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