CHAPTER 8 Managing in Competitive, Monopolistic, and Monopolistically Competitive Markets McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Outline Perfect competition – Demand at the market and firm levels – Short-run output decisions – Long-run decisions Monopoly – Monopoly power – Sources of monopoly power – Maximizing profits – Implications of entry barriers Monopolistic competition – Conditions for monopolistic competition – Profit maximization – Long-run equilibrium – Implications of product differentiation Optimal advertising decisions 8-2 Chapter Overview

Introduction Chapter 7 examined the nature of industries, and saw that industries differ with respect to their structures, conducts and performances. This chapter focuses on how managers determine the optimal price, quantity and advertising decisions in the following market environments: – Perfect competition. – Monopoly. – Monopolistic competition. 8-3 Chapter Overview

Key Conditions Perfectly competitive markets are characterized by: – The interaction between many buyers and sellers that are “small” relative to the market. – Each firm in the market produces a homogeneous (identical) product. – Buyers and sellers have perfect information. – No transaction costs. – Free entry into and exit from the market. The implications of these conditions are: – a single market price is determined by the interaction of demand and supply – firms earn zero economic profits in the long run. 8-4 Perfect Competition

Demand at the Market and Firm Levels In Action 8-5 Perfect Competition Market output 0 Price D Firm’s output S Market Firm

Short-Run Output Decisions The short run is a period of time over which some factors of production are fixed. To maximize short-run profits, managers must take as given the fixed inputs (and fixed costs), and determine how much output to produce by changing the variable inputs. 8-6 Perfect Competition

Short-Run Profit Maximization: Revenue-Cost Approach In Action 8-7 Perfect Competition Firm’s output $ 0 A B E Maximum profits

Competitive Firm’s Demand 8-8 Perfect Competition

Short-Run Loss Minimization In Action 8-9 Perfect Competition Firm’s output $ 0 Profit

Competitive Output Rule 8-10 Perfect Competition

Competitive Output Rule In Action 8-11 Perfect Competition

Short-Run Loss Minimization In Action 8-12 Perfect Competition Firm’s output $ 0 Loss

The Shut-Down Case In Action 8-13 Perfect Competition Firm’s output $ 0 Fixed Cost Loss if produce Loss if shut down

Short-Run Output Decision 8-14 Perfect Competition

Short-Run Firm Supply Curve In Action 8-15 Perfect Competition Firm’s output $ 0 Short-run supply curve for individual firm

Firm’s Short-Run Supply Curve 8-16 Perfect Competition

Market Supply Curve In Action 8-17 Perfect Competition Market output P 0 1 $10 $12 Market supply curve Individual firm’s supply curve 500 S

Long-Run Decisions: Entry and Exit In Action 8-18 Perfect Competition Market output 0 Price D Firm’s output 0 Exit Entry

Long-Run Competitive Equilibrium In Action 8-19 Perfect Competition Firm’s output $ 0 Long-run competitive equilibrium

Long-Run Competitive Equilibrium 8-20 Perfect Competition

Monopoly and Monopoly Power A market structure in which a single firm serves an entire market for a good that has no close substitutes. Sole seller of a good in a market gives that firm greater market power than if it competed against other firms. – Implication: market demand curve is the monopolist’s demand curve. – However, a monopolist does not have unlimited market power Monopoly

Monopolist’s Demand In Action 8-22 Monopoly Output Price 0 A B Monopolist’s power is constrained by the demand curve.

Sources of Monopoly Power Economies of scale Economies of scope Cost complementarity Patents and other legal barriers 8-23 Monopoly

Elasticity of Demand and Total Revenues In Action 8-24 Monopoly Q0 RevenuePrice Firm’s output 0 Unitary Elastic Inelastic Elastic MR

Marginal Revenue and Elasticity 8-25 Monopoly

Marginal Revenue and Linear Demand 8-26 Monopoly

Marginal Revenue In Action 8-27 Monopoly

Output Rule 8-28 Monopoly

Costs, Revenues, and Profit In Action 8-29 Monopoly Output $ 0 Maximum profit

Price Quantity Demand MR MC ATC Profits Profit Maximization In Action Monopoly 8-30

Pricing Rule 8-31 Monopoly

Monopoly In Action 8-32 Monopoly

Absence of a Supply Curve 8-33 Monopoly

Multiplant Decisions 8-34 Monopoly

Multiplant Output Rule 8-35 Monopoly

Implications of Entry Barriers A monopolist may earn positive economic profits, which in the presence of barriers to entry prevents other firms from entering the market to reap a portion of those profits. – Implication: monopoly profits will continue over time provided the monopoly maintains its market power. Monopoly power, however, does not guarantee positive profits Monopoly

Price Quantity Demand MR MC ATC Zero-Profit Monopolist In Action Monopoly 8-37

Deadweight Loss of Monopoly The consumer and producer surplus that is lost due to the monopolist charging a price in excess of marginal cost Monopoly

Price Quantity Demand MR MC Deadweight Loss of Monopolist In Action Monopoly 8-39 Deadweight loss

Key Conditions An industry is monopolistically competitive if: – There are many buyers and sellers. – Each firm in the industry produces a differentiated product. – There is free entry into and exit from the industry. A key difference between monopolistically competitive and perfectly competitive markets is that each firm produces a slightly differentiated product. – Implication: products are close, but not perfect, substitutes; therefore, firm’s demand curve is downward sloping under monopolistic competition Monopolistic Competition

Price Quantity Demand MR MC ATC Profit-Maximizing Monopolistically Competitive Firm In Action Monopolistic Competition 8-41 Profits

Profit-Maximization Rule 8-42 Monopolistic Competition

Long-Run Equilibrium If firms in monopolistically competitive markets earn short-run – profits, additional firms will enter in the long run to capture some of those profits. – losses, some firms will exit the industry in the long run Monopolistic Competition

Price Quantity of Brand X Demand 0 MR 0 MC ATC Entry in Monopolistically Competitive Market In Action Monopolistic Competition 8-44 Demand 1 MR 1 Due to entry of new firms selling other brands

Price Quantity of Brand X MC ATC Long-Run Monopolistically Competitive Equilibrium In Action Monopolistic Competition 8-45 Demand 1 MR 1 Long-run monopolistically competitive equilibrium

Long-Run and Monopolistic Competition 8-46 Monopolistic Competition

Implications of Product Differentiation The differentiated nature of products in monopolistically competitive markets implies that firms in these industries must continually convince consumers that their products are better than their competitors. Two strategies monopolistically competitive firms use to persuade consumers: – Comparative advertising – Niche marketing 8-47 Monopolistic Competition

Optimal Advertising Decisions 8-48 Optimal Advertising Decisions

Conclusion 8-49