1. Market Structures: Perfect and Imperfect Competition, Profit Maximization, and Pricing Strategy

2. 5.1 Perfect & Imperfect Competition Summary
Market Structures: Perfect and Imperfect Competition, Profit Maximization, and Pricing Strategy
5.1 Perfect & Imperfect Competition Summary
5.2 Market Power & Imperfect Competition
5.3 Compare Perfect Competition & Imperfect Competition
5.4 Monopolistic Competition as a Form of Imperfect Competition

3. 5.1 Perfect & Imperfect Competition Summary
Market Structures: Perfect and Imperfect Competition, Profit Maximization, and Pricing Strategy
5.1 Perfect & Imperfect Competition Summary
See class notes.

4. Perfect Competition Characterized by
A large number of firms in the market
An undifferentiated product
Ease of entry into the market
Complete information available to all market participants

5. Perfect Competition
Distinguished between behavior of individual firms and outcomes for entire market
No single firm has any influence on the price of a product
Price-taker: a firm cannot influence the price of its product, thus it can sell any amount of output at that price

6. Perfectly Competitive
Figure 5.1
Industry/Market
Individual Firm Q P Q1 MC Q2
ATC
D=P=MR B A PE Q QE D S

7. Profit Maximization = TR - TC where = profit TR = total revenue
TC = total cost
Profit-maximization rule: to maximize profits, a firm should produce the level of output where marginal revenue equals marginal cost

8. Marginal Revenue
Price equals marginal revenue for a perfectly competitive firm because the firm does not have to lower the price to sell more units of output
The profit-maximizing level of output occurs where marginal revenue equals marginal cost because any other level of output will result in smaller profit

9. Determining the Amount of Profit Earned
If you know total revenue and total cost, you can calculate amount of profit
Using TR and TC function graphs, you can calculate level of profit-maximizing by finding the greatest distance between the two curves and calculate the profit at that point

10. The Shutdown Point
The shutdown point for perfectly competitive firm: the price, which just equals AVC, below which it is more profitable for the perfectly competitive firm to shut down than to continue to produce
The supply curve is that portion of its marginal cost curve above minimum AVC

11. Supply Curve for Perfectly Competitive Industry
The supply curve shows the output produced by all perfectly competitive firms in the industry at different prices.

12. Long-run Adjustment Two factors:
Entry and exit by new and existing firms
Changes in the scale of operations by all firms
These factors can occur simultaneously

13. Long-run Adjustment
Equilibrium point for the perfectly competitive firm: the point where price equals ATC since the firm earns zero economic profit at this point
Economic profit incorporates all implicit costs of production including normal rate of return on investment

14. Long-run Adjustment: Entry and Exit
Figure 5.2
Industry/Market
Individual Firm D2
PE2
QE2
QE1 D1 S1 S2
QE3
PE1 MC
ATC
D1=P1=MR1 P Q1 Q2 A B
D2=P2=MR2

15. Long-run Adjustment
Firm is a price-taker; therefore, it must accept new equilibrium price and determine appropriate level of output
All firms know the positive economic profits
Other firms are able to enter the market

16. Optimum Scale of Production
Figure 5.3
SMC1
LRAC
SATC1
SMC2 $ Q1 Q2 Q
P1=MR1
SATC2
P2=MR2

17. Optimum Scale of Production
In Figure 5.3, LRAC incorporates both economies of scale and diseconomies of scale
Large-scale production will give managers competitive edge by decreasing production costs
Cannot influence price of product

18. Managerial Rule of Thumb: Competition Means Little Control Over Price
Managers have little or no control over product price
They compete on basis of lowering costs of production
Perfectly competitive firms earn zero economic profit because entry of other firms compete away excess profit

19. Managerial Rule of Thumb: Strategies to Gain Market Power
Managers in competitive industries can gain market power by
Merging with other companies
Differentiating products
Forming producer association to change consumer preferences and increase demand for output of the entire industry

20. 5.2 Market Power & Imperfect Competition
Market power: ability of a firm to influence the prices of its products and develop strategies to earn profits over longer periods of time
Monopoly: single firm producing product with no close substitutes
Price-searchers: firms in imperfect competition

21. Imperfect Competition Model with Positive Economic ProfitQ $
ATCM QM PM
Figure 5.4 D MR MC A
ATC B

22. Imperfect Competition with Negative Economic ProfitQ $
ATCM QM PM
Figure 5.5 MR D MC B
ATC A

23. Imperfect Competition
Monopolist maximizes profits by producing where MR = MC and earns positive economic profit due to barriers to entry
The monopolist could suffer losses if ATC is greater than price at the profit-maximizing level of output (previous slide)

24. Comparing Imperfect and Perfect Competition
Figure 5.6 MC
ATC
D=P=MR $
QPC Q QM MC Q1
ATC MR $ P1 P2

25. 5.3 Comparing Imperfect and Perfect Competition
Monopolistic firm must seek out optimal price, which depends on demand and cost conditions
Firms with market power might pursue other profit goals
Price is higher and output lower under monopoly than under perfect competition

26. Barriers to Entry Economies of scale and mergers
Barriers created by government
Input barriers
Brand loyalties
Consumer lock-in and switching costs

27. Economies of Scale and Mergers
Exist when a firm’s LRAC slopes downward or when lower production costs are associated with larger scale of operation
Can act as a barrier to entry in different industries
Mergers are particularly important in technology, media, and telecommunications

28. Barriers Created by Government
Licenses
Patents and copyrights

29. Input Barriers Control over raw materials
Barriers in financial capital markets
Larger firms can get lower interest rates
Smaller firms need more collateral for loans
Smaller firms are perceived as riskier

30. Consumer Lock-In and Switching Costs
When consumers become locked into certain types or brands and would incur substantial switching costs if they changed
Although lock-in types are dominant, they represent managerial strategies that can be used elsewhere to gain market power

31. Measures of Market Power
Managers can use measures to better understand the markets
Lerner Index: measure of market power that focuses on the difference between a firm’s product price and marginal cost of production
L = (P – MC) P

32. Antitrust Issues
Federal legislation that limits market power of firms and regulates how firms use their market power to compete
Major components of antitrust law:
Sherman Act of 1890
Clayton Act of 1914
Federal Trade Commission Act of 1914

33. Managerial Rule of Thumb: Understanding Antitrust Laws
Managers must work within antitrust constraints
Because of generalities and ambiguities, managers may not know whether their actions are illegal unless the government initiates litigation

34. 5.4 Monopolistic Competition as a form of Imperfect Competition
Product differentiation exists among firms
Large number of firms exist
No interdependence exists among these firms
Entry by new firms is relatively easy

35. Monopolistic Competition, Long Run and Short run
Figure 5.7 $ Q1 Q P1 $ Q2 Q P2 D MR MC D MR MC
ATC
ATC