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Managerial Economics & Business Strategy

Managerial Economics & Business Strategy. Chapter 8 Managing in Competitive, Monopolistic, and Monopolistically Competitive Markets. MC. $. ATC. AVC. Q f. Profit. Profit = ( P e - ATC )  Q f*. P e. P e = D f = MR. ATC. Q f*. A Numerical Example. Given P=$10 C(Q) = 5 + Q 2

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Managerial Economics & Business Strategy

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  1. Managerial Economics & Business Strategy Chapter 8 Managing in Competitive, Monopolistic, and Monopolistically Competitive Markets

  2. MC $ ATC AVC Qf Profit Profit = (Pe - ATC)  Qf* Pe Pe = Df = MR ATC Qf*

  3. A Numerical Example • Given • P=$10 • C(Q) = 5 + Q2 • Optimal Price? • P=$10 • Optimal Output? • MR = P = $10 and MC = 2Q • 10 = 2Q • Q = 5 units • Maximum Profits? • PQ - C(Q) = (10)(5) - (5 + 25) = $20

  4. MC $ AVC Loss Qf Should this Firm Sustain Short Run Losses or Shut Down? Profit = (Pe - ATC)  Qf* < 0 ATC ATC Pe = Df = MR Pe Qf*

  5. Shutdown Decision Rule • A profit-maximizing firm should continue to operate (sustain short-run losses) if its operating loss is less than its fixed costs. • Operating results in a smaller loss than ceasing operations. • Decision rule: • A firm should shutdown when P < min AVC. • Continue operating as long as P ≥ min AVC.

  6. MC $ ATC AVC Qf Firm’s Short-Run Supply Curve: MC Above Min AVC P min AVC Qf*

  7. Long Run Adjustments? • If firms are price takers but there are barriers to entry, profits will persist. • If the industry is perfectly competitive, firms are not only price takers but there is free entry. • Other “greedy capitalists” enter the market.

  8. $ $ S Pe Df D QM Qf Firm Market Effect of Entry on Price? S* Entry Pe* Df*

  9. MC $ AC QL Q Effect of Entry on the Firm’s Output and Profits? Pe Df Df* Pe* Qf*

  10. Summary of Logic • Short run profits leads to entry. • Entry increases market supply, drives down the market price, increases the market quantity. • Demand for individual firm’s product shifts down. • Firm reduces output to maximize profit. • Long run profits are zero.

  11. Features of Long Run Competitive Equilibrium • P = MC • Socially efficient output. • P = minimum AC • Efficient plant size. • Zero profits • Firms are earning just enough to offset their opportunity cost.

  12. Can we do it?? • Number 2 • A firm sells its product in a perfectly competitive market where other firms charge a price of $80 per unit. The firm’s TC are C(Q) = 40+8Q+2Q2 • How much output should the firm produce in the short run? • MR = MC • 80 = 8+4Q • 72 = 4Q • Q= 18 • What price should the firm charge in the short run? • Same price as others = $80 • What are the firm’s short run profits? • 80*18 – (40+8(18)+2(182)=608 • What adjustments should be anticipated in the long run? • More firms will enter and prices will fall, output will have to be reduced, and profits will end at the breakeven point

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