does not affect LR ATC

Constant resource price

Special case

Increasing cost industryMost industries

LR ATC increases with expansionSpecialized resources

Decreasing cost industry 9-58


59/110

Pure Competition and Efficiency

Productive efficiencyP= minimum ATC

Allocative efficiency

P= MC

Maximum consumer and

producer surplusDynamic adjustments

Invisible Hand revisited9-59


60/110


Pure Monopoly


61/110

Characteristics of Monopoly

Single seller

No close substitutes

Price makerBlocked entry

Nonprice competition

10-61


62/110

Examples of Monopoly

Regulated or natural monopolieselectricityNear monopolies

Western UnionFrisbeeDe Beers

Geographic monopoliesProfessional sport teamsDual objectives of study

10-62


63/110

Barriers to Entry

Economies of scaleLegal barriers to entry

Patents

Licenses

Ownership or control of

essential resourcesPricing and other strategic

barriers to entry10-63


64/110

Monopoly Demand

Assumptions:

Monopoly status is secure

No government regulationSingle-price monopolist

Face down-sloping demandEntire market demand

10-64

Price and Marginal Revenue


65/110

0 1 2 3 4 5 6

$142

132

122

112

102

92

82

D

A monopolist isselling 3 units at$142

To sell 4, price mustbe lowered to $132

All customers

must pay the sameprice

TR increases $132minus $30 (3x$10)

$102 becomes apoint on the MRcurve

Try other prices todetermine otherMR points

Gain = $132

Loss = $30

The Constructed Marginal Revenue Curve

Must Always Be Less Than the Price

MR

Price and Marginal Revenue

Marginal revenue is less than price

10-65


66/110

Down-Sloping Demand

Marginal revenue < priceTo increase sales, must lower price

Firm is a price maker

Choose P,Q combination

Operate in the elastic region

Marginal revenue > 0

Total-revenue test (recall)

10-66


67/110

Monopoly Revenue and Costs

(1)Quantity

Of Output

(2)Price

(AverageRevenue)

(3)Total

Revenue(1) X (2)

(4)MarginalRevenue

(5)Average

Total Cost

(6)Total Cost

(1) X (5)

(7)Marginal

Cost

(8)Profit (+)

or Loss (-)

0

123456

789

10

$172

162152142132122112

102928272

$0

162304426528610672

714736738720

$162

142122102

826242222

-18

$190.00135.00113.33100.0094.0091.67

91.4393.7597.78

103.00

$100

190270340400470550

640750880

1030

$90

807060708090

110130150

$-100

-28+34+86

+128+140+122

+74-14

-142-310

Revenue Data Cost Data

]

]]]]]]]]]

]

]]]]]]]]]

Can you See Profit Maximization?10-67


68/110

Profit Maximization

0

$200

175

150

125

25

100

75

50Pr

ice,

Cos

ts,an

dRevenue

1 2 3 4 5 6 7 8 9 10

Quant i ty

D

MR

ATC

MC

MR=MC

Pm=$122

A=$94

EconomicProfit

10-68


69/110

Misconceptions

Not the highest priceThe monopolist seeks maximum total profit, not

maximum price.

Total, not unit, profitThe monopolist seeks maximum total profit, not

maximum unit profit.

Possibility of losses

10-69


70/110

Loss Minimization

0

Pr

ice,

Cos

ts,an

dRevenue

Quant i ty

D

MR

ATC

MC

MR=MC

Loss

AVCPm

Qm

V

A

10-70

E i Eff t


71/110

Economic Effects

PurelyCompetitive

Market

PureMonopoly

D D

S=MC MC

P=MC=Minimum

ATC

MR

Pc

Qc

Pc

Pm

QcQm

Pure competition is efficientMonopoly is inefficient

a

b

c

10-71

Economic Effects


72/110

Pure competition is efficientProductive efficiency

Allocative efficiency

CS+PS maximized

Monopoly is inefficient

Charge P>MCDeadweight loss

Income transfer

Economic Effects

10-72


73/110

Cost Complications

Economies of scaleSimultaneous consumption

A products ability to satisfy a large number of consumers at the same time

Network effects are present if the value of a product to each user, including existing users,

increases as the total number of users rises.

X-inefficiencyLowest ATC not achieved

Rent seeking behaviorTechnological advanceMore likely with monopoly?

10-73


74/110

Policy Options

Use antitrust laws

Divide the firm

Natural monopolyRegulate price

Ignore

Unstable in long run

10-74

P i Di i i ti


75/110

Price Discrimination

Three forms Charge each customer max

willingness to pay

Charge one price for first unitand a lower price for subsequentunits

Charge different customers

different prices

10-75



76/110

Conditions Monopoly power Market segregation

No resale Examples Airfares

Electric utilities Theaters & golf courses


10-76


77/110

Regulated Monopoly

Natural monopolies

Rate regulation

Socially optimum priceP = MC

Fair return priceP = ATC

10-77

Regulated Monopoly


78/110

0

PriceandCosts(Do

llars)

Quantity

Dilemma of RegulationMonopoly

Price

Fair-Return

Price

SociallyOptimal

Price

Pr

D

r

f

b

aPf

Pm

Qm Qf Qr

MR

MC

ATC

Regulated Monopoly

10-78


79/110


Monopolistic Competition andOligopoly

M li ti C titi


80/110

Monopolistic CompetitionLarge number of sellersSmall market sharesNo collusionIndependent action

Differentiated ProductsProduct attributesServiceLocationBrand names and packagingSome control over price

11-80

Monopolistic Competition



81/110

Easy entry and exitNeed for advertisingNonprice Competition

Which industries?Degree of concentration

Four-firm concentration ratioHerfindahl index

Monopolistic CompetitionMonopolistic Competition

11-81



82/110

Firms demand curveHighly elastic

Short run profit or loss

Produce where MR=MCLong run normal profitEntry and exit

InefficientProduct variety


11-82



83/110

Short-Run Prof i ts

Quantity

PriceandCos

ts

MR = MC

MC

MR

D1

ATC

EconomicProfit

Q1

A 1

P1

0


11-83



84/110

Short -Run Losses

Quantity

PriceandCosts

MR = MC

MC

MR

D2

ATC

Loss

Q2

A 2

P2

0


11-84will cause an exit of firms until normal profit is restored. After such entry and exit, the



85/110

Long -Run Equi l ibr ium

Quantity

PriceandCosts

MR = MC

MC

MR

D3

ATC

Q3

P3= A 3

0


11-85where it just equals average total cost at the MR MC output. At this price P 3 and output Q3 , the-

Oligopoly


86/110

Oligopoly

A few large producersHomogeneous ordifferentiated products

Control over priceMutual interdependence

Strategic behavior

Entry barriers

Mergers

11-86

Oli l


87/110

Oligopoly

Four-firm concentration ratioNeeds to be more than 40%

Localized markets

Inter industry competitionWorld trade

Import CompetitionHerfindahl index

11-87


88/110

Game TheoryRareAirs Price Strategy

Uptow

nsPriceStra

tegy A B

C D

$12

$12

$15

$6

$8

$8

$6

$15

High

High

Low

Low

2 competitors

2 pricestrategiesEach strategyhas a payoffmatrix

Greatestcombinedprofit

Independentactionsstimulate a

response 11-88


89/110

Game TheoryRareAirs Price Strategy

Uptow

nsPriceStra

tegy A B

C D

$12

$12

$15

$6

$8

$8

$6

$15

High

High

Low

Low

Independently

lowered pricesin expectationof greater profitleads to theworst

combinedoutcomeEventually lowoutcomes makefirms return tohigher prices

11-89


90/110

Game Theory

Mutual interdependencePricing policy

CollusionEnhances profit

Incentive to cheat

Prisoners dilemma

11-90

Three Oligopol Models


91/110

Three Oligopoly Models

Kinked-demand curve

Collusive pricing

Price leadership

Why three models?Diversity of oligopoliesComplications of interdependence

11-91

Kinked Demand Curve


92/110

Kinked-Demand Curve

Noncollusive oligopolyStrategies

Match price changes

Ignore price changes

Combined strategy

Price inflexibilityThe kinked-demand curve

11-92

Kinked-Demand Curve


93/110

Price

PriceandCosts

Quantity Quantity

0 0

P0

MR2

D2

D1

MR1

e

f

g

Rivals IgnorePrice Increase

Rivals MatchPrice Decrease

Q0

Competitor and rivals strategize versus each other

Consumers effectively have 2 partial demand curvesand each part has its own marginal revenue part

MR2

D2

D1

MR1Q0

MC1

MC2

P0

Resu l t ing in a kink ed-demand cu rveto the consumer pr ice and outpu t

are opt im ized at the kink

e

f

g

11-93

Cartels and Other Collusion


94/110

PriceandCosts

Quantity


Price and outputJoint profit maximization

D

MR=MC

ATC

MC

MR

P0

A0

Q0

EconomicProfit

Effect ively Shar ingThe Monopoly Prof i t

11-94

C t l d Oth C ll i


95/110


Covert collusionTacit understandings (gentlemans agreement)

Obstacles to collusion

Demand and cost differencesNumber of firms

Cheating

RecessionPotential entry

Legal obstacles: antitrust law11-95

Price Leadership Model


96/110

Price Leadership Model

Leadership tacticsInfrequent price changes

CommunicationsLimit pricing

Breakdowns in price leadership:

Price wars

11-96

Advertising


97/110

Advertising

Prevalent in monopolisticcompetition and oligopoly

Capture market shareBetter than a price cut

Information for consumers

Manipulation

11-97

Oligopoly and Efficiency


98/110

Oligopoly and Efficiency

Not productively efficientNot allocatively efficient

Tendency to share the monopoly

profitQualificationsIncreased foreign competition

Limit pricingTechnological advance

11-98


99/110


Technology, R&D, and Efficiency

Technological Advance


100/110

Technological Advance

Occurs in the very long run

Occurs in response to incentives

Arises from firm rivalry

Firms seek new profit

opportunities

11W-100

Invention Innovation Diffusion


101/110

Invention-Innovation-Diffusion

Three step processInventionPatent

InnovationProduct innovation

Process innovation

Diffusion

Requires R&D expenditure

11W-101

Firms Optimal R&D Amount


102/110

Firm s Optimal R&D Amount

Marginal benefit and marginal costSources of fundsBank loans

BondsRetained earnings

Venture capital

Personal savingsInterest-rate cost of funds

Expected-rate-of-return11W-102



103/110

18

16

14

12

10

8

6

4

$10

20

30

40

50

60

70

80

8

8

8

8

8

8

8

8

20

16

12

8

4

020 40 60 80 100

Expectedrate of

return, %R&D

millions

InterestRate

cost offunds, %

Ex

pectedRateofReturn,r

An

dInterestRate,

i(P

ercent)

Research and DevelopmentExpenditures (Millions of Dollars)

r = i i

r

p

11W-103



104/110

Three important pointsOptimal vs. affordable R&D

Expected, not guaranteed,returns

Adjustments

11W-104


105/110

Increased Profits

Increased revenue via product

innovationImportance of price

Unsuccessful new products

Product improvementsReduced cost via processinnovation

11W-105

Imitation and R&D Incentives


106/110

Imitation and R&D Incentives

Imitation problemFast-second strategy

Benefits of being first

PatentsCopyrights and trademarks

Brand-name recognition

Trade secrets and learning bydoing

Time lags

Profitable buyouts

11W-106

R l f M k t St t


107/110

Role of Market Structure

Which type of market structureis best suited to technological

advancePure competitionMonopolistic competition

Oligopoly

Pure monopoly

11W-107

Inverted-U Theory


108/110

Inverted-U Theory

More Competition Less Competition

0 25 75 10050

Concentration Ratio (Percent)

R&DExpendi

turesasa

Percentage

ofSales

A loose oligopoly supports

the optimum R&D spending11W-108

Technological Advanceand Efficiency


109/110

and Efficiency

Productive efficiencyIncreasing productivity of inputs

Allocative efficiencyA more-preferred mix of goods and

services

Creative destruction

11W-109


110/110

hank you

Documents

Microeconomics of Product Markets