Review Assignment 1 Market Structure Archetypes: - Defining Your Market - Perfect Competition - Monopoly
Review Assignment 1 Market Structure Archetypes: - Defining Your Market - Perfect Competition - Monopoly
Review Assignment 1 Market Structure Archetypes: - Defining Your Market - Perfect Competition - Monopoly
Barriers to entry
• Specific assets • Pre-commitment contracts
• Economies of scale • Licenses and patents
• Excess capacity • Learning-curve effects
• Reputation effects • Pioneering brand advantages
Optimal Single-price Pricing
• Pricing objective – maximize total profit
• MR = MC for optimal output
=> Optimal markup formula
MC
P
1
1
at optimal output Q*
Application: The elasticity of demand for gasoline on the New
Jersey toll road = 10.
What markup would a profit maximizing firm use???
1 1
P MC MC 1.11 % MC
1 1 .9
10
Derivation of Optimal Markup Rule
From Profit Maximization: MR = MC
Working with MR side:
TR / Q = MC (defn of MR)
(P Q + Q P) / Q = MC (breakdown of TR)
P + Q( P / Q) = MC (a little algebra)
Here comes elasticity:*
P - Q[(1 / )(P / Q)] = MC
P[1 - (1 / )] = MC (Factor out P; cancel Q’s)
Optimal markup rule:
P = MC / [1 - (1 / )] (Divide by [ ] term)
___________________________________________________
*Need equation (1) for the elasticity step above:
Defn. of elasticity = (-1)(Q/Q) / (P/P)
Multiply by reciprocal = (-1)( Q/Q)(P/P)
Rearrange = (-1)( P /Q) ( Q /P)
Solve for (-1) ( P /Q) P /Q = (-1)(1 / ) (P / Q)
Monopoly: Markup and Profits
P
MC
PM
AC
Markup A
Average Cost
of Producing B D
Each Unit
QM Q
MR
Perfect competition
characteristics
• Many buyers and sellers
• Low seller concentration (each firm has low market
share)
• Homogeneous product
• Low cost and accurate information about product and
price
• Price “taker”
• Free entry and exit
• E.g. commodity markets; agricultural products
Entry and pricing
perfect competition
• Above normal profit
Attracts entry
Increases market supply
Reduces market price
Reduces unit profit (P vs. ATC)
• Below normal profit
Promotes Exit
Decreases market supply
Increases market price
Over time, increases unit profit (P vs. ATC)
Perfect Competition: Long run Pricing
After entry/exit
MR = MC → firms use equimarginal thinking
P = min LRAC → so efficient production
Normal Profit = 0 economic profit
Monopoly Versus Perfect
Competition
(a) Monopoly (b) Perfect Competition
PM
A Deadweight P1
Social Loss
D D
QM Q Q1 Q
Producer Producer
Surplus Surplus
MR
Application:
• Pick a market/industry with which you are
familiar. Based on your text reading, how
would you describe its market structure and
why? How narrowly/broadly are you defining
the market (e.g. does Coke compete in all
beverages or bottled soft drinks)? How would
you characterize barriers to entry to this
market?
Strategy
• General policies intended to generate profits
– Choice of industry
– Combination of products and services
– Competitive and cooperative behaviors
• Strategies evolve as circumstances change
• Strategies must create and capture value
Creating Value for Consumers
A firm has market power if…
...it faces a downsloping demand curve.
The firm’s pricing objective is…
…to maximize shareholder value.
The demand curve reflects…
…consumer willingness and ability to buy.
• 1 pineapple
So firm only captures
$3.50 value created $1.50 of $3.50 value
created…
Porter’s five forces
• Potential rivals
• Existing rivalry
• Substitute products
• Buyer power
• Supplier power
• Read
– Managerial Economics
• Chapter 7 – Pricing
– Coursepack
• The Power of Smart Pricing
• The Usual Decorous Waltz…
• The Myth of Market Share
• Blackboard
– Why are Hotel Minibars So Expensive?” - Glenn Ellison