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Chapter 9:
Maximizing Profit:
Profit = Total Revenue - Total Cost
Total Revenue (TR) = P × Q
PQ
P
Average Revenue (AR) = TR÷Q =
Q
Marginal Revenue:
It measures the change in total revenue
generated by one additional unit of
goods or services.
TR
MR 
Q
Weekly Revenue and Cost Data
for a Gold Miner
Price of Gold = $600 / oz
Weekly
Output
Weekly
TR
Weekly
TC
Weekly
Profit
0
1
2
3
4
5
6
7
8
9
0
600
1200
1800
2400
3000
3600
4200
4800
5400
570
810
1000
1240
1530
1920
2410
3000
3690
4480
-570
-210
200
560
870
1080
1190
1200
1110
920
Weekly Weekly
Output
TR
0
1
2
3
4
5
6
7
8
9
0
600
1200
1800
2400
3000
3600
4200
4800
5400
MR
Weekly
TC
0
600
600
600
600
600
600
600
600
600
570
810
1000
1240
1530
1920
2410
3000
3690
4480
MC
Weekly
Profit
240
190
240
290
390
490
590
690
790
-570
-210
200
560
870
1080
1190
1200
1110
920
MR
MC
MC
P
0
P = MR
q
Output
Fig. A
MC
ATC
P
a
c
0
b
q
AVC
10
9
8
7
6
5
4
3
2
MC
ATC
AVC
1
1 2
3
4
5
6
7 8
9 10
Fig. C
MC
ATC
c
P
n
b
0
q
a
m
AVC
Fig. B
MC
ATC
c
b
P
a
0
q
AVC
10
9
8
7
6
5
4
3
2
MC
ATC
AVC
1
1 2
3
4
5
6
7 8
9 10
10
9
8
7
6
5
4
3
2
MC
ATC
AVC
1
1 2
3
4
5
6
7 8
9 10
Chapter 10: Indentifying
Markets and Market Structure
Characteristics of Perfect Competition:
Numerous small firms and customers. Firms
have insignificant market share.
Homogeneity of Product. Firms produce
perfect substitutes.
Freedom of Entry and Exit.
Perfect Information.
Demand Facing a Typical Firm in Perfect Competition
A representative Firm
Industry
S
P = MR
P0
P0
D
0
Q0
Q
0
Q
Fig. A
MC
P
a
c
0
ATC AVC
b
q
Normal Profit: The entrepreneur’s
opportunity cost. It is equal to or greater
than the maximum income an entrepreneur
could have received employing his or her
resources elsewhere. Normal Profit is
included in the firm’s costs.
Economic Profit: Profit that an entrepreneur
makes over the Normal Profit.
P=20
MR=MC, at Q=2000
Total Explicit Cost = 10,000
Opportunity Cost = 22,000
Economic Profit = TR -TC
TR = P x Q = 20(2000) = 40,000
Economic Profit = TR –TC = 40,000 -10,000 - 22,000
=8,000
Accounting Profit
=30,000
TC = Total (Economic) Cost =Explicit Cost + Implicit Cost
Exercises:
MC
18
ATC
15
AVC
0
7
Exercises:
MC
16
ATC
13
12
0
AVC
4
Long Run Equilibrium under Perfect Competition
S0
D
S*
P0
P0
a
c
b
P*
0
Q0
Industry
Q*
0
q*
q0
Representative Firm
Monopoly:
This is a situation where a single
producer (firm) is the sole producer
of a good that has no close
substitutes.
Sources of Monopoly:
 The firm may control the entire supply of raw
materials required to produce that output.
 The firm may have a patent or copyright.
 The case of “Natural Monopoly”. Economies
of Scale may permit only one firm to be
efficient in the market.
Natural Monopoly
P
2.25
2
1.5
ATC
D
0
20
40
Q
Sources of Monopoly:
 The firm may control the entire supply of raw
materials required to produce that output.
 The firm may have a patent or copyright.
 The case of “Natural Monopoly”. Economies
of Scale may permit only one firm to be
efficient in the market.
 The case of Government Franchises.
 Through Mergers and Acquisitions.
Characteristics of Monopoly:
 A single seller: A single firm produces all
industry output. The monopoly is the industry.
 Entry into the industry is totally blocked.
 Imperfect dissemination of information: Cost,
price, and product quality information are
withheld from uninformed buyers.
8
7
TR2= 8(2)=16
AR2=8=P
TR3= 7(3)=21
AR3=7=P
MR3= TR3-TR2=21-16=5
MR
0
2 3
Quantity
Price
MR=MC
P
b
P
a
c
MC
AVC
ATC
ATC
AVC
MR
0
Q
D
Quantity
$
10
9
8
7
6.5
6
5
4
3
2
MC
ATC
AVC
1
0
D
MR
1 2
3
4
5
6
7 8
9 10
Q
Price
ATC
MC
b
P
c
AVC
a
MR
0
Q
D
Quantity
Price
MC
b
P
m
c
a
AVC
n
MR
0
ATC
Q
D
Quantity
Find the Profit maximizing output from the
following information.
Demand Information
Cost Information
P
Q TR MR
Q
TC MC
12
0
0
--
0
5
--
11
1
11
11
1
7
2
10
2
20
9
2
10
3
9
3
27
7
3
14
4
8
4
32
5
4
19
5
7
5
35
3
5
25
6
Profit =
TR – TC =
32 – 19 = 13
Monopolistic Competition:
It is a form of market organization in which
there are many sellers of a heterogeneous or
differentiated product, and entry into and exit
from the industry are rather easy in the long run.
Differentiated Product:
Products which are similar but not identical
and satisfy the same basic need.
Characteristics:
 Large number of buyers and sellers.
 Product Heterogeneity.
 Free Entry and Exit.
 Perfect dissemination of information.
The Market Structure Spectrum
36
The Demand Curve for Coca-Cola:
Before and After Substitutes Appear on the Market
e=-3
e = -1
e = - . 47
37
Price
MC
P
r
b
a
s
c
D
D1
MR1 MR
0
q1 q
Quantity
Price
MC
P
a
MR2
0
q
D2
Quantity
The Effect of Advertising
on the Firm’s Demand Curve
40
Oligopoly:
This is a form of market organization in
which there are few sellers of a
homogeneous or differentiated product.
Unlike the other forms of market structure
that we have discussed, a firm in
Oligopoly makes pricing and marketing
decision in light of the expected response
by rivals.
Characteristics of Oligopoly:
 Few Sellers: A handful of firms produce
the bulk of industry output.
 Homogeneous or unique product: If
product is homogeneous, then we have
“Pure Oligopoly”. If product is
differentiated, then we have “Differentiated
Oligopoly”.
 Blockaded Entry and Exit: Firms are heavily
restricted from entering the industry.
 Imperfect Dissemination of Information:
What are some examples of
Oligopoly?
 Automobiles
 Steel
 Soup
 Cereals
 Gasoline
Measure of Market Concentration:
4 Firm Concentration Ratios:
This is the percentage of total industry sales of
the 4 largest firms in the industry.
Firm A = 20%
Firm B = 5%
Firm C = 6%
Firm D = 2%
Firm E = 8%
Firm F = 35%
Firm G = 3%
Firm H = 7%
Firm I = 3%
Firm J = 11%
What is an example of a high
concentration ratio?
Out of 151 firms in the aircraft
industry the leading 4
constitutes 79% of total sales
What is the HerfindahlHirschman Index (HHI)?
A measure of industry concentration,
calculated as the sum of the squares
of the market shares held by each
firm in the industry
The Herfindahl-Hirschman Index:
HHI  S  S  S  S  ........
2
1
2
2
2
3
2
4
Firm A = 20%
Firm B = 5%
Firm C = 6%
Firm D = 2%
Firm E = 8%
Firm F = 35%
Firm G = 3% Firm H = 7%Firm I = 3% Firm J = 11%
HHI = 202 + 52 + 62 + 22 + 82 + 352 + 32
+ 72 + 32 + 112
HHI = 400 + 25 + 36 + 4 + 64 + 1225 + 9
+ 49 + 9 + 121 = 1942
In this case 1,000 < HHI < 10,000
What is a Balanced Oligopoly?
An oligopoly in which the sales of
the leading firms are distributed
fairly evenly among them
What is an Unbalanced Oligopoly?
An oligopoly in which the sales of
the leading firms are distributed
unevenly among them
Balanced and Unbalanced Oligopoly
Concentrating the Concentration:
Horizontal Mergers
A merger between firms producing the
same good in the same industry
Vertical Mergers
A merger between firms that have a
supplier - purchaser relationship
Conglomerate Mergers
A merger between firms in unrelated
industries
What is Collusion?
The practice of firms to negotiate
price and market decisions that
limit competition
What is a Cartel?
A group of firms that collude to
limit competition in a market by
negotiating and accepting agreedupon price and market shares
How do firms in an unbalanced
Oligopoly set price?
Most often they practice price
leadership
What is Price Leadership?
A firm whose price decisions are
tacitly accepted and followed by
other firms in the industry
Price Leadership:
Price,
MC
MCF
MC
P
D
MR
0
QL
QF
DL
Quantity
Imagine 3 identical firms, A, B, and C in
an industry. What happens If A raises
price?
B and C will not raise
their prices
Imagine 3 identical firms in an industry
A, B, C what happens If A lowers price?
B and C will lower their
prices
The Kinked Demand Curve Model:
Price
P
0
Q
Quantity
The Kinked Demand Curve Model:
Price
P
0
Q
Quantity
Price
P
0
Q
Quantity
Price
P
0
Q
Quantity
Brand Multiplication:
Variations of essentially one good that a
firm produces to increase its market share.
Firm’s Market Share = (Number of Brands) x
(Brand’s Market Share)
Price Discrimination :
The practice of offering a specific
good or service at different prices
to different segments of the
market.
Centralized Cartels:
P
P
 MC
MC2
MC1
P
D
MR
0
q1
0
q2
0
Q