Kinh tế học - Chapter 12: Managerial decisions for firms with market power

Chapter 12Managerial Decisions for Firms with Market PowerMarket PowerAbility of a firm to raise price without losing all its salesAny firm that faces downward sloping demand has market powerGives firm ability to raise price above average cost & earn economic profit (if demand & cost conditions permit)2MonopolySingle firmProduces & sells a good or service for which there are no good substitutesNew firms are prevented from entering market because of a barrier to entry3Measurement of Market PowerDegree of market power inversely related to price elasticity of demandThe less elastic the firm’s demand, the greater its degree of market powerThe fewer close substitutes for a firm’s product, the smaller the elasticity of demand (in absolute value) & the greater the firm’s market powerWhen demand is perfectly elastic (demand is horizontal), the firm has no market power4Measurement of Market PowerLerner index measures proportionate amount by which price exceeds marginal cost:5Measurement of Market PowerLerner indexEquals zero under perfect competitionIncreases as market power increasesAlso equals –1/E, which shows that the index (& market power), vary inversely with elasticityThe lower the elasticity of demand (absolute value), the greater the index & the degree of market power6Measurement of Market PowerIf consumers view two goods as substitutes, cross-price elasticity of demand (EXY) is positiveThe higher the positive cross-price elasticity, the greater the substitutability between two goods, & the smaller the degree of market power for the two firms7Determinants of Market PowerEntry of new firms into a market erodes market power of existing firms by increasing the number of substitutesA firm can possess a high degree of market power only when strong barriers to entry existConditions that make it difficult for new firms to enter a market in which economic profits are being earned8Common Entry BarriersEconomies of scaleWhen long-run average cost declines over a wide range of output relative to demand for the product, there may not be room for another large producer to enter marketBarriers created by governmentLicenses, exclusive franchises9Common Entry BarriersInput barriersOne firm controls a crucial input in the production processBrand loyaltiesStrong customer allegiance to existing firms may keep new firms from finding enough buyers to make entry worthwhile10Common Entry BarriersConsumer lock-inPotential entrants can be deterred if they believe high switching costs will keep them from inducing many consumers to change brandsNetwork externalitiesOccur when value of a product increases as more consumers buy & use itMake it difficult for new firms to enter markets where firms have established a large network of buyers11Demand & Marginal Revenue for a MonopolistMarket demand curve is the firm’s demand curveMonopolist must lower price to sell additional units of outputMarginal revenue is less than price for all but the first unit soldWhen MR is positive (negative), demand is elastic (inelastic)For linear demand, MR is also linear, has the same vertical intercept as demand, & is twice as steep12Demand & Marginal Revenue for a Monopolist (Figure 12.1)13Short-Run Profit Maximization for MonopolyMonopolist will produce a positive output if some price on the demand curve exceeds average variable costProfit maximization or loss minimization occurs by producing quantity for which MR = MC14Short-Run Profit Maximization for MonopolyIf P > ATC, firm makes economic profitIf ATC > P > AVC, firm incurs loss, but continues to produce in short runIf demand falls below AVC at every level of output, firm shuts down & loses only fixed costs15Short-Run Profit Maximization for Monopoly (Figure 12.3)16Short-Run Loss Minimization for Monopoly (Figure 12.4)17Long-Run Profit Maximization for MonopolyMonopolist maximizes profit by choosing to produce output where MR = LMC, as long as P  LACWill exit industry if P MRP21Monopoly Firm’s Demand for Labor (Figure 12.6)22Profit-Maximizing Input UsageFor a firm with market power, profit-maximizing conditions MRP = w and MR = MC are equivalentWhether Q or L is chosen to maximize profit, resulting levels of input usage, output, price, & profit are the same23Monopolistic CompetitionLarge number of firms sell a differentiated productProducts are close (not perfect) substitutesMarket is monopolisticProduct differentiation creates a degree of market powerMarket is competitiveLarge number of firms, easy entry24Monopolistic CompetitionShort-run equilibrium is identical to monopolyUnrestricted entry/exit leads to long-run equilibriumAttained when demand curve for each producer is tangent to LACAt equilibrium output, P = LAC and MR = LMC25Short-Run Profit Maximization for Monopolistic Competition (Figure 12.7)26Long-Run Profit Maximization for Monopolistic Competition (Figure 12.8)27Implementing the Profit-Maximizing Output & Pricing DecisionStep 1: Estimate demand equationUse statistical techniques from Chapter 7Substitute forecasts of demand-shifting variables into estimated demand equation to get28Implementing the Profit-Maximizing Output & Pricing DecisionStep 2: Find inverse demand equationSolve for P29Implementing the Profit-Maximizing Output & Pricing DecisionStep 3: Solve for marginal revenueWhen demand is expressed as P = A + BQ, marginal revenue is30Implementing the Profit-Maximizing Output & Pricing DecisionStep 4: Estimate AVC & SMCUse statistical techniques from Chapter 1031Step 5: Find output where MR = SMCSet equations equal & solve for Q*The larger of the two solutions is the profit-maximizing output levelStep 6: Find profit-maximizing priceSubstitute Q* into inverse demand P* = A + BQ* Q* & P* are only optimal if P  AVCImplementing the Profit-Maximizing Output & Pricing Decision32Implementing the Profit-Maximizing Output & Pricing DecisionStep 7: Check shutdown ruleSubstitute Q* into estimated AVC functionIf P*  AVC*, produce Q* units of output & sell each unit for P* If P* < AVC*, shut down in short run33Implementing the Profit-Maximizing Output & Pricing DecisionStep 8: Compute profit or lossProfit = TR - TCIf P < AVC, firm shuts down & profit is -TFC34Maximizing Profit at Aztec Electronics: An ExampleAztec possesses market power via patentsSells advanced wireless stereo headphones35Maximizing Profit at Aztec Electronics: An ExampleEstimation of demand & marginal revenue36Maximizing Profit at Aztec Electronics: An ExampleSolve for inverse demand37Maximizing Profit at Aztec Electronics: An ExampleDetermine marginal revenue function38Demand & Marginal Revenue for Aztec Electronics (Figure 12.9)39Maximizing Profit at Aztec Electronics: An ExampleEstimation of average variable cost and marginal costGiven the estimated AVC equation:So,40Maximizing Profit at Aztec Electronics: An ExampleOutput decisionSet MR = MC and solve for Q*41Maximizing Profit at Aztec Electronics: An ExampleOutput decisionSolve for Q* using the quadratic formula*42Maximizing Profit at Aztec Electronics: An ExamplePricing decisionSubstitute Q* into inverse demand*43Maximizing Profit at Aztec Electronics: An ExampleShutdown decisionCompute AVC at 6,000 units:*44Maximizing Profit at Aztec Electronics: An ExampleComputation of total profit****45Profit Maximization at Aztec Electronics (Figure 12.10)46Multiple PlantsIf a firm produces in 2 plants, A & BAllocate production so MCA = MCBOptimal total output is that for which MR = MCTFor profit-maximization, allocate total output so that MR = MCT = MCA = MCB47A Multiplant Firm (Figure 12.11)48