Need Economic Essay 8 Pages Due In 48 Hours /Business Finance – Economics
Market structure
refers to the competitive environment that surrounds the
firm. It generally can be described in terms such as barriers
to entry and exit, numbers of buyers and sellers competing
in the market, individual seller’s control over price, extent
of product substitutability, and the degree of mutual
interdependence between firms.
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Market structures
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Product Differentiation
• Definition: Product Differentiation between two or more products exists when the products possess attributes that, in the minds of consumers, set the products apart from one another and make them less than perfect substitutes.
• Examples: Pepsi is sweeter than Coke, Brand Name batteries last longer than “generic” batteries.
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Conditions of perfect competition
a) homogenous (identical) product;
b) many small buyers and sellers;
c) perfect dissemination of information;
d) very low barriers to entry.
Ex. Agriculture products
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Perfect competition
in the short run • Firms are considered as price takers. Individual firms are
not able to affect the price for their product, and must
accept the market price. Since the market determines
the price for the product, the market price is set where
market demand equals market supply.
• The demand curve for a firm in a perfectly competitive in
dustry is a horizontal line at the market price.
• Since the price is constant for all quantities, price also
equals average revenue and marginal revenue (MR=P).
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Profit maximization
• A firm’s profit maximization problem:
maximize (Q) = TR(Q) – TC(Q)
• A firm’s profit maximization condition:
TR(Q)/Q = TC(Q)/Q
MR(Q) = MC(Q)
• A firm’s output decision in perfect competition is to
produce where MR = P = MC(Q).
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Price/output decision for firms competing in a
perfectly competitive market in the short run
• Suppose there is a firm serving a competitive market and
the market price is equal to: P = $105.
• The total cost function is given by the equation:
TC = 4,000 + 5Q + ½ Q2.
• P = MC or 105 = 5 + Q -> Q = 100
• AC = 40 + 5 + 50 = 95 when Q = 100
• Profit = (P – AC) x Q = 1,000
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Questions
11. You are the manager of a firm that sells its product in a
competitive market at a price of $50. Your firm’s cost
function is TC = 40 + 5Q2.
a) Calculate the profit-maximizing output.
b) Calculate the total profit.
13. What if TC = 100 + 0.05Q2 ?
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Short Run Perfectly Completive Equilibrium
Perfect competition
in the long run • Since the typical firm in this industry is making abnormal
profits ($1,000) in the short run, there will be an
expansion of the output of existing firms and we expect
to see the entry of new firms into the industry. The entry
of new firms shifts the market supply curve to the right
and drives down the market price and the abnormal
profit disappears.
• If some firms are losing money in the industry, these
firms will exit the market causing a leftward shift in the
market supply curve. This increases market price. Over
time, the individual firm will return, to the point where MR
equals MC and AC, and economic profit (or loss) equals
zero 11 12
Comparative Statics
supply shifts when
number of firms
increase
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Monopoly
• A monopoly is a market where a single seller offers
a unique product that has no close substitutes.
• Monopolies occur largely due to the existence of
barriers to entry in a given industry.
Ex. Suppose a new medication is discovered to treat a previously
untreatable illness; the company with this new-found medication has a
monopoly on the market
Ex. The market structure for providing aeronautical services such as
fueling, tie-down and parking, and aircraft maintenance, would be
considered a monopoly with respect to just the small airport; however,
the market would be an oligopoly on a state level.
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Barriers to entry
• legal/government barriers;
• capital requirements;
• technology;
• natural barriers;
• labor unions;
• project risks;
• development costs.
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1) Legal/government barriers
• A major barrier to entry, particularly in international
markets, is legal or government restrictions.
• Government regulation can help prevent market access,
creating situations where an artificial monopoly may be
created.
• Ex. License, patent
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2) Capital requirements
• Another possible barrier to entry in any industry is the
capital required to enter the market. The capital
necessary to commence production may be sufficiently
large so that the potential profits do not justify the
investment, the risk is too large, or the capital cannot be
obtained.
• Ex. A new aircraft manufacturing company
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3) Technology
• Technology can be a substantial barrier to entry.
Without a certain required level of technology, firms may
be unable to compete effectively in a market.
Ex. For over 30 years Boeing held a monopoly in the
very large commercial aircraft industry with its 747.
Ex. Concorde – the only supersonic passenger aircraft
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4) Labor union
• Another barrier to entry, particularly in the aviation
industry, can be labor unions. Labor unions essentially
band workers together to bargain as a monopolist of
labor supply and can thereby raise members’ wages
above the competitive level.
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5) Project risks
• The tremendous project risk, coupled with the other
extensive technical and capital requirements, make it
difficult to enter the very large aircraft market.
• Lockheed’s L-1011 TriStar project is a prime example of
the risk involved with aircraft manufacturing. The TriStar
project experienced delays that reduced its
competitiveness versus the similar McDonnell Douglas
DC10; these delays ultimately doomed the project. The
financial failure of the L-1011 caused Lockheed to exit
the commercial aircraft manufacturing market.
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6) Development costs
• In 1965 when Boeing decided to develop the 747, the
projected launch costs were $1.5 billion.
• in 2000, Airbus announced its intention to develop a very
large double-decker aircraft to compete with the Boeing
747 in the very large aircraft market. The project was
estimated to cost Airbus $13 billion, yet with subsequent
delays and problems that figure climbed to $14–15 billion
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7) Natural monopoly
• Natural monopolies can occur in the market due to
economies of scale. In industries that have very high
fixed costs, significant economies of scale can be
achieved as production increases.
• There usually is an extremely high fixed cost in
constructing a hydroelectric power plant; however, once
the plant is constructed, the cost of generating extra
electrical power is very low.
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PRICE/OUTPUT DECISION
FOR MONOPOLIES
• The market demand equals the firm’s demand. With only
one firm competing in the market, the firm faces the
entire market.
• The profit-maximizing output is the point where
MR equals MC.
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14. GE is the only producer of new jet engines for general aviation
aircraft. Demand for a single engine is P = 2,000,000 – Q while the
MCs of producing an engine are: MC = 1,999 Q.
a) What would be the monopoly price and quantity of these engines?
b) What economic profit would GE earn on the sale of these engines?
c) What would happen to price and quantity if the market were
competitive (assuming the same costs)?
15. What if we have Q = 25 – 0.5P and TC = 50 + 2Q?
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Figure 8.10 Equilibrium Price
under Monopoly and Perfect Competition
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(Inverse) Elasticity rule
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Example
Product: new drug, protected by patent
Estimated elasticity: -1.5 (constant)
Marginal cost: $10 (for a 12-dose package)
a) What’s the profit maximizing price?
b) What are values of markup at optimal price?
c) Check elasticity rules
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MC
Demand
MR
QM
PM
PC
QC
CS with competition: A+B+C ; CS with monopoly: A PS with competition: D+E ; PS with monopoly: B+D
A
B C
D
E
DWL = C+E
Chapter Eleven
The Welfare Economies of Monopoly
Copyright (c)2014 John Wiley & Sons, Inc.
Remarks on monopoly pricing
• Maximum pricing will cause demand for the product to
fall as consumers find ways to adapt to substitute goods
or otherwise change their habits to buy less of the
monopolized product.
• Aggressive monopoly pricing will also cause other firms
to invest more in overcoming barriers and entering the
market.
• Therefore, even a true monopolist protected tends to
moderate price somewhat in an attempt to discourage
the consumer adjustments and market innovations that
will eventually slash monopoly profits.
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MONOPOLY MARKET POWER
IN AVIATION
• Aircraft manufacturing, jet engine manufacturing, and
airports are all industries with firms that are capable of
exerting substantial market power.
• The airline industry is somewhat unique in that its major
suppliers all have substantial market power. However,
airlines complete fiercely in a market that more often
resembles an oligopoly.
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Slot controls at airports
• A slot is the right to land or takeoff from an airport at a given time.
• Slots are allocated through a variety of mechanisms. The first rule,
the “grandfather right,” entitles an airline to the same slot in the
future (if they are currently using it). Slot usage is determined by the
“use-it or lose-it” rule that states that the airline must use the slot for
at least 80% of the time during the scheduled period. If the airline
fails to meet this requirement then the grandfather right does not
apply and the slot is lost. The remaining slots are then dispersed to
applicants, with only 50 percent of new slots allocated to new
entrants.
• Very few slots become available for new entrants. The available
slots were likely at inconvenient times. These slot controls represent
a significant barrier to entry.
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Commercial aircraft manufacturing 1
Today there are four major aircraft manufacturers.
• Boeing and Airbus compete in the large commercial
aircraft market, comprising aircraft over 100 seats.
• Bombardier and Embraer compete in the regional jet
market.
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Commercial aircraft manufacturing 2
• Consider Southwest Airlines, an all-Boeing 737 operator.
Part of Southwest’s success has been a common fleet
type; this has increased crew flexibility, reduced crew
training cost, and reduced spare part inventories.
• In this situation, switching to an Airbus aircraft would
entail substantial costs. This may put Boeing in a
position to exert a degree of monopoly power over
Southwest Airlines.
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Commercial aircraft manufacturing 3
• Modern aircraft manufacturing is a heavily capital-intensive industry
requiring immense expenditures in research, development, and
manufacturing. As technology has increased and economies of
scale benefits have become more important, the cost of designing
and marketing an aircraft have become substantial, strengthening
the barriers to entry into the industry.
• This trend has also seen the number of firms competing in the
commercial aircraft industry drastically reduced. Therefore, there are
now very few firms competing in the industry, creating a market
structure that resembles an oligopoly.
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Monopsony
• A monopsony is a market condition in which only one
buyer faces many sellers. The defense industry in the
US may be a monopsony in which there is only one
buyer, the US government, and there are several sellers.
• A market condition consisting of only one buyer and only
one seller is called a bilateral monopoly.
