Anúncio
Anúncio
Anúncio
Anúncio
Anúncio
Anúncio
Anúncio
Anúncio
Anúncio
Anúncio
Próximos SlideShares
Carregando em ... 3
1 de 196
Anúncio

1012019 Printhttpscontent.ashford.eduprintAUBUS640..docx

1. 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,sec… 1/45 Processing math: 0% 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,sec… 2/45 7 © Alan Schein/Corbis Market Structures and Price Determination Learning Objectives A�er reading this chapter, you should be able to: Dis�nguish among the four main types of markets (or market structures). Explain how markets work and how they determine the market- clearing prices. Dis�nguish between price-taking and price-making situa�ons for individuals and firms.
2. Discuss how the extent of product differen�a�on is cri�cally important for price-making. Iden�fy how the firm selects the price and output levels that maximize profit under various market structures. Processing math: 0% 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,sec… 3/45 A market is a tangible place or an intangible situa�on in which buyers and sellers communicate for the purpose of exchanging value. Purchasing items at a grocery store is an example of a tangible market. © Jupiterimages/Thinkstock Introduction In this chapter, we are primarily concerned with the manager's problem of choosing the appropriate price and output level in order to maximize the firm's profits. As you know, profits are the excess of revenues over costs. In the preceding four chapters we have been concerned with the demand and revenue side (Chapters 3 and 4) and the produc�on and cost sides (Chapters 5 and 6). In this chapter, we bring together the
3. cost and demand sec�ons of this course to help the manager make be�er pricing and output decisions. Business firms operate in markets; they sell their outputs of products or services in markets, and they buy their fixed and variable inputs in markets. Their inputs are in turn the outputs of other firms and individuals that supply products and services (such as direct materials, direct labor, buildings and equipment) to these input markets. Before proceeding with the firm's pricing and output decisions, it seems prudent to clarify what we mean by "markets." What Is a Market? A market can be defined as a tangible place or an intangible situa�on in which buyers and sellers communicate for the purpose of exchanging things of value. Buyers exchange money for goods or services, and sellers exchange goods or services for money. In barter markets, buyers and sellers exchange goods or services that they own for other goods or services that they want. Since the earliest �mes, people would gather in the village marketplace to buy and sell (or exchange by barter) food, clothing, animals, tools, weapons, and so on. Such physical market loca�ons s�ll exist, of course; even in modern ci�es you will find vegetable markets, fish markets, and so on. Other market loca�ons are visited only by those directly engaged in the transac�on, such as a person ge�ng a haircut at the hairdresser's shop, or a farm laborer going out to a farm looking for work. Market transac�ons can take place without the buyer or
4. the seller physically mee�ng: For example, you can use a telephone to call a roofer to fix your roof while you are at work, and later pay his invoice. To do this you (metaphorically) enter the market for roof repairs and choose one or more roof repairers who give you a price quota�on (or assurance that the price for the repair job will be fair), a verbal or wri�en contract is then entered into, and the transac�on is subsequently completed. The Internet has provided buyers and sellers with quick and effec�ve online access to millions of markets. Prospec�ve buyers can easily find out who sells the item they wish to purchase, what price and quality features are associated with the offer made by each seller, when and how delivery and payment will take place, and so on. Buyers and sellers can nego�ate the transac�on price online without mee�ng, or mul�ple and anonymous buyers can compete for the sale of a specific item via online auc�ons (on sites such as eBay). Similarly, buyers and sellers rou�nely enter into contracts to purchase and sell items, or to provide services for remunera�on, using text messaging or email correspondence. The extent of a market is limited by �me, space, and informa�on. First, markets take place at certain �mes, and it is too late tomorrow to enter today's market expec�ng to get yesterday's prices—prices (and perhaps also quali�es) may have changed considerably compared to yesterday's market outcomes. For example, if we hear on the news that Facebook stock prices fell today, trying to buy Facebook stock tomorrow we might find that its stock prices have
5. risen considerably. Second, markets take place at par�cular loca�ons, real or virtual, which in many cases limits the number of par�cipants if buyers and sellers have to be physically present to buy or sell the product or service, or if buyers need to follow specific processes to access a virtual market environment. For example, ge�ng a haircut requires the buyer to travel to a hairdresser, and there may be only three or four service providers within a convenient distance for the buyer, notwithstanding that there may be hundreds of barbers and hairdressers spread around the city and across the state. Similarly, a mobile mechanic may consider taking automobile repair jobs only within a radius of 20 miles, despite there being thousands more poten�al buyers of auto repairs outside that radius. Thirdly, markets are limited by the availability of informa�on to poten�al buyers and sellers. For example, poten�al home buyers may not know that their dream home has been put up for sale, and thus they do not a�end the auc�on at which it is sold. Similarly, poten�al sellers may not know that someone would be willing to offer them thousands of dollars for their an�que furniture, if only both par�es knew about the other's willingness to buy or sell. Markets require that par�cipants be informed about the market's existence and be able to enter (personally or by proxy) the marketplace (real or virtual) at the �me that the market transac�on is to occur. Thus, a market is a means by which buyers and sellers can get together in some sense to allow them to enter into and complete a transac�on. In any market, a transac�on can occur if a price can be agreed upon between the buyer and the seller. Our major concern in this chapter is how the structure of
6. the market influences the ability of the selling firm to set the price level for its output. The Four Basic Market Structures Economists iden�fy four basic market structures as follows: pure compe��on markets in which there are many sellers supplying iden�cal products, such as farmers selling milk, eggs, or corn, or individuals selling shares on the Stock Exchange; monopolis�c compe��on markets in which there are many sellers each supplying differen�ated products, such as coffee shops in the central business district of a large city;Processing math: 0% 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,sec… 4/45 Market Structures oligopoly markets in which rela�vely few sellers each supply iden�cal or differen�ated products, such as automobiles, aircra�, steel, and other building materials; and monopoly markets in which there is only one seller of the product or service which has no direct subs�tutes, such as your local gas or electricity u�lity. The number of compe�ng sellers and the degree of
7. product differen�a�on interact to give rise to an expecta�on, by the focal firm, of what rivals will do in reac�on to its price changes. When there are many firms (i.e., in pure compe��on and in monopolis�c compe��on), we expect that firms will not expect rival firms to react to their pricing decisions. Note that by "many firms" we mean a number sufficiently large that the produc�ve capacity of any one firm is a very small propor�on of the total produc�on capacity of the firms opera�ng in the market. Because of this rela�ve insignificance of any one supplier in pure compe��on and monopolis�c compe��on, none of these firms expects its ac�ons to be reacted to (or perhaps even no�ced) by other firms. Conversely, by "few firms" we mean a number small enough such that any one firm can produce a rela�vely large propor�on of market demand and consequently can influence the market price upwards (by withholding supply) or downwards (by flooding the market). Being a significant en�ty in such markets, the firm must expect reac�on from those affected by its compe��ve moves; we shall expand upon the expecta�ons of oligopolists regarding their rivals' reac�ons to their compe��ve moves later in this chapter. Monopolists do not have to worry about rivals' reac�ons because they have no direct rivals, but they do have to be concerned with the reac�ons of public regulatory bodies to their pricing and other compe��ve moves. Many public u�li�es that provide ci�es and communi�es with water, electric power, and household gas supplies are regulated monopolies that are subject to con�nual scru�ny by their regulators. Monopoly suppliers of services based on new technologies, such as Microso� and Google, must also heed the monopoliza�on sec�ons of
8. the Federal An�-Combines Act. The dis�nguishing differences of the four basic market structures are summarized in Table 7.1, along with examples of each type. Table 7.1: The four market structures Pure compe��on Monopolis�c compe��on Oligopoly Monopoly Number of compe�ng firms Many, due to no barriers to entry of new rivals Many, due to no barriers to entry of new rivals Few, due to high barriers to entry of new rivals One, due to an absolute barrier to entry for poten�al rivals Degree of product
9. differen�a�on Zero (iden�cal products) Small (slightly differen�ated products) Zero to substan�al (ranges from iden�cal to highly differen�ated products) Extreme (unique product with no direct subs�tutes, due to entry barrier) Expecta�on of rivals' reac�ons No reac�on expected due to very small share of total supply of the product No reac�on expected due to very small share of total supply of the product
10. Rivals are generally expected to match price increase but to ignore price reduc�ons1 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/ch07introduc�on#Ch7footNote1) No rivals, but does expect government regula�on if behaving "badly" Examples Agricultural commodi�es; stock markets; financial markets; foreign exchange markets Personal services; clothes retailers; foodservice providers (e.g., Coffee shops and restaurants) Steel, aluminum, cement, and glass building materials; car and airplane manufacturers; local oligopolies Pharmaceu�cal firm with patents;
11. electricity and gas u�li�es; unique items; labor unions; cartels The degree of product differen�a�on refers to the extent to which compe�ng suppliers' products contain the same or different product a�ributes, or more or less of these a�ributes, as discussed in Chapter 3. Product differen�a�on is as perceived by the customer and implies a preference ranking between and among compe�ng suppliers, that is, the customer would expect to gain more u�lity from some product variants than from others offered in the same market. In pure compe��on, the compe�ng sellers provide iden�cal products, meaning that their products are completely undifferen�ated, such as the shares in a company that might be offered for sale in the stock market by many small stockholders. In monopolis�c compe��on, the sellers compete in the same product category providing basically similar products which are more or less differen�ated in terms of their loca�on or the other product a�ributes offered. For example, the various coffee shops and fast- food stores that are sca�ered around a big city all offer food, snacks, and beverages but in slightly different formats and combina�ons, with be�er or worse service quality, and in more or less convenient loca�ons. In oligopoly markets, the degree of product differen�a�on can range from none to quite substan�al. It will be quite low in markets where a few sellers provide iden�cal products (such as tendering to buyer specifica�on for steel, aluminum, and other building materials) and the only
12. elements of differen�a�on might be the firms' more-or- less convenient loca�ons, proposed delivery �mes, reputa�on for service quality, or personal rela�onships between the buyer (or purchasing agent) and the seller. Taking the a�ribute view of product quality, as we did in Chapter Processing math: 0% https://content.ashford.edu/books/AUBUS640.12.1/sections/ch0 7introduction#Ch7footNote1 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,sec… 5/45 3, we can see that these loca�on, �ming, and service differences among compe�ng suppliers cause the buyer to differen�ate the quality of one seller from another when the basic product (e.g., steel supplied to exac�ng specifica�ons) is otherwise iden�cal. Conversely, product differen�a�on in oligopoly markets may be quite substan�al because the sellers' products or services are quite different or would be delivered in different ways by firms that are equally convenient or pleasant to deal with. Examples include the markets for automobiles, passenger flights, university degrees, suburban houses, and so on. In these examples, the different brands and models of cars, different classes of air travel, different subject ma�er to study, and different design features and loca�ons of homes cause the poten�al
13. buyer to restrict their choice to a subset of the suppliers or service providers in the broader market. In monopoly markets, the products of the monopolist are totally differen�ated from those available in other markets—by defini�on, a monopoly is the single supplier of a par�cular product category. Monopolies usually occur due to barriers to entry—meaning there are obstacles to the entry of compe�ng firms. These barriers include legal restric�ons preven�ng new entrants (such as for the post office and for gas and electricity u�li�es); restricted access to the technology necessary to compete effec�vely (such as trade secrets or patents); or control of necessary raw materials or human skills (such as control of all the bauxite deposits for making aluminum, or employment of the only person with a unique talent). Barriers to entry also operate to prevent entry of new firms into oligopoly markets, thus preserving the fewness of firms in those markets. For example, the barriers to entry preserving the fewness of firms in the automobile industry are due to the huge cost of establishing an automobile manufacturing plant and the associated network of distributors and service facili�es; the strong and established reputa�ons for quality of the exis�ng sellers; and the limited access to the latest and patented technology held by the incumbent firms.2 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/ch07introduc�on#Ch7footNote2) 1. This refers to one par�cular oligopoly situa�on. During a
14. "price war" for example, price reduc�ons by one firm should be expected to be matched or exceeded by rival firms. Alterna�vely, with price leadership, the price leader expects the price followers to match both price increases and price reduc�ons—we discuss these oligopoly situa�ons later in this chapter. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/ch07introduc�on#return1) ] 2. Another reason for the preserva�on of monopolies is that some markets are natural monopolies, meaning that they are rela�vely small markets and are most efficiently served by only one firm, due to the economies of plant size (introduced in Chapter 5). They are "natural" in the sense that although there are not insurmountable barriers to entry, if a new entrant did enter it would soon realize that it would be more profitable to sell out to, or merge with, the exis�ng firm and thus revert to the monopoly structure of the market. We consider natural monopoly later in this chapter. Similarly, some would argue that the automobile industry and the airplane manufacturing industry (for example) are natural oligopolies due to the massive economies of scale and economies of scope available to exis�ng firms, such that new entrants would ul�mately sell out to or merge with exis�ng firms (or perish due to price compe��on). [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/ch07introduc�on#return2) ] Processing math: 0% https://content.ashford.edu/books/AUBUS640.12.1/sections/ch0 7introduction#Ch7footNote2 https://content.ashford.edu/books/AUBUS640.12.1/sections/ch0 7introduction#return1
15. https://content.ashford.edu/books/AUBUS640.12.1/sections/ch0 7introduction#return2 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,sec… 6/45 Due to the fact that excess demand drives prices upward and excess supply drives prices downward, profit-maximizing sellers of undifferen�ated products must be price-takers. © Ryan McVay/Thinkstock 7.1 Short-Run Price and Output Decisions in Pure Competition In iden�cal–products markets, prices are determined by what we call market forces. These market forces are the pressure exerted by buyers and sellers to move the market price level upward or downward, and occur due to either excess supply or excess demand. Excess supply at the market price means that the quan�ty supplied exceeds the quan�ty demanded at that price, and thus sellers are unable to sell all that they want to sell at the exis�ng price. Because products are iden�cal in undifferen�ated product markets, a very slight reduc�on in price would allow the firm to offer a be�er value proposi�on to poten�al buyers. When products are undifferen�ated, price is necessarily the only difference between the various sellers' products, so all poten�al buyers would flock to any seller offering a lower price. That
16. firm would soon sell out, and other sellers would be similarly mo�vated to also reduce their price slightly, so that they too would sell more output (and make more profit). When all firms have slightly reduced their prices, the market price will have moved to the new slightly lower level. If there remains excess supply at this price level, the process would con�nue: Each firm is again mo�vated to reduce price slightly to sell all their output (rather than a lesser amount) at a price just below the market price. This process con�nues un�l the excess supply disappears, and it disappears when the quan�ty supplied by the sellers (at the market price) is just equal to the quan�ty demanded by all the buyers at that same price. Excess demand occurs when the quan�ty demanded by buyers at the market price exceeds the quan�ty that suppliers wish to provide at that price. Excess demand causes upward pressure on the market price level, and this occurs because any firm will see that it could sell all it wants to at a slightly higher price and will be mo�vated to raise its price to maximize its profits. Since all firms are similarly mo�vated to gain more revenue for the same quan�ty of output, the market price is pushed upwards slightly. If there remains excess demand at this higher price, it means that some buyers are s�ll seeking to buy the product but are unable to do so, so the profit- maximizing firm will see the opportunity to again raise price slightly and sell all it wants to at a slightly higher price. This process will be repeated un�l the excess market demand (and the upward pressure on market price) disappears and market quan�ty demanded equals market quan�ty supplied.
17. This principle—that excess demand drives the market price upward, and conversely, excess supply drives the market price downward—is the fundamental reason why profit-maximizing sellers of undifferen�ated products must be price-takers; that is, they simply accept the market-determined price (see Chapter 1). If a firm sets price above the market price, it would sell no product at all (and that will not be profit-maximizing). Conversely, if it sets price below the market price, buyers would want to buy all the firm could produce, but the rising marginal cost of the la�er units (due to the law of diminishing returns; see Chapter 5) would exceed the price and it would not be profit-maximizing to serve all the demand at the lower price. Although the seller opera�ng in pure compe��on can change its own price upward or downward, the profit-maximizing thing for the individual seller to do is to accept the market price level (unless there is evidence of excess demand or excess supply). There are many markets with many sellers of undifferen�ated products that fulfill the characteris�cs of pure compe��on. Examples are: the (stock) market for ownership shares in listed public companies, which determines the price of one unit of stock in a par�cular company at any par�cular �me; the loanable funds market, which determines the interest rate (borrowing price) for loans of any specific period and risk profile, issued in any specific currency; the bond market which determines bond prices for the bonds of
18. a specific company with a specific dura�on remaining before those bonds are redeemed; the foreign exchange market, which determines the exchange rate for a par�cular na�onal currency (i.e., price of that currency in terms of other currencies); and the market for undifferen�ated agricultural products such as milk, eggs, corn, and co�on.3 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.1#Ch7footNote3) In all these markets, price determina�on takes place all day every day, and prices move upwards or downwards many �mes each day according to whether there is temporarily excess demand or temporarily excess supply in the market at the prevailing price level. In Figure 7.1, we show the market demand and supply curves for a par�cular iden�cal products market. The market demand curve is the summa�on of the demand curves of individuals, as we saw in Chapters 3 and 4. Note that it slopes downward to the right so more will be demanded at lower prices than at higher prices. This follows from the u�lity-maximizing behavior of individuals who, as we saw in Chapter 3, will a�empt to equalize the ra�o of marginal u�lity to price (MU/P) for all products and services they consume. If the price of product X has fallen, other things being equal, the MUx/Px ra�o for the last unit purchased of product X must have increased, so consumers will buy more of X to restore the u�lity-maximizing balance of MU/P across all goods and services purchased. This subs�tu�on in favor
19. of product X does not go on forever because the MU of any par�cular product or service declines (due to the law of diminishing marginal u�lity) as the individual consumes more of that item. So MUx falls as more of product X is consumed un�l a new u�lity-maximizing combina�on of products and services is found (for each consumer) that necessarily includes more of product X than it did at the higher price. Thus, the market demand curve slopes downward to the right because more units are demanded at lower prices than at higher prices. Conversely, the market supply curve slopes upward and to the right so more is supplied to the market when the price is higher than when it is lower. The market supply curve reflects the summa�on of the supply of all the firms opera�ng in the market for a par�cular product or service. It slopes upward to the Processing math: 0% https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.1#Ch7footNote3 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,sec… 7/45 right because of the profit-maximizing behavior of suppliers who are subject to the law of diminishing returns in their produc�on processes. This law, you will recall from Chapter 5, reflects the declining marginal
20. product (MP) of the variable input factors as these are applied progressively and more intensively to the fixed factors of produc�on. We saw in Chapter 5 that diminishing marginal produc�vity causes the marginal cost (MC) of produc�on to rise progressively as the output rate increases.4 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.1#Ch7footNote4) The profit-maximizing firm will not want to supply output at levels where the MC (which equals incremental cost in this case) is higher than the price (which equals incremental revenue in this case). But at a higher market price the profit-maximizing firm would willingly supply more units of output, since the incremental revenue would exceed MC for at least one more unit of output. When all sellers act in this same way, it is clear that the aggregate amount they supply to the market must increase when the market price is higher and decrease when the market price is lower—thus the market supply curve slopes upward and to the right. In Figure 7.1, we demonstrate the existence of excess demand at price P1, where Q2 is demanded but only Q1 is supplied. This excess demand will leave a quantum of demand (equal to Q2–Q1) unsa�sfied and you can see that all of those poten�al buyers would be willing to pay P1 or more to purchase the product.5 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.1#Ch7footNote5) These unsa�sfied buyers will offer to purchase at prices higher than P1 and the
21. price will dri� upwards toward the price (P*) at which there is no excess demand le�. For example, suppose that in the egg market there is an automated auc�on system to determine the market price. The auc�oneer would first propose an ini�al price, such as P2 (per dozen of a par�cular quality, such as extra-large free-range eggs) and the poten�al buyers (i.e., food stores) enter their bids to buy various quan��es at that price, and the poten�al sellers enter their bids to supply various quan��es at that price. Suppose the automated system then calculates that quan�ty demanded (Q2) exceeds quan�ty supplied (Q1). The auc�oneer (or the automated system) then proposes a somewhat higher price and the poten�al buyers and sellers adjust their offers accordingly. We expect the buyers to want to buy somewhat less at the higher price as they will be ac�ng to maximize their profits and know that they face a downward-sloping demand curve for this product in their retail stores. Conversely, we expect the sellers to offer somewhat more eggs to the market at a higher price because, although they face increasing marginal costs of produc�on, the higher price will cover the incremental costs of addi�onal supply.6 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.1#Ch7footNote6) If there is s�ll excess demand at the higher price, the auc�oneer again proposes a s�ll higher price, and this process con�nues un�l the quan�ty demanded just equals the quan�ty supplied (i.e., Q*) at the equilibrium market price (P*).
22. Figure 7.1: Market supply and demand curves and the equilibrium market price Oppositely, if the price is ini�ally at the higher level, P2, the quan�ty supplied will greatly exceed the quan�ty demanded by the amount shown in Figure 7.1 as "Excess supply." Suppliers will find that there is insufficient demand for their products and they will have unplanned accumula�on of inventory (if the product is tangible) or underemployed workers and facili�es (if the product is a service). This will induce suppliers to reduce their quan�ty supplied (or output levels if supplied in real �me) while offering excess inventory of the product for sale at lesser prices.7 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.1#Ch7footNote7) Because (in pure compe��on) the firms' products are perceived to be iden�cal, the buyers will buy from any seller asking a lower price causing sellers who maintain the higher price to sell nothing at all. Thus, prices will fall un�l the excess supply situa�on is removed, and this occurs at price P*. At price P* there is neither excess demand nor excess supply, and thus there are no longer any market forces opera�ng to either raise or lower the price, and thus we say that P* is the equilibrium price. As noted in Chapter 1, the equilibrium price is also known as the market-clearing price, as its clears the market of all products to be sold. The Profit-Maximizing Output for Firms in Pure Competition We have argued above that the profit-maximizing firm will
23. want to raise its output rate if the market price is higher and reduce its output rate when the market price is lower. We will now explain more fully how the price-taking firm, opera�ng in an undifferen�ated market where price is determined by market forces, makes its output-rate decision. In Figure 7.2, we show the market price determina�on in the le�- hand graph and the firm's output rate decision in the right-hand graph. We extend a line across from the market graph to the firm's graph to signify the price level that the firm must set; in effect, that line becomes the demand curve for the purely compe��ve firm. A demand curve shows how much a firm can sell at various price levels—in this case the purely compe��ve firm can only use one price level, but it can sell any amount (i.e., all that it wants to) at the market price level. Thus, we showProcessing math: 0% https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.1#Ch7footNote4 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.1#Ch7footNote5 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.1#Ch7footNote6 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.1#Ch7footNote7 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,sec… 8/45 The foreign exchange market is an
24. example of pure compe��on. Price determina�on occurs daily, and prices shi� several �mes each day according to whether there is temporarily excess demand or supply in the market at the prevailing price level. © TongRo Image Stock/Thinkstock the firm's demand curve as the horizontal line labeled d. Since the firm can sell any number of output units at the market price, its marginal revenue, which is defined as the change in total revenue (TR) due to a one-unit change in the output rate, or MR = ΔTR/Δq, must be equal to price, and thus the MR curve, shown as mr, is depicted by the same line as the demand curve for firms opera�ng in pure compe��on. Now, to maximize profit at the market-determined price the firm must choose its output level such that marginal costs (MC) are equal to marginal revenue (MR). To understand why profits are maximized when MC = MR, consider a situa�on where MC > MR; this would mean that the last unit of output adds more to total cost (TC) than it adds to total revenue (TR) and thus it must reduce profit. Conversely if MR > MC this would mean that the last unit of output adds more to TR than it adds to TC, and thus its produc�on and sale must increase profit. It follows that produc�on should be increased to the output level where MC = MR (but not beyond this output level) if the firm wishes to maximize profit. In Figure 7.2, we can see this occurs at the output rate depicted as q*. Note that if the firm produced even one extra unit beyond q*, the point on the MC curve would lie above the mr curve, and thus profits would be
25. reduced. Conversely, if the firm produced one less unit than q* the relevant point on the MC curve would be less than the MR and the firm would have foregone an opportunity to make a small addi�onal contribu�on (since incremental revenue would be higher than incremental costs) to the firm's profit. Thus, the profit-maximizing rule is to set output level such that MC = MR, which in the case of the firm in pure compe��on is the same as se�ng output such that MC = P. Figure 7.2: The firm's choice of output rate in pure compe��on No�ce that the area of the shaded rectangle in Figure 7.2 represents the firm's profits. The area of a rectangle equals height by width, of course. The height of the shaded box is equal to the difference between price and the short-run average cost at output level q*, that is P*–SACʹ, which is the (average) profit per unit at output level q*. The width of the box is equal to the number of units produced. Thus, total profits are equal to average profit per unit �mes the number of units, shown as the area of the shaded rectangle. The difference between price and SAC (i.e., P* – SACʹ) is also known as the price–cost margin or simply the profit margin. Also no�ce that in Figure 7.2 we have used lowercase le�ers to depict the firm's demand, marginal revenue, and output levels to avoid confusion with the market-level demand and output variables. The rela�onship between big Q* and li�le q* is interes�ng, however. Since we have shown a representa�ve or average firm, we can say that Q* = nq* where n is the number of firms in the industry—the
26. profit-maximizing outputs of the many small firms must add up to the total amount supplied to the market at price P*, namely Q*. (Obviously the scales on the horizontal axes in Figure 7.2 are different for the market graph and the firm's graph.) Shifts of Market Demand and Supply Curves The equilibrium market price is temporary, however, since any shi� of either the market supply curve or the market demand curve will cause a situa�on of either excess demand or supply to arise, and thus price will move towards a new equilibrium level. Such price adjustments happen con�nually in the stock markets, funds markets, bond markets, foreign exchange markets, and in agricultural commodity markets. So, firms that operate in purely compe��on markets should expect market price to change from �me to �me, and will need to respond quickly to adjust their output levels so that they can maximize profits under the new market condi�ons. In Figure 7.3, we show a shi� in the market demand curve due to a change that has happened in the consumers' world. Perhaps their incomes have increased, or they have had a change in tastes towards this product. Or, perhaps the price of another product complementary in consump�on has fallen, or for some other reason (as discussed in Chapters 3 and 4), individual demands for this product have increased and thus the aggregate or market demand has shi�ed to the right. Since this demand shi� will cause excess demand at the former equilibrium market price P*, the price will be quickly adjusted
27. upwards towards a new equilibrium price P**. Figure 7.3: Output adjustments by firms due to a shi� in market demand curve Processing math: 0% 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,sec… 9/45 Law of Demand and Supply The individual firm's response to the higher market price will be to increase its output up to the point where MC equals the new marginal revenue level, which is shown as mrʹ in Figure 7.3. You can observe that the firm's profit has increased substan�ally, being equal to the much larger rectangle (in darker shading) defined by its height (the ver�cal distance between the new price level P** and the somewhat higher SAC level at output level q**) and its width (the number of units at the new profit-maximizing output level q**). Also, note that the increase in the equilibrium market supply (from Q* to Q**) must be equal to n �mes the increase in supply of the individual firm (from q* to q**), where n is again the number of firms in the industry. Note that we have now explained both the ini�al (Q*) and the subsequent
28. (Q**) market equilibrium quan��es supplied as the aggregate of the amounts supplied by the many firms in the industry in each situa�on. What is true for two aggregate output levels can be shown for other output levels as well. Thus, you will appreciate that the market supply curve S is actually the horizontal summa�on of the MC curves of the many firms in the industry.8 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.1#Ch7footNote8) Indeed, the MC curve (for firms in pure compe��on) is effec�vely the individual firm's supply curve, since it shows what output level the individual will supply at various price levels. We saw in Chapter 3 that the market demand curve D is the horizontal summa�on of the individual consumers' demands at various price levels. Thus, individual suppliers and individual consumers jointly determine the market price in markets for undifferen�ated products. These market forces that cause price to rise when there is excess demand and to fall when there is excess supply are simply the result of individual consumers and suppliers trying to maximize their u�li�es and their profits, respec�vely. 3. Just as in the stock market example where we view the market for one company's stock (e.g., Google) to be a separate market from the market for another company's stock (e.g., Facebook), in these other markets, we view different quali�es of product (e.g., eggs from hens in cages versus eggs from free- range hens) as separate markets. In the market for free- range eggs, for example, most consumers will regard the various
29. suppliers of free-range eggs to be supplying iden�cal products (in the absence of significant brand name recogni�on that would differen�ate these products of compe�ng suppliers). So, although buyers will compare the products offered across a product category as differen�ated subs�tutes (e.g., bonds with different maturi�es issued by different firms) they will choose the bond that offers the superior value proposi�on from their point of view, and in that bond market (e.g., for a bond issued by a par�cular organiza�on with a par�cular maturity) they will expect to pay the market-determined price. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.1#return3) ] 4. The output rate refers to the number of units of output produced per period of �me, shown as Q/t in the figures, to refer to output levels in any one produc�on period. An increased rate of output necessarily requires increased input of the variable inputs and involves the law of variable propor�ons (or the law of diminishing returns to the variable inputs). For the most part, we will simply say increases or decreases in output, or in output levels, but keep in mind that in the short-run context we mean the output rate per period of �me. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.1#return4) ] 5. The demand curve not only shows the maximum quan�ty buyers will demand at any price, but simultaneously shows the maximum price they will pay for any quan�ty. Note that all of the buyers between Q1 and Q2 are willing to pay a price higher than P1 (except for the very last buyer who is prepared to pay only P1). [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.1#return5) ]
30. 6. Note that eggs can be held in cold storage for weeks and that the sellers can decide to supply more eggs from storage if the price is high enough or conversely, take some or all their eggs back into storage if the price is not high enough. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.1#return5) ] 7. The upward-sloping supply curve reflects the rising MC levels of individual suppliers. For those firms, MC (incremental costs) should not exceed price (incremental revenue) if they are to maximize profit. When the market price is lower, MC > P for the later units of produc�on. So the firm must reduce its output rate to reduce its MC and avoid making losses on output units produced when MC is higher than the market price. Price will tumble down from P2 to P* because at least some firms will sell their build-up of excess inventories at prices below P2 and no buyer will be willing to pay a higher price for an undifferen�ated product if a lower price is available somewhere in the market. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.1#return7) ] 8. The industry supply curve should be drawn as somewhat curved, as in Figure 7.4, to reflect it being the horizontal summa�on of the firms' MC curves which are typically curved. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.1#return8) ] Processing math: 0% https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.1#Ch7footNote8
31. https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.1#return3 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.1#return4 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.1#return5 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.1#return5 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.1#return7 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.1#return8 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,se… 10/45 The entry of new firms can only occur in the long run. When the barrier to entry is low, new firms will con�nue to sprout up in the industry as long as its profits are superior to those obtainable in other industries. © Peter Beck/Corbis 7.2 Long-Run Adjustments in Pure Competition In Table 7.1, we noted that there are many firms in purely compe��ve industries because there are no barriers to entry, which means that other firms can enter the industry if they want to. Of course, they will want to in the
32. case we have just seen—the healthy profits being earned by the representa�ve firm in the above situa�on will surely a�ract the entry of new firms keen to share in the profitability of this industry. Entry of new firms can only happen in the long run which, as we saw in Chapter 5, is the hypothe�cal situa�on in which a firm can change the fixed inputs necessary for produc�on. Some of these new entrant firms will be new firms started by individuals keen to be self-employed rather than work in another firm as an employee, while other new entrant firms will be exis�ng firms star�ng to produce the focal product as a product-line extension or exis�ng firms leaving industries that are unprofitable or less profitable and moving their resources into this more-profitable industry. In the case of entry by start-up firms, these firms must change their fixed resources from zero to some finite plant size, while firms switching into produc�on of this product must acquire at least some new industry- specific fixed resources in order to produce the product that is characteris�c of the industry. Because the market supply curve is the horizontal summa�on of the individual firms' MC curves, it is evident that the entry of new firms must shi� the industry supply curve to the right, and we know that this will cause excess supply (assuming market demand is unchanged) and, thus, the market price will fall to a new equilibrium level. This will cause each firm to reduce its output level in order to maximize profits under the new condi�ons and the level of profit for the firms will be smaller than before as a direct result of the entry of the new firms. Indeed, if there are no barriers to entry, new firms will con�nue to
33. enter this industry as long as its profits are superior to those obtainable in other industries, such that eventually all profit will be squeezed out of this industry, as we shall see. Choice of Plant Size in the Long Run In Chapter 5, we noted that in the long run the firm can switch to any other size of plant and that, in so doing, it might experience economies of plant size, constant returns to plant size, or diseconomies of plant size. That is, a larger plant size might cause the SAC curve to sit lower, or at the same level, or at a higher level than the current plant size. So, if the entry of new firms reduces the profits of exis�ng firms, the exis�ng firms should inves�gate whether a different (larger or smaller) plant size would allow them to be more profitable. But, in fact, the situa�on facing the firm producing undifferen�ated products in an industry with no barriers to entry is worse than that—there is generally only one plant size that will allow them to even survive, and that is the one we called (in Chapter 5) the op�mum size of plant, which is the SAC that is nested at the lowest point of the long-run average cost curve (LAC). In Figure 7.4, we show an LAC curve and the op�mum size of plant is denoted as SAC*. Imagine that the representa�ve firm is ini�ally opera�ng the smaller plant size shown as SACʹ and the equilibrium market price is ini�ally P* reflec�ng the intersec�on of the ini�al market demand and supply curves D and S. The representa�ve firm's profit- maximizing output level is ini�ally q* where MC = mr under the ini�al market and industry condi�ons.
34. Figure 7.4: Movement to the op�mum plant size in the long run At the ini�al market demand (D) and supply (S) situa�on, the representa�ve firm is making a healthy profit, since the market price P* is higher than its average costs (on the SAC' curve) at the profit-maximizing output level q*. But the existence of this profit will a�ract the entry of new firms in the long run. The poten�al for exis�ng firms to make even larger profits by building the op�mum size of plant will result in addi�onal supply of product from these firms, which must shi� the market supply curve to the right, as shown by Sʹ in the le�-hand side of Figure 7.4. If just the right number of new firms enter the market, and all firms adopt the op�mum size of plant, the supply curve will be shi�ed across to Sʹ, which will force the equilibrium price down to P** just equal to the minimum level of the LAC curve. You can see that the only way that the representa�ve firm can survive in this industry is to move to plant sizeProcessing math: 0% 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,se… 11/45 SAC* since it is inevitable that the market price will fall to the long-run equilibrium price level P**, which just covers average costs at the minimum point of LAC* (where MC* = mr*). If it fails to move to the op�mum plant size before too many new firms enter the
35. industry it will be le� stranded with a higher cost structure, will take losses, and may be unable to afford to build the op�mum plant size that will allow it to remain in the industry.9 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.2#Ch7footNote9) Normal Profit in the Long Run But why would a firm want to stay in an industry if the price is just equal to the level of average costs? Does this mean the firm is making no profit at all? Well, no, it does not, because we are speaking in terms of economic costs (see Chapter 5) meaning that the costs include the opportunity costs of being in this par�cular industry—that is, the cost curves include, as a foregone opportunity cost, the return on investment that could have been obtained in the next-best-alterna�ve investment opportunity. That means there is no incen�ve to shi� from this industry to the next-best-alterna�ve industry because the firm is already earning what it could earn in that alterna�ve industry. When price is just equal to SAC, economists say that the firm is earning normal profit, meaning the profit level is as good as the firm could earn elsewhere. So, suppose the firm could alterna�vely have earned 5% return on investment (ROI) in the next-best-alterna�ve use of its resources (in a different industry); normal profit in the chosen industry represents a 5% rate of return on investment. Conversely, when price exceeds SAC, like in the shaded box in Figure 7.2, economists say the firm is earning pure profit, or excess profit, also known as economic profit, which is a be�er profit rate than it
36. could earn elsewhere (i.e., > 5% ROI in this example). If the firms in a purely compe��ve market are making losses in the short run, due to too many firms in the industry, they will want to sell up their fixed resources and invest in a different industry as soon as they can—that is, in the long run. Some of these firms will have smaller financial reserves and will be forced to close, or will find a buyer sooner than others, and as they do stop supplying output, the market supply curve will move back to the le�, li�le by li�le, un�l a new market equilibrium is a�ained and all remaining firms can earn normal profit again. Examples of this kind of adjustment are seen in small- farm agriculture and also in the coastal fishing industry: when prices are "bad," some firms cease supplying the market and sell their farm or their fishing boat, reducing total supply. When prices rise again, others buy the assets (farms or boats) and enter the industry, forcing prices down again, and this process con�nues with profits oscilla�ng around the normal profit level. What we have seen here, in the context of an industry with no barriers to the entry of new firms and where the firms produce undifferen�ated products, is that while firms may make pure profits in the short run, they can only expect to make normal profits in the long run.10 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.2#Ch7footNote10) In the next sec�on we look at firms producing differen�ated products in other market forms where they are protected by barriers to the entry of new firms, and we will see that such firms can make
37. pure profits in the long run. 9. Note that a late move to the op�mum size plant by an exis�ng firm would shi� the market supply curve to the right and depress market price below the LAC curve. Thus, all firms would take losses and would wish to exit the industry. Some would be able to liquidate their fixed assets sooner than others and would leave, thus causing the market price to rise, such that all remaining firms would no longer be taking losses and would no longer want to exit the industry. Note also that short-run profits may induce a flood of new entrants (ac�ng independently) such that the market price might be forced down below minimum LAC. This would cause some firms to exit the industry un�l exactly the right number of firms remain in the industry, such that market supply and demand intersect at an equilibrium price level that is just equal to the minimum level of the LAC curve. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.2#return9) ] 10. The pure compe��on long-run equilibrium assumes that all pure-profit opportuni�es elsewhere have already been taken; that is, in the absence of barriers to entry, new firms keep being established to exploit pure-profit opportuni�es un�l there are none le�. The long-run equilibrium situa�on (where all firms make only normal profits) is never likely to be observed in prac�ce because market demand and supply curve are con�nually shi�ing back and forth due to exogenous shocks, causing the firms to be con�nually adjus�ng to those changes. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.2#return10) ] Processing math: 0%
38. https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.2#Ch7footNote9 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.2#Ch7footNote10 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.2#return9 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.2#return10 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,se… 12/45 A farmer's market is an example of monopolis�c compe��on because there are many vendors offering slightly differen�ated products. Some vendors might have friendlier service or be�er looking produce than the compe��on. © iStockphoto/Thinkstock 7.3 Monopolies and Oligopolies As we saw in Table 7.1, there are three market forms in which the firms' products are differen�ated, namely monopolis�c compe��on, oligopoly, and monopoly. In the following subsec�ons we shall examine the firm's pricing and output decision for profit maximiza�on in each of these market structures. The common theme is that these firms are price-makers and face downward-sloping demand curves (at the firm level), which means that they can sell more
39. output at lower prices and less at higher prices. Thus, they have a combined price and output decision to make. Monopolis�c compe��on is characterized by many firms producing slightly differen�ated products in an industry that has no barriers to entry. Thus, it is different from pure compe��on in only one way: the firms' products are differen�ated rather than iden�cal. Because the products are differen�ated, raising price slightly above the price of rivals will not cause sales to fall to zero (as it would in the iden�cal products case). While some customers will switch to another product when the firm raises its price slightly, most customers will remain with the firm, because they believe the firm s�ll offers them the best value proposi�on even at a slightly higher price. You will recall from Chapter 3 that the value proposi�on can be characterized as "quality over price." Different percep�ons of quality underlie the percep�on of product differen�a�on. In monopolis�c compe��on different customers look at the compe�ng products from their own individual perspec�ves and perceive qualita�ve differences that either do appeal to them (or do not), thus inducing them to pay more (or less) for the different products. An example of monopolis�c compe��on would be a farmer's market, where some of the vendors have more friendly personali�es, and some of the vendor's apples are shinier and less marked than others. You might willingly pay five cents more per apple if the seller was friendlier and the apple was perfect compared with another nearby seller who was grumpy and had blotchy apples. But, if the former seller raised his price by another 10 cents you might
40. change your mind and buy the cheaper less-perfect apple from the less-perfect vendor. Others might s�ck with the friendly seller at the higher price even when the price is raised by an addi�onal 10 cents because in their minds it is s�ll the best value proposi�on. Another example of monopolis�c compe��on might be coffee shops in large ci�es; people will see them as differen�ated on one or more criteria that are important to them (e.g., coffee taste, convenience of loca�on, cheerful vendor) and will prefer one over the others. However, this preference will not be sustained if their preferred seller raises its price by too much—another seller's product then becomes a be�er value proposi�on. A third example might be clothing retailers in large shopping malls. O�en there are dozens of compe�ng clothing stores in a large mall, and the clothes for sale typically differ between the stores, the quality of service may differ, and some stores are closer to the parking lot. Even when two or more stores sell exactly the same dress, the "product" (which includes the a�ributes of service quality, shopping ambiance, and convenience of loca�on) is likely to be seen as slightly differen�ated. Accordingly, some of these firms will have slightly higher prices and others slightly lower prices for their similar but differen�ated products, and all firms could raise their prices slightly without losing all their customers. On the other hand, if they reduced prices slightly, they would gain a significant number of customers, but many others would ignore the price reduc�ons and s�ck to their current supplier.11 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#Ch7footNote11)
41. The demand curve for a monopolis�c compe�tor will be downward sloping but rela�vely flat. That is, there will be a rela�vely price–elas�c demand reac�on to price increases or price decreases, meaning that the percentage change in quan�ty demanded would be significantly larger than the percentage change in the firm's price level, as we learned in Chapter 4. Also in Chapter 4 we learned that when the firm's demand curve is downward sloping, total revenue (TR) will rise at first and later fall as price is varied from rela�vely high levels to rela�vely low levels, such that the TR is represented by an inverse U-shaped curve, sloping upwards at first, reaching a maximum, and sloping downwards therea�er as price is reduced s�ll further (see Figure 4.2 in Chapter 4). Since marginal revenue (MR) is the rate of change of TR, we saw that it falls progressively, reaches zero at the midpoint of the demand curve, and is nega�ve therea�er. This rela�onship between the demand curve and the MR curve for a monopolis�c compe�tor is shown in Figure 7.5, but note that because the firm's demand curve is highly elas�c the MR curve does not become nega�ve (i.e., cut the horizontal axis) within the range of outputs relevant to the firm's SAC and MC curves in Figure 7.5. The profit-maximizing rule remains the same: The firm should set price and output such that marginal costs equal marginal revenue, in this case MC = mr. Thus, the firm sets price P and output level q and consequently maximizes profit, which is shown as the rectangle equal to the average profit (i.e., P – SAC) �mes q units. Figure 7.5: Price and output determina�on for the firm in monopolis�c compe��on
42. Processing math: 0% https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#Ch7footNote11 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,se… 13/45 Long-Run Adjustment in Monopolistic Competition Because this firm is making pure profit and there are no barriers to entry in monopolis�c compe��on, other firms will be mo�vated to enter this industry producing similar but differen�ated products un�l all the pure profit is squeezed out. As in purely compe��on markets, the exis�ng firms must adjust their plant sizes to ensure that they can make normal profits rather than losses (which would force them to exit the industry). In Figure 7.6 we show the long-run equilibrium outcome for firms opera�ng in a monopolis�cally compe��on market. Their demand curve has shi�ed to the le� as new rivals con�nue to enter and "steal" some of their sales. They can only survive if they build the size of plant (SAC*) that is tangent to the LAC at the point where the LAC is tangent to their demand curve, such that P = SAC = LAC, and separately MC = mr, of course. Figure 7.6: Long-run equilibrium for the firm in monopolis�c compe��on
43. Thus, the firm in monopolis�c compe��on faces the same fate as the firm in pure compe��on; that is, other profit-seeking firms will enter the industry and squeeze out all the excess profits. The firms will nonetheless con�nue in business in their chosen industry because their economic cost of produc�on includes the opportunity cost of using their resources in the next-best-alterna�ve industry. The lesson to be learned is that absence of barriers to entry means that while these firms may earn pure profits in the short run they cannot expect to earn pure profits in the long run. We turn now to the remaining market forms that are characterized by barriers to the entry of new firms, and consequently examine situa�ons where the firms can make pure profits in the long run. Oligopoly An oligopoly is a market in which there are only a few sellers; the word is derived from the Greek word oligos, meaning few and the La�n word polis, meaning seller. "Few" in this context means a number small enough so that the ac�ons of any one firm have a no�ceable impact on the demand for each of the other firms in the market. Few also means that the firms will each have a significant share of the total sales in the market, and this market share becomes an important yards�ck by which they measure their success in the market. In the real world, the great majority of markets are oligopolies— prominent examples are the aircra�, automobile, steel, chemical, and pharmaceu�cal industries. These are na�onal and in some cases interna�onal
44. oligopolies. In other industries, where there are hundreds or even thousands of firms na�onally or globally, firms will cons�tute oligopolies in the local or regional area due to transporta�on costs or consumer ignorance. For example, your bread would come from one of a few local bakeries, your car would be bought from one of a few local dealerships, ready-mixed cement would be sourced from a few local cement companies, and so on. Looking at this from the customer's viewpoint, an oligopoly exists when a typical customer considers only a few sellers when making a purchase decision, such that the sale made by Processing math: 0% 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,se… 14/45 The aircra� industry is an example of an oligopoly because it is a market in which there are only a few sellers. © iStockphoto/Thinkstock one seller is in effect a sale missed by another. If one seller conducts a promo�onal campaign or reduces its price, its sales increase substan�ally and the sales of the other firms decrease significantly, unlike monopolis�c compe��on where the gain of sales to one firm were spread as insignificantly small
45. reduc�ons of demand across many rivals.12 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#Ch7footNote12) Thus, oligopolists suffer from mutual dependence, meaning the ac�ons of one firm impact upon the others, and vice versa. Restric�ng our discussion to price and output changes for the moment, the focal firm opera�ng in an oligopoly will soon learn that when another firm makes a price reduc�on and gains a substan�al increase in sales, the focal firm suffers a significant decrease in sales. This also works the other way around when the focal firm reduces its price. The firm will also learn that when it increases its price, it loses a substan�al propor�on of its sales while other firms gain significantly, and vice versa. Recogni�on of this mutual dependence will cause oligopolists to predict the reac�ons of rivals to their compe��ve ac�ons. If a firm expects that its rivals will react to its price reduc�on by also reducing price (to avoid loss of market share), the firm may decide that it is not worthwhile cu�ng price. Sales volume would increase only slightly, but there would be a reduced price for all units of output that would have been sold at the original (higher) price. Similarly, if the firm expects that other firms will ignore its price increase (since their sales volumes would increase significantly) it may decide that a price increase is not worthwhile. In the following sec�ons, we shall discuss two scenarios o�en experienced by oligopolists that are based on the firm's predic�on of how rivals
46. will react to its price changes. The first is the kinked demand curve, which results in prices not being adjusted very frequently despite changes in cost or demand condi�ons, and the second is conscious parallelism, which results in prices being adjusted every �me there is a significant change in cost or demand condi�ons.13 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#Ch7footNote13) The Kinked Demand Curve of Oligopoly Oligopolists face a kinked demand curve when they expect rivals to ignore a price increase (to gain market share) but to match a price decrease (to protect their market share) and this arises because the demand curve for a price increase is highly price elas�c while the demand curve applicable for price reduc�ons is highly price inelas�c.14 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#Ch7footNote14) That is, for price increases above the current price, quan�ty demand would decrease along a rela�vely flat demand curve, while for price decreases the quan�ty demanded would increase along a rela�vely steep demand curve. Thus, the demand curve faced by the firm is made up of two segments of different slopes that join at the current price level, and thus the firm's demand curve has a kink at the current price level, as shown in Figure 7.7. Figure 7.7: Price rigidity with a kinked demand curve
47. Although this figure looks complex, you already have the knowledge to interpret it. The kinked demand curve (shown as the kinked line dadʹ, or the line connec�ng the points d, a, and dʹ) is made up of sec�ons of two different demand curves. The upper sec�on of the kinked demand curve (i.e., the sec�on da) is the demand curve that is appropriate for independent price increases, and the lower sec�on (i.e., adʹ) is the demand curve appropriate for joint price reduc�ons. Similarly, the marginal revenue curve (the disjointed line db-cmr) is made up of two parts of the marginal revenue curves that are associated with the relevant sec�ons of the demand curve, with a gap (b-c) between the two tangible sec�ons.15 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#Ch7footNote15) Note that each of the marginal revenue curves is located such that it has the same ver�cal intercept and twice the slope of its "parent" demand curve, as we learned in Chapter 4. Now note that I have shown the MC curve passing through the gap in the marginal revenue curve. Thus, if the price were to be raised above price P, the price-quan�ty coordinate would move back along the independent- ac�on demand curve (i.e., sec�on da) and MR would exceed MC, indica�ng that the firm should increase its output rate to maximize profit. Conversely, if the price were to be reduced below P along the joint- ac�on demand curve (i.e., sec�on adʹ), output would increase, MC would exceed MR at any higherProcessing math: 0% https://content.ashford.edu/books/AUBUS640.12.1/sections/sec
48. 7.3#Ch7footNote12 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#Ch7footNote13 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#Ch7footNote14 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#Ch7footNote15 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,se… 15/45 When the cost of avia�on fuel increases, airlines respond by raising airfares. This is an example of conscious parallelism. © Comstock/Thinkstock output rate, so profit would be increased by raising price back to where it was. Thus, the current price level P is indeed the profit-maximizing price, with the magnitude of profit depicted by the rectangle defined by the price–cost margin (P-SACʹ) �mes the number of units sold, q. Since the MC curve passes through the gap in the marginal revenue curve, costs condi�ons could change substan�ally without causing the price to change. For example, the MC curve could shi� ver�cally up or down a considerable distance yet s�ll remain within the gap in the MR curve. Similarly, with the MC curve unchanged, changes in the customers' incomes or preferences that cause the demand curves to move either
49. to the right or to the le� would shi� the gap in the MR curve (to the right or the le�, within limits) without causing the MC curve to intersect a solid sec�on (either db or cmr) of the MR curve. Thus, the current price would remain the profit-maximizing price (although the magnitude of profit would rise or fall due to the shi�s in the cost or demand curves) and we would see the characteris�c price rigidity of kinked demand curve oligopoly. That is, price levels remain fixed at the current level despite changes in cost or demand condi�ons because of the firms' expecta�ons that price increases would be ignored and price reduc�ons would be followed. Conscious Parallelism in Oligopoly Markets In many oligopoly markets the recogni�on of their mutual dependence leads rival firms to adopt an implicit price leadership model, whereby one firm (the price leader) ini�ates a price increase and the other firms (price followers) independently raise price by the same amount or by a similar percentage. Note that an explicit agreement to jointly adjust prices would be quite illegal under collusive pricing provisions of the An�-Combines Act in the United States (or under similar laws against price fixing in other countries). It is not illegal, however, for one firm to raise price independently and take the risk that others will not follow. If rival firms subsequently also raise their prices to a similar extent, all firms will avoid the kink, since quan�ty demanded would move upwards along an extension of the more inelas�c (joint- ac�on) part of the oligopolist's demand curve. In prac�ce, we o�en see firms in oligopoly markets independently but more or less
50. simultaneously adjus�ng their prices upward (or downward) in response to cost or demand increases (or decreases) that are common to them all. Typically commercial banks all raise (or lower) their interest rates on consumer loans, home mortgages, and business loans over the few days following the central bank (the Federal Reserve in the United States) raising (or lowering) the rate at which it lends money to the banks. Airlines might independently adjust airfares upwards by a similar propor�on when the cost of fuel rises for all airlines. Manufacturers in a par�cular industry might all raise their prices at about the same �me due to the government's implementa�on of a carbon tax applicable to that industry, and so on. This has been called conscious parallelism, defined as firms independently ac�ng in a parallel fashion while conscious that their rivals have the same incen�ves to act in the same way at about the same �me. Given an�-collusion laws it is impera�ve that rival firms do not communicate with each other at all about prices or costs, since evidence of that communica�on might be held as prima facie evidence of collusive price fixing. In Figure 7.8 we show a firm raising its price in conscious parallelism due to a cost increase that applies more or less equally to all firms in an oligopoly. The firm's ini�al price is P and its demand curve is kinked at point a, causing a ver�cal gap in the marginal revenue curve through which the ini�al marginal cost curve (shown as MC) passes.16
51. (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#Ch7footNote16) The cost curves then shi� upwards from MC to MCʹ and from SAC and SACʹ. This firm, ac�ng as a price leader, then raises its price from P to Pʹ in the expecta�on that rival firms will do likewise, and if this indeed happens the firm effec�vely moves up the joint-ac�on sec�on of the demand curve from point a to point aʹ where a new kink would be expected, since the firm does not expect rivals to raise their prices by any higher amount. Figure 7.8: Price leadership through conscious parallelism in oligopoly markets In Figure 7.8, you will see that we have also shown the market demand curve, D, for the industry, and it is drawn such that the total market demand for the product is four �mes larger than the quan�ty demanded of the focal firm at each of the price levels indicated. This would mean that the focal firm has a 25% share of the market at each price level, and demonstrates that the joint-ac�on sec�on of the demand curve is the firm's constant-share-of-the-market demand curve. In this par�cular case there might be three other firms each also having 25% of the market, or there might be more than, or fewer than, three other firms whose shares of the market sum to the remaining 75% of the market demand at any par�cular price. As men�oned previously, oligopolists Processing math: 0% https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#Ch7footNote16
52. 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,se… 16/45 Due to government prohibi�on, the United States Postal Service has a monopoly on le�er carrying. Monopolies occur when there is only one seller of a par�cular product in a specific market. © iStockphoto/Thinkstock are typically very concerned with maintaining their share of the market and will tend to achieve this by ac�ng in conscious parallelism when costs or demand condi�ons change. Before we leave oligopoly, note that compe�ng firms do not need to set exactly the same price levels, as might seem to be implied by Figures 7.7 and 7.8. Price differen�als between and among firms are common in oligopoly markets and reflect both the differences in the a�ributes contained in the products (i.e., differences in the firms' costs) and differences in customer preferences for those a�ributes (i.e., differences in demand) across compe�ng firms. For example, a par�cular Mercedes Benz model is typically sold at a price that is higher than a similar sized and equipped Ford or Toyota. Such rela�ve prices tend to be the historical outcome of prior profit- maximizing adjustments to price by each firm and tend to
53. be maintained over �me by the prac�ce of conscious parallelism.17 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#Ch7footNote17) Monopoly Monopolies are defined as the only seller of a par�cular product in a par�cular market. This may be because they are the first firm to supply that product to that market (such as an entrepreneurial new venture introducing a new product to a previously unserved market, or an exis�ng firm entering a previously unserved geographical market) or because the entry of other firms into the market is prevented by barriers to entry. As discussed earlier in this chapter, barriers to entry are insurmountable problems that prevent poten�al entrants from assembling the necessary resources to begin producing and selling a compe��ve product. The inability to gain access to the necessary technology (e.g., the monopoly may have a patent on the technology) or to acquire another indispensable resource (e.g., there is only one deep water harbor near a major city and that is controlled by the port authority) will prevent another firm from entering the monopolist's market. Perhaps the major reason for monopoly markets is government prohibi�on of a second supplier. For example, the United States Postal Service is allowed a na�onal monopoly on le�er carrying, and electricity and gas companies are o�en granted regional monopoly status for the provision of these u�lity services.
54. Since the monopolist firm is the only firm in the market, the market demand curve becomes the firm's demand curve, and the monopolist must choose the profit-maximizing price and output combina�on on that demand curve. The profit- maximizing rule is the same, of course, namely MC = MR. We saw in Chapter 4 that a linear demand curve has an associated marginal revenue curve that shares the same ver�cal intercept with the demand curve and has twice the slope of the demand curve, as we have shown in Figure 7.9. Superimposing the firm's short-run cost curves SAC and MC on the demand and marginal revenue curves, we see that the monopolist should choose price P and sell output level Q to maximize its profit in the short run. Its short- run profit is indicated by the rectangle of height P – SACʹ (the profit margin per unit) and width Q (the number of units of output). Now considering the long-run average cost curve, LAC, and the associated long-run marginal cost curve, LMC, the monopolist can increase profit in the long run by choosing the output level where LMC = MR, which is shown as Q*, and set the corresponding price P*. The resultant magnitude of profit in the long run is shown by the considerably larger rectangle of height equal to the price–cost margin at output level Q* (i.e., P* – SAC*) and of width equal to Q* units of output. Figure 7.9 is already quite busy, so it does not show the SAC* curve or its related SMC* curve of the plant size that the monopolist would choose in the long run—that is your task! To prove that you understand the analysis, look carefully at Figure 7.9 and tell yourself where in that figure you
55. would place the SAC* and SMC* curves of the plant that the profit-maximizing monopolist would want to build and operate in the long run.18 (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#Ch7footNote18) Figure 7.9: Monopoly price and output choice in the short and long run Processing math: 0% https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#Ch7footNote17 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#Ch7footNote18 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,se… 17/45 Natural Monopolies As men�oned earlier, another reason for the existence and persistence of monopolies is that they may be natural monopolies, meaning that even if another firm did enter the market there would subsequently be a takeover or merger of the two firms and the market would revert to a monopoly again. The inevitable merger of compe�ng firms in a natural monopoly situa�on is due to the rela�onship between the limited size of the market and the economies of plant size available in the industry. If the market demand
56. curve crosses the LAC curve before the lowest point on that curve, the two firms opera�ng smaller plant sizes could make greater profit as a single firm opera�ng a larger but lower-cost plant size. This is illustrated in Figure 7.10, where we show the market demand curve (D) crossing the LAC before its minimum point. For simplicity of exposi�on, we assume that there are ini�ally two firms, each separately opera�ng a rela�vely small plant size, which we will depict by lowercase le�ers sac and mc for exposi�onal clarity. For further simplicity, we assume the two firms share the market equally, that is, 50% each, and always match the other's price. Accordingly their joint-ac�on or share-of-market demand curve (shown as d) will be coextensive with the MR curve, since both d and MR lie halfway between the ver�cal axis and the market demand curve. The joint-ac�on demand curve, d, will have a marginal revenue curve, shown as mr, associated with it. To maximize profits, each firm would set mc = mr, produce output level qʹ and sell at price Pʹ. The profit of each firm would amount to the rectangle shown by the profit margin (Pʹ – sacʹ) mul�plied by the number of units sold, qʹ. Figure 7.10: Natural monopoly Now, the owners/shareholders of these two firms will pre�y soon figure out that if they merged they could make more profit than they could separately as compe�tors in a market that is rela�vely small compared to the available economies of plant size. Opera�ng independently as compe�ng duopolists (i.e., two sellers) they can only make total profit of twice the
57. profit rectangle shown as (Pʹ – sacʹ) �mes qʹ in Figure 7.10. Merging to become a monopolist would allow them to build the plant size SAC* and operate it at the output rate Q* where SMC* = MR = LMC. The profit of the resultant monopoly firm would then be the average profit margin (P* – SACʹ) �mes the output level Q*, which is clearly much larger than the sum of their previous profits opera�ng as compe�ng duopolists. If you understand Figure 7.10, you should be proud of yourself because it was ge�ng pre�y heavy, wasn't it? Figure 7.10 incorporated a variety of concepts newly introduced in this chapter and also called upon other concepts from earlier chapters, and is probably the most complex figure in this book. Good for you if you understood it all the first �me through. If not, go through the chapter again, maybe when you are not so �red, and I'm sure it will s�ck the next �me through. Regulated Monopoly Now for something rela�vely simple to finish the chapter—the situa�on of regulated monopoly. Government regula�ons o�en are imposed on so-called public u�lity "monopolists" to prevent them from making huge profits, o�en from a natural monopoly posi�on, by charging rela�vely high prices for electricity (for example) to ci�zens who have no alterna�ve source of supply. In Figure 7.11, we assume that the regulators have imposed a ceiling price, or maximum allowable price, of Preg on the monopolist (who would prefer set price P* to maximize profits). Figure 7.11: Price regula�on of monopoly
58. Processing math: 0% 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,se… 18/45 If prices above Preg are prohibited, then the demand curve facing the firm is effec�vely the kinked line that is horizontal at the level Preg out to point a and then con�nuing down the market demand curve, D. As we know, from the oligopoly discussion, a kinked demand curve means that the marginal revenue curve must be the discon�nuous line Preg a– bMR, in this case coextensive with the horizontal sec�on of demand curve (from Preg out to point a), then falling abruptly to point b and then con�nuing down the MR curve. To maximize profit subject to the regulated price, the monopolist will choose the output level Qreg (where LMC passes equals marginal revenue at point a) and build the size of plant that has its SAC curve (not shown) tangent to the LAC curve at output level Qreg. The regulators are not likely to be happy with that, however, since the monopolist is s�ll making excess profits, because the regulated price is above the firm's LAC curve. The regulators are likely to set the regulated price at the lower level Pʹ,
59. where the LAC curve cuts the demand curve, D, such that the supply of the u�lity is increased to Qʹ and the monopoly makes only normal profit where price equals average costs. Note that marginal revenue will not equal marginal costs in this situa�on; the monopolist is prevented from maximizing profits by the regulator who is ac�ng in the public interest to facilitate a lower price and a higher output level for consumers of this product. This form of price regula�on is known as average-cost pricing. 11. No�ce that lack of informa�on, causing the buyer to be unaware of the price difference (or price change), is another reason why some customers do not switch to the lower-priced supplier. Unless customers know all the prices in all the stores all of the �me, they may unwi�ngly pay more on some occasions, being unable to verify if the same or similar item is available elsewhere as a be�er value proposi�on. If buyers must incur search costs of �me and money to find out firms' prices, they might be be�er off simply paying a li�le more for a product when its price is raised and thereby avoid those search costs. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#return11) ] 12. Industries with many firms that look like monopolis�c compe��on when considered na�onally or globally, typically operate as a series of interlinked oligopolies at the local level due to the shopping convenience and informa�on advantages of the local firms, causing poten�al customers to not consider more- distant suppliers. But note that Internet shopping, which offers informa�on, convenience, and lower prices in many cases, tends to offset these advantages of local firms and may
60. make such "many firm" industries operate more like monopolis�c compe��on. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#return12) ] 13. There are many other oligopoly scenarios that might be examined, such as cartel pricing, where the firms act collusively (and illegally) to set the same price, or raise prices by the same percentage to preserve their price differen�als. There are also several price-leadership models of oligopoly, such as low-cost firm price leadership and dominant-firm price leadership. These operate in essen�ally the same manner as conscious parallelism, whereby all firms tend to adjust their prices upward or downward at about the same �mes, following a price adjustment by any one firm, and thus preserve their market shares. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#return13) ] 14. Recall from Chapter 4 that price elas�c means that the percentage change in quan�ty demanded will be higher than the percentage change in price, while price inelas�c means that the percentage change in quan�ty demanded will be less than the percentage change in price. For example, sales might decrease 20% for a 10% price increase, but increase only 2% for a 10% price reduc�on. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#return14) ] 15. We are calling it a "curve" to follow conven�on, even though the MR is not curved when it is derived from a linear demand "curve" and in the case of the kinked demand curve the MR is a series of straight line segments! [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#return15) ]
61. 16. The lower parts of the discon�nuous MR curves are not shown in Fig 7.8, since they would lie below the horizontal axis in this case. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#return16) ] 17. Marketers speak of "price posi�oning" whereby they choose strategically to set price at a premium to (above) or at a discount to (below) the prices of rival firms. Note that unless the quality of the product is simultaneously set at a commensurately higher (or lower) level rela�ve to rivals' quali�es, the price differen�al will not hold up in the market since customers will scru�nize compe�ng products looking for the best value proposi�on, where value equals quality divided by price, as we saw in Chapter 3. [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#return17) ] 18. Note that the SAC level at output level Q* must equal the LAC at that output level, and that the short-run marginal cost (SMC*) curve needs to equal the MR at output level Q*. Try to work it out before you look at Figure 7.10! [return (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/sec7.3#return18) ] Processing math: 0% https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#return11 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#return12 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#return13 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec
62. 7.3#return14 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#return15 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#return16 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#return17 https://content.ashford.edu/books/AUBUS640.12.1/sections/sec 7.3#return18 10/1/2019 Print https://content.ashford.edu/print/AUBUS640.12.1?sections=fm, ch07,ch07introduction,sec7.1,sec7.2,sec7.3,ch07summary,ch08, ch08introduction,se… 19/45 Summary In this chapter, we have been concerned with the opera�on of business firms in markets, and specifically with their choice of price and output levels that will maximize their profits. A�er defining a market as a situa�on in which buyers and sellers communicate for the purpose of exchanging value, the four basic market structures were introduced. These are categorized on the basis of (a) iden�cal or differen�ated products; (b) barriers to entry of new firms, or not; (c) number of compe�ng firms; and (d) expecta�on of rivals' reac�on to strategic changes. Pure compe��on is characterized by many firms producing iden�cal products, no entry barriers, and no expecta�on of rival reac�ons. Firms in such markets must take the market-determined price as given and simply adjust output to maximize profit in the short run, but can
63. also adjust their plant size to the op�mum plant size in the long run. While they can make excess profits in the short run, they will be reduced to making only normal profit in the long run. Monopolis�c compe��on is characterized by many firms producing slightly differen�ated products, no entry barriers, and no expecta�on of rival reac�ons. Firms opera�ng in such markets are able to choose their own price and output levels and can also adjust their plant size in the long run but will not adopt the op�mum size of plant because they face a downward- sloping demand curve. While they can make excess profits in the short run, they will be reduced to making only normal profit in the long run, where their demand curve is forced into tangency with the LAC curve on the downward-sloping sec�on of that curve. Oligopolis�c compe��on is characterized by few firms, due to barriers to entry of new firms. These firms produce differen�ated products, and the firms recognize their mutual dependence and form expecta�ons about whether or not rivals will follow their price increases or price reduc�ons. We considered the kinked demand curve and price leadership via conscious parallelism whereby firms change prices independently but expect rivals to act in the same manner. Oligopolists can make excess profits in both the short and long run, assuming sufficient market demand. A monopoly market is characterized by a single seller and is typically due to insurmountable barriers to entry. Although a natural monopoly market may allow entry of new firms, they are des�ned to merge with, or be taken over by, the monopoly firm due to the
64. profit incen�ve facing shareholders to consolidate produc�ve capacity within a single business en�ty due to the economies of plant size available to a monopoly firm. Because monopolies can make excess profits in both the short run and the long run, governments o�en regulate a maximum price that the monopoly may charge, and the monopoly then selects the output level that is profit maximizing, given this constraint. In the following chapter, we will u�lize the conceptual material from this and from preceding chapters to address pricing by business firms in real-world situa�ons when the managers do not have the data they need to simply draw the cost and demand curves and find the intersec�on of the MC and MR curves. Instead they must u�lize es�mated demand and cost func�ons or u�lize rules-of-thumb pricing procedures that avoid or minimize data search costs and provide acceptably correct solu�ons to their profit- maximizing problem. Ques�ons for Review and Discussion Click on each ques�on to reveal the answer. 1. Define "market." Explain how people can enter a market without actually being there. (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/fm/books/AUBUS640.12.1/sec�ons/fm/books/AUBUS640.12 .1/sec�ons/fm/books/AUBUS640.12.1/sec�ons/fm/boo A market is a place or a situa�on where poten�al buyers and sellers can meet in person or by proxy to exchange items of value (including money). People can enter markets without being there by using a
65. purchasing or sales agent, by using an electronic intermediary (e.g., buying and selling online) or paper-based statement of willingness to buy or sell at a par�cular price. 2. What are "barriers to entry"? Does a monopoly or oligopoly market necessarily have insurmountable barriers to entry? (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/fm/books/AUBUS640.12.1/sec�ons/fm/books/AUBUS640.12 .1/sec�ons/fm/books/AUBUS640.12.1/sec�ons/fm/boo Barriers to entry are reasons why new firms cannot enter some markets. They are either legislated by governments or are due to the prospec�ve entrants' inability to purchase or gain control of resources that are necessary to become established and to compete in the market. A monopoly or oligopoly market may not have insurmountable barriers to entry, but could be a "natural" monopoly or oligopoly in the sense that although other firms can enter the market they would soon be absorbed by merger or takeover. This would occur because shareholder value would be maximized by a smaller number of firms in markets that are small rela�ve to the scale of plant at which diseconomies of plant size begin. 3. Define product differen�a�on in terms of the a�ributes of the firm's products or services. (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/fm/books/AUBUS640.12.1/sec�ons/fm/books/AUBUS640.12 .1/sec�ons/fm/books/AUBUS640.12.1/sec�ons/fm/boo Product differen�a�on can be defined as the design of products within a product category such that the products contain different product a�ributes,
66. and/or different combina�ons of product a�ributes, and/or different quan��es of the same product a�ributes. 4. In what way(s) does a monopolis�cally compe��ve market differ from a purely compe��ve market? (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/fm/books/AUBUS640.12.1/sec�ons/fm/books/AUBUS640.12 .1/sec�ons/fm/books/AUBUS640.12.1/sec�ons/fm/boo Monopolis�cally-compe��ve markets differ from purely- compe��ve markets in that the former supply differen�ated products whereas the la�er supply iden�cal or undifferen�ated products. They share the characteris�cs of many firms, due to no barriers to entry, and firms having no expecta�on of rival reac�ons. 5. Under what circumstances would an industry that has many firms opera�ng na�onally be perceived by customers to be an oligopoly? (h�p://content.thuzelearning.com/books/AUBUS640.12.1/sec�o ns/fm/books/AUBUS640.12.1/sec�ons/fm/books/AUBUS640.12 .1/sec�ons/fm/books/AUBUS640.12.1/sec�ons/fm/booProcessi ng math: 0% https://content.ashford.edu/books/AUBUS640.12.1/sections/fm/ books/AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/sect ions/fm/books/AUBUS640.12.1/sections/fm/books/AUBUS640. 12.1/sections/fm/books/AUBUS640.12.1/sections/fm/books/AU BUS640.12.1/sections/fm/books/AUBUS640.12.1/sections/fm/b ooks/AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/secti ons/fm/books/AUBUS640.12.1/sections/fm/books/AUBUS640.1 2.1/sections/fm/books/AUBUS640.12.1/sections/fm/books/AUB US640.12.1/sections/fm/books/AUBUS640.12.1/sections/fm/boo ks/AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/sections /fm/books/AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/
67. sections/fm/books/AUBUS640.12.1/sections/fm/books/AUBUS6 40.12.1/sections/fm/books/AUBUS640.12.1/sections/fm/books/ AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/sections/f m/books/AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/s ections/fm/books/AUBUS640.12.1/sections/fm/books/AUBUS64 0.12.1/sections/fm/books/AUBUS640.12.1/sections/fm/books/A UBUS640.12.1/sections/fm/books/AUBUS640.12.1/sections/fm/ books/AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/sect ions/fm/books/AUBUS640.12.1/sections/fm/books/AUBUS640. 12.1/sections/fm/books/AUBUS640.12.1/sections/fm/books/AU BUS640.12.1/sections/fm/books/AUBUS640.12.1/sections/fm# https://content.ashford.edu/books/AUBUS640.12.1/sections/fm/ books/AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/sect ions/fm/books/AUBUS640.12.1/sections/fm/books/AUBUS640. 12.1/sections/fm/books/AUBUS640.12.1/sections/fm/books/AU BUS640.12.1/sections/fm/books/AUBUS640.12.1/sections/fm/b ooks/AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/secti ons/fm/books/AUBUS640.12.1/sections/fm/books/AUBUS640.1 2.1/sections/fm/books/AUBUS640.12.1/sections/fm/books/AUB US640.12.1/sections/fm/books/AUBUS640.12.1/sections/fm/boo ks/AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/sections /fm/books/AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/ sections/fm/books/AUBUS640.12.1/sections/fm/books/AUBUS6 40.12.1/sections/fm/books/AUBUS640.12.1/sections/fm/books/ AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/sections/f m/books/AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/s ections/fm/books/AUBUS640.12.1/sections/fm/books/AUBUS64 0.12.1/sections/fm/books/AUBUS640.12.1/sections/fm/books/A UBUS640.12.1/sections/fm/books/AUBUS640.12.1/sections/fm/ books/AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/sect ions/fm/books/AUBUS640.12.1/sections/fm/books/AUBUS640. 12.1/sections/fm/books/AUBUS640.12.1/sections/fm/books/AU BUS640.12.1/sections/fm/books/AUBUS640.12.1/sections/fm# https://content.ashford.edu/books/AUBUS640.12.1/sections/fm/ books/AUBUS640.12.1/sections/fm/books/AUBUS640.12.1/sect ions/fm/books/AUBUS640.12.1/sections/fm/books/AUBUS640.
Anúncio