Download lecture six - Webster in china

Lecture six
© copyright：qinwang 2013
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SHUFE school of international business
Market structure and firm behavior
 Market structure
 Perfect competition and firm decision
 Pure monopoly and firm decision
 Monopolistic competition and firm
decision
 Oligopoly and firm decision
Market structure
 Market structure： the competitiveness
of the products or services。
 Market competitive analysis：market
rates; price competition; barriers to
entry and barriers to exit; industrial
growth rate; fixed cost and variable
cost.
 Influence Factors：




Number of consumers and firms
Difference of product
Scale economies
Entry barrier and exit barrier
 Market structure:
Pure
Competition
higher
Monopolistic
Competition
Oligopoly
competitive
Monopoly
weaker
Perfect (pure) market





Many firms and consumers
all making same product (homogenization)
Each firm’s output small relative to total
No entry and exit barrier
Complete information
 Example:
Pure monopoly
Market with a single seller
Firm demand = market demand
No substitution
High entry and exit barrier
 Example:
Monopolistic Competition
 Large number of firms sell a
differentiated product
 Products are close (not perfect) substitutes
 Market is monopolistic
 Product differentiation creates a degree of
market power
 Market is competitive
 Large number of firms, easy entry
 Example:
Oligopoly market




Number of firms is small
Products are same or different
High barriers to entry
Interdependence of firms
 example:
Decision in pure market
（1） Price strategy
（2） Short-run decision
Maximum of profit
Shut-down point
（3） Long-run decision: enter or exit
Pure competition： Firms are
price-takers
Demand for a Competitive
Price-Taker
 Demand curve is horizontal at price
determined by intersection of market
demand & supply
 Perfectly elastic
 Marginal revenue equals price
 Demand curve is also marginal revenue curve
(D = MR)
 Can sell all they want at the market price
 Each additional unit of sales adds to total
revenue an amount equal to price
Profit-Maximization in the
Short Run
price
MC
AC
MR=P=AR
P0
0
Profit-maximization Q0
product
Profit = π = TR - TC
Example: A firm in pure market
Product
Total cost AC
MC
2
3
4
5
6
7
8
22
30
36
45
60
77
96
-8
6
9
15
17
19
11
10
9
9
10
11
12
 If P=17，how many product should be supplied？
What is the Profit of per unit？What is the total
profit？
Profit-Maximization in the
Short Run
 In the short run, the firm incurs costs
that are:
 Unavoidable and must be paid even if
output is zero
 Variable costs that are avoidable if the
firm chooses to shut down
 In making the decision to produce or
shut down, the firm considers only
the (avoidable) variable costs &
ignores fixed costs
Profit Margin (or Average Profit)
 Level of output that maximizes total
profit occurs at a higher level than the
output that maximizes profit margin
(& average profit)
 Managers should ignore profit margin
(average profit) when making optimal
decisions

( P  ATC )Q
Average profit 

Q
Q
 P  ATC  Profit margin
Shut down
price
MC
（1）if market price =P1
（2） if market price =P2
P1
AC
AVC
P2
（3） if market price =P3
P3
0
Q3 Q2 Q1
product
Long-run decision: Entry or exit?
If TR<LTC, P<LAC，exit；if TR>LTC，P>LAC，then entry
P
LMC
LAC
E
Pe
A
0
A
Pe  MR  AR
Q
P
P
SMC
SAC
E2
P2
E1
P1
P3
P1
E3
P3
0
Q
( Industry )
C
P2
0
A
B

( Firm)
Q
Long-Run Competitive Equilibrium
 All firms are in profit-maximizing
equilibrium (P = LMC)
 Occurs because of entry/exit of firms
in/out of industry
 Market adjusts so P = LMC = LAC
Long-run equilibrium
Ranidae
Ranidae is introduced from Cuba. It grows fast and is
delicious. Some farmers in south of China began to breed Ranidae
in 1985, until 1992, there were about 800 farmers and with 500
mu breeding area.
Mr.Li,50 years old, began to breed Ranidae in 1986 and had
earned 700,000 yuan until1992. Mr.Zhang,40 years old, earned
280000 in 1992 for selling tadpole.
In 1993, local newspaper published a wrong news: the price
of Ranidae in city A is 52 yuan/kg, sales of Ranidae in City A
is about 700 kg. export price of Ranidae is 260-280 yuan/kg. At
that time, a lot of farmers tried to breed Ranidae. The number
of farmer rised to 6471 and breeding area increased to 6021 mu.
Ranidae’s price is only 16-20 yuan/kg, less than half of the cost.
what should the farmers do?
 Discussion:
 Cabbage in Shanghai and Watermelon
in other provinces.
Perfect(pure) market
 The firm supplies its product at the
minimum of its long-run cost, so it
gets efficiency.
 Resources are allocated efficiently
between products and firms.
 The total of Consumer surplus and
supplier surplus are maximized.
Monopolistic competition
 Price strategy
 Short-run decision
 Long-run decision
 Product strategy: differentiation
 Competitive strategy
Short-run decision
In short-run,
When
SMC=MR,
Profit
maximum
P C、R
SMC
P0
AC0
A
SAC
B
E
D  AR
MR
0
Q0
Q
Long-run equilibrium
P
SMC
SAC
AC0
P0
P
MR
0
P
Q0
LMC
D
Q
P0
MR
SMC
SAC
P0
AC0
MR
0
Q0
D
Q
LAC
0
Q0
D
Q
Market Power
 Ability of a firm to raise price without
losing all its sales
 Any firm that faces downward sloping
demand has market power
 Gives firm ability to raise price above
average cost & earn economic profit
(if demand & cost conditions permit)
Measurement of Market Power
 Degree of market power inversely
related to price elasticity of demand
 The less elastic the firm’s demand, the greater
its degree of market power
 The fewer close substitutes for a firm’s
product, the smaller the elasticity of demand
(in absolute value) & the greater the firm’s
market power
 When demand is perfectly elastic (demand is
horizontal), the firm has no market power
Measurement of Market Power
 Lerner index measures proportionate
amount by which price exceeds marginal
cost:
P  MC
Lerner index 
P
 Equals zero under perfect competition
 Increases as market power increases
 Also equals –1/E, which shows that the index (&
market power), vary inversely with elasticity
 The lower the elasticity of demand (absolute
value), the greater the index & the degree of
market power
Measurement of Market Power
 If consumers view two goods as
substitutes, cross-price elasticity of
demand (EXY) is positive
 The higher the positive cross-price
elasticity, the greater the substitutability
between two goods, & the smaller the
degree of market power for the two firms
Product strategy：differentiation
 Technology innovation： higher
quality, new function, new product
(objective difference)
 Advertising and promotion:
(subjective difference)
 Service strategy： service system
after sale
 Discuss: advertising
 Giving information or inducing
 Benefit to Competition or concentration
 Promoting efficiency or waste
Optimal advertising intensity
 The marginal profit or contribution margin
from an additional unit of output:
PCM=P-MC
 The marginal cost of advertising (MCA)
MCA  Ak / Q
Optimal level of advertising outlays:
PCM=MCA
Competitive strategy
 Low cost strategy
 Dell’s cost leadership in PC assembly
 Differentiation strategy
 Focus strategy