Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Managerial Economics &
Business Strategy
Chapter 8
Managing in Competitive,Monopolistic,
and Monopolistically Competitive
Markets
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Overview
I,Perfectly Competition
? Characteristics and profit outlook
? Effect of new entrants
II,Monopolies
? Sources of monopoly power,
? Maximizing monopoly profits,
? Pros and cons
III,Monopolistic Competition
? Profit maximization
? Long run equilibrium
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Perfect Competition
? Many buyers and sellers
? Homogeneous product
? Perfect information
? No transaction costs
? Free entry and exit
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Key Implications
? Firms are,price takers” (P = MR)
? In the short-run,firms may earn profits or
losses
? Long-run profits are zero
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Unrealistic? Why Learn?
? Many small businesses are,price-takers,” and
decision rules for such firms are similar to those of
perfectly competitive firms
? It is a useful benchmark
? Explains why governments oppose monopolies
? Illuminates the,danger” to managers of competitive
environments
? Importance of product differentiation
? Sustainable advantage
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Managing a Perfectly
Competitive Firm
(or Price-Taking Business)
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Setting Price
Firm Q
f
$
Df
Market
QM
$
D
S
Pe
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Setting Output,
? MR = MC
? MR = P,therefore
? Set P = MC to maximize profits
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Graphically
$
Qf
ATC
AVC
MC
Pe = Df = MR
Qf*
ATC
Pe
Profit = (Pe - ATC) ? Qf*
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
A Numerical Example
? Given
? P=$10
? C(Q) = 5 + Q2
? Optimal Price?
? P=$10
? Optimal Output?
? MR = P = $10 and MC = 2Q
? 10 = 2Q
? Q = 5 units
? Maximum Profits?
? PQ - C(Q) = (10)(5) - (5 + 25) = $20
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Long Run Adjustments?
? If firms are price takers but there are
barriers to entry,profits will persist
? If the industry is perfectly competitive,
firms are not only price takers but there is
free entry
? Other,greedy capitalists” enter the market
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Effect of Entry on Price?
Firm Q
f
$
Df
Market
QM
$
D
S
Pe
S*
Pe* Df*
Entry
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Effect of Entry on the Firm’s Output and Profits?
$
Q
AC
MC
QL
Pe Df
Pe* Df*
Qf*
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Summary of Logic
? Short run profits leads to entry
? Entry increases market supply,drives down
the market price,increases the market
quantity
? Demand for individual firm’s product shifts
down
? Firm reduces output to maximize profit
? Long run profits are zero
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Features of Long Run
Competitive Equilibrium
? P = MC
? Socially efficient output
? P = minimum AC
? Efficient plant size
? Zero profits
? Firms are earning just enough to offset their opportunity
cost
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Monopoly
? Single firm serves the,relevant market”
? Most monopolies are,local” monopolies
? The demand for the firm’s product is the
market demand curve
? Firm has control over price
? But the price charged affects the quantity demanded of
the monopolist’s product
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
“Natural” Sources of
Monopoly Power
? Economies of scale
? Economies of scope
? Cost complementarities
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
“Created” Sources of
Monopoly Power
? Patents and other legal barriers (like
licenses)
? Tying contracts
? Exclusive contracts
? Collusion
Contract..,
I,
II,
III,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Legal Barriers to
Monopoly Power
? Section 3 of the Clayton Act (1914)
? Prohibits exclusive dealing and tying arrangements
where the effect may be to,substantially lessen
competition”
? Sections 1 and 2 of the Sherman Act (1890)
? Prohibits price-fixing,market sharing,and other
collusive practices designed to,monopolize,or attempt
to monopolize” a market
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Managing a Monopoly
? Market power permits
you to price above MC
? Is the sky the limit?
? No,How much you sell
depends on the price
you set!
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
A Monopolist’s Marginal
Revenue
P
Q
Q
Demand
Elastic
Inelastic
Unitary
MR
Total
Revenue
($)
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Monopoly Profit Maximization
$
Q
ATC
MC
D
MR QM
PM
Profit
ATC
Produce where MR = MC,
Charge the price on the demand curve that corresponds to that quantity,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
A Useful Formula
? What’s the MR if a firm faces a linear
demand curve for its product?
? P(Q) = a + bQ
? MR = a + 2bQ
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
A Numerical Example
? Given estimates of
? P = 10 - Q
? C(Q) = 6 + 2Q
? Optimal output?
? MR = 10 - 2Q
? MC = 2
? 10 - 2Q = 2
? Q = 4 units
? Optimal price?
? P = 10 - (4) = $6
? Maximum profits?
? PQ - C(Q) = (6)(4) - (6 + 8) = $10
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Long Run Adjustments?
? None,unless the
source of monopoly
power is
eliminated,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Why Government Dislikes
Monopoly?
? P > MC
? Too little output,at too high a price
? Deadweight loss of monopoly
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
$
Q
ATC
MC
D
MR QM
PM
MC
Deadweight Loss
of Monopoly
Deadweight Loss of Monopoly
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Arguments for Monopoly
? The beneficial effects of economies of
scale,economies of scope,and cost
complementarities on price and output may
outweigh the negative effects of market
power
? Encourages innovation
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Monopolistic Competition
? Numerous buyers and sellers
? Differentiated products
? Implication,Since products are differentiated,each firm
faces a downward sloping demand curve,
? Firms have limited market power,
? Free entry and exit
? Implication,Firms will earn zero profits in the long run,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Key Implications
? Since products are differentiated,each firm
faces a downward sloping demand curve;
firms have limited market power,
? Free entry and exit,so firms will earn zero
profits in the long run,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Managing a Monopolistically
Competitive Firm
? Market power permits you to price above
marginal cost,just like a monopolist,
? How much you sell depends on the price
you set,just like a monopolist,But …
? The presence of other brands in the market
makes the demand for your brand more
elastic than if you were a monopolist,
? You have limited market power,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Marginal Revenue Like a
Monopolist
P
Q
Q
Demand
Elastic
Inelastic
Unitary
MR
Total
Revenue
($)
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Monopolistic Competition,
Profit Maximization
? Maximize profits like a monopolist
? Produce where MR = MC
? Charge the price on the demand curve that
corresponds to that quantity
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Graphically
$ ATC MC
D
MR QM
PM
Profit
ATC
Quantity of Brand
X
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Long Run Adjustments?
? In the absence of free entry,no adjustments
occur,
? If the industry is truly monopolistically
competitive,there is free entry,
? In this case other,greedy capitalists” enter,and their
new brands steal market share,
? This reduces the demand for your product until profits
are ultimately zero,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
$ AC MC
D
MR
Q*
P*
Quantity of Brand
X MR1
D1
Entry
P1
Q1
Long Run Equilibrium
(P = AC,so zero profits)
Graphically
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Monopolistic Competition
The Good (To Consumers)
? Product Variety
The Bad (To Society)
? P > MC
? Excess capacity
? Unexploited economies of
scale
The Ugly (To Managers)
? Zero Profits
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Strategies to Avoid (or Delay)
the Zero Profit Outcome
? Change; don’t let the long-run set in,
? Be the first to introduce new brands or to
improve existing products and services,
? Seek out sustainable niches,
? Create barriers to entry,
? Guard,trade secrets” and,strategic plans”
to increase the time it takes other firms to
clone your brand,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Maximizing Profits,A
Synthesizing Example
? C(Q) = 125 + 4Q2
? Determine the profit-maximizing output and
price,and discuss its implications,if
? You are a price taker and other firms charge $40 per unit;
? You are a monopolist and the inverse demand for your product
is P = 100 - Q;
? You are a monopolistically competitive firm and the inverse
demand for your brand is P = 100 - Q
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Marginal Cost
? C(Q) = 125 + 4Q2,
? So MC = 8Q
? This is independent of market structure
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Price Taker
? MR = P = $40
? Set MR = MC
? 40 = 8Q
? Q = 5 units
? Cost of producing 5 units
? C(Q) = 125 + 4Q2 = 125 + 100 = 225
? Revenues,
? PQ = (40)(5) = 200
? Maximum profits of -$25
? Implications,Expect exit in the long-run
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Monopoly/Monopolistic Competition
? MR = 100 - 2Q (since P = 100 - Q)
? Set MR = MC,or 100 - 2Q = 8Q
? Optimal output,Q = 10
? Optimal price,P = 100 - (10) = 90
? Maximal profits,
? PQ - C(Q) = (90)(10) -(125 + 4(100)) = 375
? Implications
? Monopolist will not face entry (unless patent or other entry
barriers are eliminated)
? Monopolistically competitive firm should expect other firms
to clone,so profits will decline over time
Managerial Economics &
Business Strategy
Chapter 8
Managing in Competitive,Monopolistic,
and Monopolistically Competitive
Markets
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Overview
I,Perfectly Competition
? Characteristics and profit outlook
? Effect of new entrants
II,Monopolies
? Sources of monopoly power,
? Maximizing monopoly profits,
? Pros and cons
III,Monopolistic Competition
? Profit maximization
? Long run equilibrium
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Perfect Competition
? Many buyers and sellers
? Homogeneous product
? Perfect information
? No transaction costs
? Free entry and exit
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Key Implications
? Firms are,price takers” (P = MR)
? In the short-run,firms may earn profits or
losses
? Long-run profits are zero
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Unrealistic? Why Learn?
? Many small businesses are,price-takers,” and
decision rules for such firms are similar to those of
perfectly competitive firms
? It is a useful benchmark
? Explains why governments oppose monopolies
? Illuminates the,danger” to managers of competitive
environments
? Importance of product differentiation
? Sustainable advantage
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Managing a Perfectly
Competitive Firm
(or Price-Taking Business)
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Setting Price
Firm Q
f
$
Df
Market
QM
$
D
S
Pe
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Setting Output,
? MR = MC
? MR = P,therefore
? Set P = MC to maximize profits
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Graphically
$
Qf
ATC
AVC
MC
Pe = Df = MR
Qf*
ATC
Pe
Profit = (Pe - ATC) ? Qf*
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
A Numerical Example
? Given
? P=$10
? C(Q) = 5 + Q2
? Optimal Price?
? P=$10
? Optimal Output?
? MR = P = $10 and MC = 2Q
? 10 = 2Q
? Q = 5 units
? Maximum Profits?
? PQ - C(Q) = (10)(5) - (5 + 25) = $20
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Long Run Adjustments?
? If firms are price takers but there are
barriers to entry,profits will persist
? If the industry is perfectly competitive,
firms are not only price takers but there is
free entry
? Other,greedy capitalists” enter the market
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Effect of Entry on Price?
Firm Q
f
$
Df
Market
QM
$
D
S
Pe
S*
Pe* Df*
Entry
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Effect of Entry on the Firm’s Output and Profits?
$
Q
AC
MC
QL
Pe Df
Pe* Df*
Qf*
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Summary of Logic
? Short run profits leads to entry
? Entry increases market supply,drives down
the market price,increases the market
quantity
? Demand for individual firm’s product shifts
down
? Firm reduces output to maximize profit
? Long run profits are zero
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Features of Long Run
Competitive Equilibrium
? P = MC
? Socially efficient output
? P = minimum AC
? Efficient plant size
? Zero profits
? Firms are earning just enough to offset their opportunity
cost
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Monopoly
? Single firm serves the,relevant market”
? Most monopolies are,local” monopolies
? The demand for the firm’s product is the
market demand curve
? Firm has control over price
? But the price charged affects the quantity demanded of
the monopolist’s product
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
“Natural” Sources of
Monopoly Power
? Economies of scale
? Economies of scope
? Cost complementarities
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
“Created” Sources of
Monopoly Power
? Patents and other legal barriers (like
licenses)
? Tying contracts
? Exclusive contracts
? Collusion
Contract..,
I,
II,
III,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Legal Barriers to
Monopoly Power
? Section 3 of the Clayton Act (1914)
? Prohibits exclusive dealing and tying arrangements
where the effect may be to,substantially lessen
competition”
? Sections 1 and 2 of the Sherman Act (1890)
? Prohibits price-fixing,market sharing,and other
collusive practices designed to,monopolize,or attempt
to monopolize” a market
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Managing a Monopoly
? Market power permits
you to price above MC
? Is the sky the limit?
? No,How much you sell
depends on the price
you set!
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
A Monopolist’s Marginal
Revenue
P
Q
Q
Demand
Elastic
Inelastic
Unitary
MR
Total
Revenue
($)
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Monopoly Profit Maximization
$
Q
ATC
MC
D
MR QM
PM
Profit
ATC
Produce where MR = MC,
Charge the price on the demand curve that corresponds to that quantity,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
A Useful Formula
? What’s the MR if a firm faces a linear
demand curve for its product?
? P(Q) = a + bQ
? MR = a + 2bQ
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
A Numerical Example
? Given estimates of
? P = 10 - Q
? C(Q) = 6 + 2Q
? Optimal output?
? MR = 10 - 2Q
? MC = 2
? 10 - 2Q = 2
? Q = 4 units
? Optimal price?
? P = 10 - (4) = $6
? Maximum profits?
? PQ - C(Q) = (6)(4) - (6 + 8) = $10
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Long Run Adjustments?
? None,unless the
source of monopoly
power is
eliminated,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Why Government Dislikes
Monopoly?
? P > MC
? Too little output,at too high a price
? Deadweight loss of monopoly
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
$
Q
ATC
MC
D
MR QM
PM
MC
Deadweight Loss
of Monopoly
Deadweight Loss of Monopoly
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Arguments for Monopoly
? The beneficial effects of economies of
scale,economies of scope,and cost
complementarities on price and output may
outweigh the negative effects of market
power
? Encourages innovation
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Monopolistic Competition
? Numerous buyers and sellers
? Differentiated products
? Implication,Since products are differentiated,each firm
faces a downward sloping demand curve,
? Firms have limited market power,
? Free entry and exit
? Implication,Firms will earn zero profits in the long run,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Key Implications
? Since products are differentiated,each firm
faces a downward sloping demand curve;
firms have limited market power,
? Free entry and exit,so firms will earn zero
profits in the long run,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Managing a Monopolistically
Competitive Firm
? Market power permits you to price above
marginal cost,just like a monopolist,
? How much you sell depends on the price
you set,just like a monopolist,But …
? The presence of other brands in the market
makes the demand for your brand more
elastic than if you were a monopolist,
? You have limited market power,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Marginal Revenue Like a
Monopolist
P
Q
Q
Demand
Elastic
Inelastic
Unitary
MR
Total
Revenue
($)
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Monopolistic Competition,
Profit Maximization
? Maximize profits like a monopolist
? Produce where MR = MC
? Charge the price on the demand curve that
corresponds to that quantity
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Graphically
$ ATC MC
D
MR QM
PM
Profit
ATC
Quantity of Brand
X
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Long Run Adjustments?
? In the absence of free entry,no adjustments
occur,
? If the industry is truly monopolistically
competitive,there is free entry,
? In this case other,greedy capitalists” enter,and their
new brands steal market share,
? This reduces the demand for your product until profits
are ultimately zero,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
$ AC MC
D
MR
Q*
P*
Quantity of Brand
X MR1
D1
Entry
P1
Q1
Long Run Equilibrium
(P = AC,so zero profits)
Graphically
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Monopolistic Competition
The Good (To Consumers)
? Product Variety
The Bad (To Society)
? P > MC
? Excess capacity
? Unexploited economies of
scale
The Ugly (To Managers)
? Zero Profits
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Strategies to Avoid (or Delay)
the Zero Profit Outcome
? Change; don’t let the long-run set in,
? Be the first to introduce new brands or to
improve existing products and services,
? Seek out sustainable niches,
? Create barriers to entry,
? Guard,trade secrets” and,strategic plans”
to increase the time it takes other firms to
clone your brand,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Maximizing Profits,A
Synthesizing Example
? C(Q) = 125 + 4Q2
? Determine the profit-maximizing output and
price,and discuss its implications,if
? You are a price taker and other firms charge $40 per unit;
? You are a monopolist and the inverse demand for your product
is P = 100 - Q;
? You are a monopolistically competitive firm and the inverse
demand for your brand is P = 100 - Q
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Marginal Cost
? C(Q) = 125 + 4Q2,
? So MC = 8Q
? This is independent of market structure
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Price Taker
? MR = P = $40
? Set MR = MC
? 40 = 8Q
? Q = 5 units
? Cost of producing 5 units
? C(Q) = 125 + 4Q2 = 125 + 100 = 225
? Revenues,
? PQ = (40)(5) = 200
? Maximum profits of -$25
? Implications,Expect exit in the long-run
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Monopoly/Monopolistic Competition
? MR = 100 - 2Q (since P = 100 - Q)
? Set MR = MC,or 100 - 2Q = 8Q
? Optimal output,Q = 10
? Optimal price,P = 100 - (10) = 90
? Maximal profits,
? PQ - C(Q) = (90)(10) -(125 + 4(100)) = 375
? Implications
? Monopolist will not face entry (unless patent or other entry
barriers are eliminated)
? Monopolistically competitive firm should expect other firms
to clone,so profits will decline over time
