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Economics for Managers

Economics for Managers. by Dr. William Hua WANG Associate Professor, China Area Manager Euromed Management Ecole de Marseille William-hua.wang@euromed-management.com. III A close look at firm behaviours. Summary. III A close look at firm behaviours

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Economics for Managers

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  1. Economics for Managers by Dr. William Hua WANG Associate Professor, China Area Manager Euromed Management Ecole de Marseille William-hua.wang@euromed-management.com

  2. III A close look at firm behaviours

  3. Summary III A close look at firm behaviours 3.1 Firm behaviour and industry structure – patterns of competition 3.2 Pricing strategy – under different situations

  4. 3.1 Firm behaviour and industry structure – patterns of competition 1. Perfect Competition 1.1 Perfect Competition Defined 1.2 The Competitive Firm 1.3 The Competitive Industry 1.4 Perfect Competition and Economic Efficiency 2. Monopoly 2.1 Monopoly Defined 2.2 The Monopolist’s Supply Decision 2.3 Can Anything Good Be Said About Monopoly? 2.4 Price Discrimination Under Monopoly 3. Between competition and monopoly 3.1 Monopolistic Competition 3.2 Oligopoly 3.3 Monopolistic Competition, Oligopoly, and Public Welfare 3.4 A Glance Backward: Comparing the Four Market Forms

  5. Perfect Competition Defined 1.1 • Many small firms and customers • Homogeneous product • Free entry and exit • Well-informed producers and consumers • Firm is a price taker. • Price is set in the market. • Firm is too small to affect the market.

  6. Firms under the perfect competition MC AC B D = MR = AR A S-R Equilibrium of the Competitive Firm 1.2 Revenue and Cost per Bushel $3.00 2.25 1.50 0 50,000 Bushels of Corn per Year

  7. Firms under the perfect competition MC AC Revenue and Cost A per Bushel B D = MR = P S-R Equilibrium of Competitive Firm w/Lower Price 1.2 $2.25 1.50 0 30,000 Bushels of Corn per Year

  8. Firms under the perfect competition The Competitive Firm 1.2 Shutdown and Break-Even Analysis • Rule 1: The firm will make a profit if total revenue (TR) > total cost (TC) Should not plan to shut down in either the short run or the long run. • Rule 2: Even if TR < TC, the firm should continue to operate in the short run as long as TR > TVC. If TR > TVC, the firm can at least pay some of its fixed costs. The firm should close in the long run if TR < TC.

  9. Firms under the perfect competition The Shutdown Decision 1.2

  10. One toy (among the others) in one company: Sell it or Stop it now? Selling price: 12 yuan Selling quantity: 10 million Average cost: 14.55 yuan within which: (1) Costs caused directly by manufacture and marketing of the toy: 10.30 yuan (2) « Overhead » (company’s overall general expenses): 4.25 yuan

  11. Firms under the perfect competition MC AC AVC P P 3 3 A B P P 2 2 P P 1 1 Shutdown Analysis FIGURE 10-4 1.2 Price • The competitive firm will produce nothing • unless price lies above the minimum • point on the AVC curve. 0 Quantity Supplied

  12. The competitive industry 1.3 • The Long-Run Industry Supply Curve • The long-run supply curve of the competitive industry is also the industry’s long-run average cost curve. • The industry is driven to that supply curve by the entry or exit of firms and by the adjustment of firms already in the industry.

  13. The competitive industry S LRAC B S A Output in Millions of Bushels of Corn S-R Industry Supply and L-R Industry Average Cost FIGURE 10-10 1.3 $2.62 Price, Average Cost per Bushel 1.50 0 70

  14. 3.1 Firm behaviour and industry structure – patterns of competition 1. Perfect Competition 1.1 Perfect Competition Defined 1.2 The Competitive Firm 1.3 The Competitive Industry 1.4 Perfect Competition and Economic Efficiency 2. Monopoly 2.1 Monopoly Defined 2.2 The Monopolist’s Supply Decision 2.3 Can Anything Good Be Said About Monopoly? 2.4 Price Discrimination Under Monopoly 3. Between competition and monopoly 3.1 Monopolistic Competition 3.2 Oligopoly 3.3 Monopolistic Competition, Oligopoly, and Public Welfare 3.4 A Glance Backward: Comparing the Four Market Forms

  15. Monopoly Defined 2.1 • Only one firm in the industry • No close substitute for the product • Little chance of successful entry by a competitor

  16. Monopoly Defined 2.1 Sources of Monopoly • Barriers to entry • Legal restrictions • Patents • Control of a scarce resource or input • Deliberately erected entry barriers • Large sunk costs • Cost advantages • Technical superiority • Economies of scale

  17. Monopoly Defined 2.1 Natural Monopoly • Declining long-run average costs • When a large firm can produce and sell more cheaply than a small firm • Costs of production would be higher if a natural monopoly were broken up into many smaller firms.

  18. Monopoly Defined B A C AC Natural Monopoly 2.1 Intel AMD Arcelor $3.00 Average Cost Mittal 2.50 Mittal + Arcelor 2.00 1 2 2.5 Quantity Supplied

  19. TheMonopolist’s Supply Decision 2.2 • Price maker (or price searcher) • Faces a negatively sloped demand curve • Standard supply-demand analysis does not apply. • Joint decision about price and output

  20. TheMonopolist’s Supply Decision 2.2 • Monopolist sets output where MC = MR • Market demand  price for this output • P > MR • Monopolist makes profits (or losses) to the extent that price is greater (less) than average cost.

  21. TheMonopolist’s Supply Decision MC D P AC M MC C D (AR) AC MR Profit-Maximizing Equilibrium for a MonopolistFIGURE 12-2 2.2 $9 Price per Unit 7 4 0 150 Quantity

  22. TheMonopolist’s Supply Decision A Monopolist’s Price-Output Decision 2.2

  23. TheMonopolist’s Supply Decision 2.2 • Compared to perfect competition, a monopoly: • May enjoy a long-run profit • Restricts its output to raise its selling price (both in the long and short runs) • Leads to inefficient resource allocation (MC < MU)

  24. TheMonopolist’s Supply Decision MC D AC P M B MC D (AR) C AC MR Compare Monopoly to Competitive Industry 2.2 $10 Price per Unit 8 150 300 Quantity

  25. Can Anything Good Be Said About Monopoly? 2.3 • Under some circumstances a monopoly may: • Raise demand for its product (thus negating the inefficient reduction in output noted above) • Reduce marginal and average cost (produce more efficiently) • Stimulate innovation

  26. Can you find one case of monopoly ?

  27. Diamond group deals with antitrust concerns De Beers, the biggest diamond producer in the world, currently has a deal with Alrosa of Russia, the second biggest diamond producer, to sell €800m ($1.03bn) of its gems each year. The European Commission warned last year that this was anti-competitive. Antitrust limitations stop De Beers from controlling the whole value chain, from diamond-mining to cutting and polishing to jewellery retail. Ten years ago, the market share of De Beers was closer to 70 percent. Now it controls 50 percent of the world’s rough diamond supply. In July De Beers pleaded guilty to a 10-year-old charge of price-fixing in industrial diamonds, and paid a fine of $10m. This long-awaited move has freed De Beers to operate directly in the US, the world’s biggest market for diamond jewellery. Source: Rebecca Bream, De Beers presents a more polished image, Financial Times, 9th November 2004, page 19. For more than a hundred years De Beers is privately owned by the Oppenheimer family. The mining group Anglo American owns 45 percent of De Beers.

  28. 3.1 Firm behaviour and industry structure – patterns of competition 1. Perfect Competition 1.1 Perfect Competition Defined 1.2 The Competitive Firm 1.3 The Competitive Industry 1.4 Perfect Competition and Economic Efficiency 2. Monopoly 2.1 Monopoly Defined 2.2 The Monopolist’s Supply Decision 2.3 Can Anything Good Be Said About Monopoly? 2.4 Price Discrimination Under Monopoly 3. Between competition and monopoly 3.1 Monopolistic Competition 3.2 Oligopoly 3.3 Monopolistic Competition, Oligopoly, and Public Welfare 3.4 A Glance Backward: Comparing the Four Market Forms

  29. Monopolistic Competition 3.1 Characteristics of Monopolistic Competition • Many sellers • Freedom of entry and exit • Perfect information • Heterogeneous products • First three characteristics same as those for perfect competition. • Fourth is an important distinction. • Demand curve facing the firm is negatively sloped. • Majority of firms are in this type of market structure.

  30. Monopolistic Competition 3.1 • Price and Output Determination under Monopolistic Competition • MR = MC rule applies for setting output. • Long-run equilibrium: the firm’s demand curve must be tangent to its average cost curve.

  31. Monopolistic Competition MC AC P C E D MR Short-Run Equil. under Monopolistic Competition 3.1 $1.00 Price per Gallon .90 12,000 Gallons of Gasoline per Week

  32. Monopolistic Competition MC AC E D MR Long-Run Equil. under Monopolistic Competition 3.1 P $.95 M $.85 Price per Gallon 10,000 15, 000 Gallons of Gasoline per Week

  33. Monopolistic Competition The Excess Capacity Theorem 3.1 • Under monopolistic competition, in the long run the firm will produce an output lower than that which minimizes its unit costs. • Hence, unit costs will be higher than necessary. • Achievement of minimum average costs would require fewer but larger firms. • This inefficiency may, however, be a reasonable price to pay for providing a large range of consumer choice.

  34. Oligopoly 3.2 • Oligopoly = market dominated by a few sellers, at least several of which are large enough relative to the total market that they can influence the market price • Oligopoly  more intense competition than pure competition • A market or industry is dominated by a small number of sellers (oligopolists). • Big 3, Big 4, Big 6 • C4>40%: Supermarket in UK (70%),Brewing industry in UK (85%). The tobacco, beer, aircraft, motor vehicle, and music recording industries in USA.

  35. Oligopoly 3.2 • Why Oligopolistic Behavior is So Difficult to Analyze • Oligopolistic firms interact with each other in complex ways, and almost anything can and sometimes does happen under oligopoly.

  36. Oligopoly 3.2 • A Shopping List • Ignore interdependence • Strategic interaction • Cartels • Price leadership and tacit collusion • Sales maximization • Kinked demand curve • Game theory

  37. Oligopoly 3.2 • Sales Maximization: An Oligopoly Model with Interdependence Ignored • Firms may attempt to maximize revenue rather than profit if • control is separated from ownership. • compensation of managers is related to the size of the firm. • Output set where marginal revenue = 0 (rather than marginal cost) • Compared to a profit-maximizer • Higher output • Lower price

  38. Oligopoly MC AC E F A D B MR 3.2 Sales-Maximization Equilibrium FIGURE 13-3 $1.00 .80 Price per Box .75 .69 2.5 3.75 Millions of Boxes per Year

  39. Oligopoly The Kinked Demand Curve Model 3.2 ? • Because the managers of a firm think that other firms will match any cut they make in price, but not any increase, they may think they face an inelastic demand curve with respect to price cuts and an elastic curve with respect to price increases. • The demand curve is kinked, and the marginal revenue curve is discontinuous. • If so, neither price nor output will change in response to moderate shifts in costs.

  40. Oligopoly d MC D A B D E MR d C mr The Kinked Demand Curve and Sticky PricesFIGURE 13-5 3.2 Price $10 1,000 Explain the « Stickness » in oligopolistic pricing Quantity Supplied per Year

  41. Comparing the Four Market Forms 3.4

  42. III A close look at firm behaviours

  43. Executive Summary III A close look at firm behaviours 3.1 Firm behaviour and industry structure – patterns of competition 3.2 Pricing strategy – under different situations

  44. 3.2 Pricing Strategy: under different situations • Pricing in Practice • Pricing and Market Structure • Alternative Pricing Strategies • Price Discrimination • Multiple Product Pricing • Transfer Pricing • Pricing and the Product Life Cycle

  45. Pricing in Practice 1 • Is there a unique equilibrium price? • in most cases, no • Factors determining price • the life cycle of a product • the aims of the firm • the degree of competition • information on costs and demand • past practices

  46. Pricing and Market Structure 2 • The firm’s market power • the greater the power, the greater the discretion over price • the importance of strategy • reactions of rivals • Limit pricing • where potential entrants have higher AC

  47. ACnew entrant PL AC monopolist Limit pricing Pricing and Market Structure 2 £ O Q

  48. Galanz (China) vs. Moulinex (France)

  49. Alternative Pricing Strategies 3 • Do firms know their costs and revenues? • difficulties in identifying the profit-maximising price and output • difficulties in predicting rivals’ behaviour • Cost-based pricing • the use of a profit mark-up on AC • choosing the level of output

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