Managerial Economics & Business Strategy Chapter 8 Managing in Competitive, Monopolistic, and Monopolistically Competitive Markets

Profit Profit = (Pe - ATC)  Qf* MC $ Qf ATC AVC Pe Pe = Df = MR ATC

A Numerical Example Given Optimal Price? Optimal Output? C(Q) = 5 + Q2 Optimal Price? Optimal Output? MR = P = $10 and MC = 2Q 10 = 2Q Q = 5 units Maximum Profits? PQ - C(Q) = (10)(5) - (5 + 25) = $20

Should this Firm Sustain Short Run Losses or Shut Down? Profit = (Pe - ATC)  Qf* < 0 MC ATC $ Qf AVC ATC Loss Pe = Df = MR Pe Qf*

Shutdown Decision Rule A profit-maximizing firm should continue to operate (sustain short-run losses) if its operating loss is less than its fixed costs. Operating results in a smaller loss than ceasing operations. Decision rule: A firm should shutdown when P < min AVC. Continue operating as long as P ≥ min AVC.

Firm’s Short-Run Supply Curve: MC Above Min AVC ATC $ Qf AVC P min AVC Qf*

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.

Effect of Entry on Price? Market QM $ D S Pe Firm Qf $ Df S* Entry Pe* Df*

Effect of Entry on the Firm’s Output and Profits? MC $ Q AC Pe Df Df* Pe* QL Qf*

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.

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.

Can we do it?? Number 2 A firm sells its product in a perfectly competitive market where other firms charge a price of $80 per unit. The firm’s TC are C(Q) = 40+8Q+2Q2 How much output should the firm produce in the short run? MR = MC 80 = 8+4Q 72 = 4Q Q= 18 What price should the firm charge in the short run? Same price as others = $80 What are the firm’s short run profits? 80*18 – (40+8(18)+2(182)=608 What adjustments should be anticipated in the long run? More firms will enter and prices will fall, output will have to be reduced, and profits will end at the breakeven point