Einstein College of Engineering BA 912 ECONOMIC ANALYSES FOR BUSINESS Unit I DEVELOPMENT ECONOMICS. ? ? Development economics or the economics of development is the application of economic analysis to the understanding of the economies of developing countries in Africa, Asia, and Latin America. It is the sub discipline of economics that deals with the study of the processes that create or prevent economic development or that result in the improvement of incomes, human welfare, and structural transformation from a predominantly agricultural to a more advanced industrial economy.
The subfield of development economics was born in the 1940s and 1950s but only became firmly entrenched following the awarding of the Nobel Prize to W. Arthur Lewis and Theodore W. Schultz in 1979. Lewis provided the impetus for and was a prime mover in creating the sub discipline of development economics. ?
As a subfield concerned with “how standards of living in the population are determined and how they change over time” (Stern), and how policy can or should be used to influence these processes, development economics cannot be considered independently of the historical, political, environmental, and sociocultural dimensions of the human experience. Hence development economics is a study of the multidimensional process involving acceleration of economic growth, the reduction of inequality, the eradication of poverty, as well as major changes in economic and social structures, popular attitudes, and national institutions.
Development economics covers a variety of issues, ranging from peasant agriculture to international finance, and touches on virtually every branch in economics: micro and macro, labor, industrial organization, public finance, resource economics, money and banking, economic growth, international trade, etc. , as well as branches in history, sociology, and political science. It deals with the economic, social, political, and institutional framework in which economic development takes place. 1.
The study of economic development has been driven by theories of economic development, which have developed along the lines of the classical ideas, the Marxist idea, or a combination of both. 2. Some approaches have focused on the internal causes of development or underdevelopment, while others have focused on external causes. 3. Economic growth increase in output and income has been used as a substitute for development and, in some cases, has been treated as synonymous with development. 4. Economic growth and economic development have been mostly studied by means of cross-country econometric analysis.
Einstein College of Engineering ECONOMIC PROBLEMS 1. 2. 3. 4. 5. 6. Scarcity, choice and the basic economic problem Opportunity costs, allocation of resources Production possibility curve and productive efficiency Positive and normative statements Markets versus planning, free-market system, command economy Economic models. Scarcity, choice and the basic economic problem ? Inflation, unemployment, pollution, energy shortages and government deficits are some of the complex problems confronting an economy, which have an impact at the micro level also.
These problems arise due to the fact that resources are limited while human wants are unlimited. ? This leads to dissatisfaction, causing human being to look for ways to fulfill their needs. Thus scarcity leads to the necessity of making choices. Problems of choice arise at all levels – at the level of the individual, at the level of producers, and at the level of the overall economy. ? Scarcity results when natural resources, human resources and capital resources are not available in sufficient quantity to satisfy all wants.
So a producer has to decide what he wants to produce using a particular resource. ? For example, if he chooses to produce paper for textbooks from a stand of trees, then no other product can be produced from that particular stand of trees. Yet, there are many other products that could have been produced using the same natural resource, which are also desired by consumers. ? The opportunity cost of the decision thus becomes an important consideration; by making a choice, the next best alternative good cannot be produced. Consumers typically make their decisions based on two considerations- budget constraints and personal preferences. A budget constraint is the difficulty a person faces when he tries to satisfy his unlimited wants with a limited income. ? Thus, a purchase decision is based on income, price, and personal tastes and preferences. A consumer can have a choice of alternative products with a limited income if he can find a person with whom he can exchange goods or services. ? By means of such exchanges, he can increase his level of satisfaction.
Such gains in satisfaction can be termed as ? gains from trade‘. Opportunity costs, allocation of resources Opportunity cost can be defined as the cost of any decision measured in terms of the next best alternative, which has been sacrificed. To illustrate the concept better, let us assume that a person who has Rs. 100 at his disposal can spend it on either of the three options: having a dinner Einstein College of Engineering at a restaurant, going for a music concert or for a movie. The person prefers going for a dinner rather than to the movie, and the movie over the music concert.
Hence, his opportunity cost is sacrificing the movie, the next best alternative once he goes for a dinner. If we carry forward the same example at the firm level, a manager planning to hire a stenographer may have to give up the idea of having an additional clerk in the accounts department. This is applicable even at the national level where the country allocates higher defense expenditures in the budget at the cost of using the same money for infrastructural projects. In order to maximize the value of the firm, a manager must view costs from this perspective.
Production possibility curve and productive efficiency Now let us analyze how individuals, producers and other economic agents use the limited resources to meet the unlimited needs. This to a large extent is possible with the help of the production possibility curve (PPC). The production possibility curve can be defined as a curve which shows the maximum combination of output that the economy can produce using all the available resources. The production possibility curve helps us understand the problem of scarcity better, by showing what can be produced with given resources and technology.
Technology is the knowledge of how to produce goods and services. The following assumptions are made in constructing a PPC: ? The economic resources available for use in the year are fixed. ? These economic resources can be used to produce two broad classes of goods. ? Some inputs are better used in producing one of these classes of goods, rather than the other. Einstein College of Engineering Positive and normative statements Another debate about the nature of economics is whether it is a positive or a normative science. According to J. M. Keynes, ? A positive science may be defined as a body of systematized knowledge concerning what is.
A normative science or regulative science is a body of systematized knowledge relating to the criteria of what ought to be and concerned with the ideal as distinguished from the actual….. The objective of a positive science is the establishment of uniformities; of a normative science, the determination of ideals.? Positive economics explains economic phenomena according to their causes and effects. At the same time, it says nothing about the ends; it is not concerned with moral judgments. On the other hand, normative economics explains how things ought to be.
According to Milton Freidman, positive economics deals with how an economic problem is solved. Markets versus planning, free-market system, command economy This economic system emphasizes the freedom of individuals as consumers and suppliers of resources, and allows market forces to determine the allocation of scarce resources through the price mechanism. Based on market demand and supply, consumers are free to buy goods and services of their choice and producers allocate their resources based on the demand. Decisions made by producers and consumers are influenced greatly by price. ? Price plays a major role in a market economy.
The role of the government is negligible: consumers choose the goods they want and producers allocate their resources based on the market demand for different products. In such a system, efficiency is achieved through the profit motive. Producers make goods at the lowest cost of production, and consumers get higher value goods and services at lower prices. ? Command Economy In a command economy, all the economic decisions are taken by the government – what to produce, how to produce and for whom to produce. Thus, all decisions, from the allocation of resources to the distribution of nd products, is taken care off by the government. In this type of systems, efficiency can be achieved only when demands are accurately estimated and resources allocated accordingly. The USSR was an example of a command economy. The government had complete control over the economy, and consumers were just the price takers. The government set output targets for each district and factory and allocated the necessary resources. Economic models Economic models are a set of equations or relationships used to summarize the working of the national economy or of a business firm or some other economic unit.
Models may be Einstein College of Engineering simple or complex and they are used to illustrate a theoretical principle or to forecast economic behavior. ? Economic models can be further classified into Micro Economics Models and Macro Economic Models. ? Micro Economic Models: Models when they incorporate individual economic units such as households and firms, often grouped into individuals markets and industries and the relationship between them are called as micro models. ? Macro Economic Models: these models are used to explain and predict the working or performance of the economy as a whole, e. changes in the level of NI, the level of employment and inflation. Different approaches in solving the above issues/problems: ? Inputs (Factors of production) – 1) Land, 2) Labour and 3) Capital resources. 1) Land – Natural resources 2) Labour – human time spent in production 3) Capital resources – machines, computers, hammers, trucks, automobiles etc. , Formulation of Societies • Market Economy or Free-market or laissez-faire economy makes decisions on an individual level with minimal government intervention. • Planned Economy or Command Economy where all economic decisions are made by the government (Sloman, 2001).
SOCIETY’S CAPABILITIES • Takes the initiative in combining the resources of land, labour, and capital • Makes strategic business decisions • Is an innovator • Commercializes new products, new production techniques, and even new forms of business organization • Takes risk to get profits PRODUCTION POSSIBILITIES FRONTIER • Society uses its scare resources to produce goods and services • The alternatives and choices it faces can best be understood through macro economic model • We assume: 1. Full employment 2. Fixed Resources 3. Fixed Technology 4. Two goods Einstein College of Engineering
Important aspects • Use of Resources • Production Techniques • Consumption • Wants and demand Putting the PPF to work • Before development, the nation is poor. It must devote almost all its resources to food and enjoy few comforts • PPF provides a rigorous definition of scarcity • How societies choose among different patterns of output, how they pay for their choices, and how they benefit or lose • PPF answers for what, how and whom. The Production Possibilities Frontier • Let‘s introduce the Production Possibilities Frontier – Better known as the PPF. • The PPF is a basic workhorse in economics. Important for understanding some basic issues in economics. • Great application is with international trade theory. • Helps one understand and distinguish between comparative advantage and absolute advantage. • An important historical figure in all this is David Ricardo. David Ricardo ? Famous 19th century British economist. ? Some consider him the grandfather of international trade theory. ? Very influential in pioneering the theory of comparative advantage, inter alia. ? Very interesting, very bright guy. ? Had a lot of say about the ? corn laws? in England. The Production Possibility Frontier – What Is It? The description of the best possible combinations of two goods to produce using all of the available resources. ? Shows the trade-off between more of one good in terms of the other. ? Assumes: input endowments given, technology given, time given and efficient production. ? Efficiency and Production Possibilities Frontier Einstein College of Engineering PPF model ? Shows possible combinations of 2 types of goods that can be produced when available resources are used fully and efficiently o Figure ? Inefficient and unattainable production o Point I and U on the curve ?
Shape of the PPF o Any movement along PPF involves giving up something ? ? ? ? Production Possibilities Frontier – PPF Figure A through F are attainable I represents inefficient use of resources U represents unattainable combinations ? The resources in an economy are not all perfectly adaptable ? Law of increasing opportunity cost – each additional increment of one good requires the economy to give up larger increments of other good ? The PPF has a bowed-out shape due to the law of increasing opportunity cost Shifts in the PPF ? Economic Growth – an expansion in the economy‘s ability to produce ? Changes in resource availability ?
Increase (more labor) – PPF shifts outward ? Decrease (less resources) – PPF shifts inward ? Increases in stock of capital goods ? Technological change Einstein College of Engineering OVERVIEW OF INTERNATIONAL TRADE THEORY ? Free Trade occurs when a government does not attempt to influence, through tariffs, quotas, or other means, ? what citizens can buy from other countries or ? produce and sell to other countries The Benefits of Trade allow countries to be richer by specializing in products they can produce most efficiently The history of trade and government involvement presents mixed evidence ?
There may be some ways that some governments can make things better by intervening ? But government intervening in free trade is definitely dangerous ? ? THEORY OF ABSOLUTE ADVANTAGE ? Adam Smith argued (Wealth of Nations, 1776): Capability of one country to produce more of a product with the same amount of input than another country. ? A country should produce only goods where it is most efficient, and trade (import) for those goods where it is not efficient ? Trade between countries is, therefore, beneficial ? Example: Ghana/cocoa ? Export those goods and services for which a country is more productive than other countries ?
Import those goods and services for which other countries are more productive than it is Einstein College of Engineering ? There may also be long-term benefits ? to free trade As people specialize and seek higher incomes, they may learn to do their specialties better COMPARATIVE ADVANTAGE: ? ? ? Suppose one country is more efficient than another in everything? There are still global gains to be made if a country specializes in products it produces relatively more efficiently than other products David Ricardo (Principles of Political Economy, 1817): ? Efficiency of resource utilization leads to more productivity ?
A country should import even if country is more efficient in the product’s production than country from which it is buying Trade is a positive-sum game Produce and export those goods and services for which it is relatively more productive than other countries Import those goods and services for which other countries are relatively more productive than it is ? ? ? Einstein College of Engineering Relations between Absolute Advantages Theory and Comparative Advantages Theory ? Your country has comparative advantage in the product or service where the ratio is Resources required in your country Resources required in the other country is lowest
PRODUCT LIFE-CYCLE THEORY – R. VERNON (1966) ? ? ? ? ? As products mature, location of both sales and optimal production changes Affects the direction and flow of imports and exports Globalization and integration of the economy has caused the changes in location to be different ? Technological innovation is a key determinant of trade patterns in manufactured products.? During trade cycle, home country initially is an exporter, then loses its comparative advantage & eventually becomes importer. Einstein College of Engineering Eg. In early 1960s Xerox machine was found initially consumed in US.
Exported to Advanced countries of Europe. As demand began to grow in those countries, Xerox entered into join ventures to produce in Japan(Fuji Xerox). Once, Xrox patents on photocopier expired, other foreign competitors entered into market (Canon in Japan, Olivetti in Italy). Saying ? Most of the new products found, produced, developed and introduced in US? is ethnocentric. It‘s true that it played a dominant role in global economy. ECONOMIC EFFICIENCY Goal ? To be able to explain economic efficiency as it relates to a business. Concepts ? Efficiency Einstein College of Engineering ? ? ? Capacity Marketplace Specialization
What is Economic Efficiency? ? Economic Efficiency is the wise use of available resources so that costs do not exceed benefits. ECONOMIC GROWTH Growth Growth economics studies factors that explain economic growth – the increase in output per capita of a country over a long period of time. The same factors are used to explain differences in the level of output per capita between countries, in particular why some countries grow faster than others, and whether countries converge at the same rates of growth. Much-studied factors include the rate of investment, population growth, and technological hange. These are represented in theoretical and empirical forms (as in the neoclassical and endogenous growth models) and in growth accounting. • Economic growth is an increase in the total output of the economy. It occurs when a society acquires new resources, or when it learns to produce more using existing resources. The main sources of economic growth are capital accumulation and technological advances. • • Outward shifts of the curve represent economic growth. An outward shift means that it is possible to increase the production of one good without decreasing the production of the other. • From point D, the economy can choose any combination of output between F and G. Einstein College of Engineering • • Not every sector of the economy grows at the same rate. In this historic example, productivity increases were more dramatic for corn than for wheat over this time period. Capital Goods and Growth in Poor and Rich Countries • Rich countries devote more resources to capital production than poor countries. • As more resources flow into capital production, the rate of economic growth in rich countries increases, and so does the gap between rich and poor countries.
Economic Growth and the Gains from Trade • By specializing and engaging in trade, Colleen and Bill can move beyond their own production possibilities. Einstein College of Engineering THE ROLE OF GOVERNMENTS ECONOMIC DEVELOPMENT AND DEVELOPMENT ECONOMICS ? Objective: transformation and economic development in undeveloped areas ? History: once succeed in past as parts of classical economics. New opportunity: ? New cases: China, India, Russia ? New development in other areas, such as game theory, public choice and economic history ?
New economists from developing countries who observe and experience the process of development ? No institutional factors or variables in the model of mainstream, so no concerning on institutions in development economics, ? Not to say, concerning on the system of government ? In 1950s, overlook the market system, stress on capital, and on governments, but in distribute capital and technology rather than in supplying public goods. So no institutional change of governments, no advantage of governments in efficiency, no labor division and specialization in private and public goods between market and governments ?
Maybe politician and elites don‘t like it ? In 1970s, governments failed, back to market, ? But, still no efficiency of governments, no market economy‘s efficiency ? No institutional change of public finance, no efficiency of governments ? The system of public finance is important, but be ignored. ? In 1990s, public finance or relationship between market and governments has been discussed (Stiglitz, 1999) in development economics. ? Popular of new institutional school ? Uncorporate equilibrium of group game theory(Auman and Shelling) ?
Public budget system be still overlooked ? How to establish or initiate a new institution A NEW MODEL OF ECONOMIC DEVELOPMENT ? Perfectly competitive markets are defined by two primary characteristics: (1) The goods being offered for sale are all the same, and (2) The buyers and sellers are so numerous that no single buyer or seller can influence the market price. Einstein College of Engineering Problem of mainstream model: ? The price is an exogenous variable in the function of economic growth, and a base on which economic entities make their decisions. Information economics no use about information of prices, here, because consumers always change their ideas. Outcome: ? The efficiency of market economy missed: ? The role of entrepreneur: Guess the price of goods, even in a perfect competitive market ? The efficiency of public finance: Bargaining between taxpayers and governments for the price of public goods Impacts: ? The model in mainstream just concerns production, which rely on labor, capital, technology, then innovation, but no any business ? Misunderstanding: capitalists‘ or entrepreneurs‘ market economy ?
This misleading no influence on USA, but impact on developing countries which lack of entrepreneurs and institutions. What is market economy? ? Distribute resources by market system? ? Maximum of profit by mathematics? ? If so, the planner will do it best (Barro & Sala-i-Martin, 2004). ? But who knows the information in calculation? ? The advantage of market over plan: Run business and efficiency from the mechanism of prices ? Need a institution to permit entrepreneurs to guess and bargain the price with consumers, and governments do it with taxpayers. Ways of economic development: ?
Trade: entrepreneurs guess preferences of consumers, and raise the prices; ? Technology of trade to reduce transaction cost: invention of money; ? Institutional changes to reduce transaction cost: property right system; ? Technology of production to reduce costs: machines and organizations; ? Institutional changes in governments to reduce transaction cost: budget system; ? Capital and resources to replace labor: no save of cost, but bring us more leisure time—the objective of economic development ? All factors have been analyzed in past, but budget system.
What is it? How to get it? Einstein College of Engineering THE EFFICIENCY OF PUBLIC FINANCE AND THE ROLE OF GOVERNMENTS IN SOME CASES ? Is a state or government a trouble maker (like it in SA)? Or is it a solution (like it in EA)? ( Evans,1992) ? No answer just like private company, but we cannot ignored it ? The key points here are what kind of government it is, what it does as a government and how it does those works. —-Efficiency Efficiency of governments ? Come from the political structure or budget system ? The change of structure is slow and difficult ?
East Asia rely on both of market and government—-strange way ? However, not to plan or distribute resources, but to supply public goods efficiently Three systems: ? the system to enforce laws and contracts with sovereignty, ? the system of making decisions and supervising the actions of governments by taxpayers, ? the system of showing and coordinating the preference of taxpayers on public goods and negotiating between taxpayers and governments The hardness of economic development ? We cannot copy a system; they are a consequence of political struggle or cooperate game. The system change will be influenced heavily by culture, history and old system. ? Mass democracy is not a good way; the important point is taxpayer participating in the system. keep small group for cost and equilibrium(Olson,1980) EXTERNALITIES Adam Smith‘s ? invisible hand? of the marketplace leads self-interested buyers and sellers in a market to maximize the total benefit that society can derive from a market. 1. An externality refers to the uncompensated impact of one person‘s actions on the wellbeing of a bystander. 2.
Externalities cause markets to be inefficient, and thus fail to maximize total surplus. When a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect. 3. When the impact on the bystander is adverse, the externality is called a negative externality. 4. When the impact on the bystander is beneficial, the externality is called a positive externality. Einstein College of Engineering Externality: a by-product of a transaction that affects someone not immediately involved in the transaction. Imply that the competitive equilibrium will not result in the social optimum • Imply that the competitive equilibrium will result in a dead weight loss • Create a role for government intervention Negative Externalities • Automobile exhaust • Cigarette smoking • Barking dogs (loud pets) • Loud stereos in an apartment building Positive Externalities • Immunizations • Restored historic buildings • Research into new technologies Negative externalities lead markets to produce a larger quantity than is socially desirable. Positive externalities lead markets to produce a smaller quantity than is socially desirable. Externalities, which occur in cases where the “market does not take into account the impact of an economic activity on outsiders. ” There are positive externalities and negative externalities. Positive externalities occur in cases such as when a television program on family health improves the public’s health. Negative externalities occur in cases such as when a company‘s process pollutes air or waterways.
Negative externalities can be reduced by using government regulations, taxes, or subsidies, or by using property rights to force companies and individuals to take the impacts of their economic activity into account. EXTERNALITIES: impacts on third parties besides the buyer and seller. Consumption Externalities: impacts on third parties as a result of the consumption of a good. Eg. Each infected person who takes Drugs eliminates disease helps all of society, not Just the drug company which provides the medicine.
Production Externalities: impacts on third parties as a result of the production of a good. Eg. New discoveries & innovations impact all of Society, not just the scientist who disovers them and the firm who employs the Scientist (streptomyacin patent problem) Market Power: The power of a single Company to change the price of a good or service in the market place. Includes: MONOPOLY, MONOPOLISTIC COMPETITION, And BILATERAL MONOPOLY. Examples: Drug Companies while they have Patents.
Einstein College of Engineering Inequities: any economic, social or political mechanism that systematically causes one part of the population to be worse off than another part of a population through time without the possibility of correction. Examples: Poor Populations have greater vulnerability to TB due to their economic and social conditions. Dynamic Market Failure: the failure through time to achieve technological change and the failure of the market to achieve stable, equilibrium outcomes.
Examples: As a disease disappears in a given locale: – lack of incentives for new drug development – Lack of treatment for those who are diseased Both in the area and in other areas where pandemics may occur Indivisibilities: a problem cannot be sub- divided into smaller pieces for the purpose of Solving the problem or marketing the solution Example: even one remaining infected person means no cure has been achieved. Any plan to wipe out a disease means that a comprehensive worldwide plan must be undertaken.
Information Asymmetry: decision makers do not have access to the same information which leads to different definitions, boundaries, and solutions to problems to be solved and social outcomes. Examples: indifference to disease, lack of education about how to treat diseases, and failure to understand the tradeoff between private rights and public goods. BA 912 ECONOMIC ANALYSES FOR BUSINESS Unit II MARKET A market is any one of a variety of different systems, institutions, procedures, social relations and infrastructures whereby person‘s trade, and goods and services are exchanged, forming part of the economy.
It is an arrangement that allows buyers and sellers to exchange things. Markets vary in size, range, geographic scale, location, types and variety of human communities, as well as the types of goods and services traded. Some examples include local farmers‘ markets held in town squares or parking lots, shopping centers and shopping malls, international currency and commodity markets, legally created markets such as for pollution permits, and illegal markets such as the market for illicit drugs.
In mainstream economics, the concept of a market is any structure that allows buyers and sellers to exchange any type of goods, services and information. The exchange of goods or services for money is a transaction. Market participants consist of all the buyers and sellers of a good who influence its price. Einstein College of Engineering This influence is a major study of economics and has given rise to several theories and models concerning the basic market forces of supply and demand. There are two roles in markets, buyers and sellers. The market facilitates trade and enables the distribution and allocation of resources in a society.
Markets allow any tradable item to be evaluated and priced. A market emerges more or less spontaneously or is constructed deliberately by human interaction in order to enable the exchange of rights (cf. ownership) of services and goods. Historically, markets originated in physical marketplaces which would often develop into or from small communities, towns and cities. TYPES OF MARKETS Although many markets exist in the traditional sense such as a marketplace there are various other types of markets and various organizational structures to assist their functions.
The nature of business transactions could define markets. Financial markets Financial markets facilitate the exchange of liquid assets. Most investors prefer investing in two markets, the stock markets and the bond markets. NYSE, AMEX, and the NASDAQ are the most common stock markets in the US. Futures markets, where contracts are exchanged regarding the future delivery of goods are often an outgrowth of general commodity markets. Currency markets are used to trade one currency for another, and are often used for speculation on currency exchange rates.
The money market is the name for the global market for lending and borrowing. Prediction markets Prediction markets are a type of speculative market in which the goods exchanged are futures on the occurrence of certain events. They apply the market dynamics to facilitate information aggregation. Organization of markets A market can be organized as an auction, as a private electronic market, as a commodity wholesale market, as a shopping center, as a complex institution such as a stock market, and as an informal discussion between two individuals.
Markets of varying types can spontaneously arise whenever a party has interest in a good or service that some other party can provide. Hence there can be a market for cigarettes in Einstein College of Engineering correctional facilities, another for chewing gum in a playground, and yet another for contracts for the future delivery of a commodity. There can be black markets, where a good is exchanged illegally and virtual markets, such as eBay, in which buyers and sellers do not physically interact during negotiation.
There can also be markets for goods under a command economy despite pressure to repress them. Mechanisms of markets In economics, a market that runs under laissez-faire policies is a free market. It is “free” in the sense that the government makes no attempt to intervene through taxes, subsidies, minimum, price ceilings, etc. Market prices may be distorted by a seller or sellers with monopoly power, or a buyer with monopsony power. Such price distortions can have an adverse effect on market participant’s welfare and reduce the efficiency of market outcomes.
Also, the level of organization or negotiation power of buyers, markedly affects the functioning of the market. Markets where price negotiations meet equilibrium though still do not arrive at desired outcomes for both sides are said to experience market failure. Study of markets ? The study of actual existing markets made up of persons interacting in space and place in diverse ways is widely seen as an antidote to abstract and all-encompassing concepts of ? the market? and has historical precedent in the works of Fernand Braudel and Karl Polanyi. The latter term is now generally used in two ways. First, to denote the abstract mechanisms whereby supply and demand confronts each other and deals are made. ? In its place, reference to markets reflects ordinary experience and the places, processes and institutions in which exchanges occur. ? Second, the market is often used to signify an integrated, all-encompassing and cohesive capitalist world economy. ? A widespread trend in economic history and sociologyis skeptical of the idea that it is possible to develop a theory to capture an essence or unifying thread to markets. For economic geographers, reference to regional, local, or commodity specific markets can serve to undermine assumptions of global integration, and highlight geographic variations in the structures, institutions, histories, path dependencies, forms of interaction and modes of self-understanding of agents in different spheres of market exchange Reference to actual markets can show capitalism not as a totalizing force or Einstein College of Engineering completely encompassing mode of economic activity, but rather as ? a set of economic practices scattered over a landscape, rather than a systemic concentration of power?
DEMAND & SUPPLY • • • • • The Basic Decision-Making Units A firm is an organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy. An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business. Households are the consuming units in an economy. The Circular Flow of Economic Activity • • • • The circular flow of economic activity shows the connections between firms and households in input and output markets.
Input Markets and Output Markets Output, or product, markets are the markets in which goods and services are exchanged. Input markets are the markets in which resources—labor, capital, and land—used to produce products, are exchanged. Input Markets Input markets include: • The labor market, in which households supply work for wages to firms that demand labor. Einstein College of Engineering • • The capital market, in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods.
The land market, in which households supply land or other real property in exchange for rent. DETERMINANTS OF HOUSEHOLD DEMAND • • • • • • The price of the product in question. The income available to the household. The household‘s amount of accumulated wealth. The prices of related products available to the household. The household‘s tastes and preferences. The household‘s expectations about future income, wealth, and prices. Quantity Demanded • Quantity demanded is the amount (number of units) of a product that a household would buy in a given time period if it could buy all it wanted at the current market price.
Demand in Output Markets • • A demand schedule is a table showing how much of a given product a household would be willing to buy at different prices. Demand curves are usually derived from demand schedules. ANNA’S DEMAND SCHEDULE FOR TELEPHONE CALLS PRICE (PER CALL) $ 0 0. 50 3. 50 7. 00 10. 00 15. 00 QUANTITY DEMANDED (CALLS PER MONTH) 30 25 7 3 1 0 • The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices. Einstein College of Engineering
The Law of Demand • • The law of demand states that there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price. This means that demand curves slope downward. Other Properties of Demand Curves • • Demand curves intersect the quantity (X)-axis, as a result of time limitations and diminishing marginal utility. Demand curves intersect the (Y)-axis, as a result of limited incomes and wealth. Income and Wealth • • • • • Income is the sum of all households‘ wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure.
Wealth, or net worth, is the total value of what a household owns minus what it owes. It is a stock measure. Normal Goods are goods for which demand goes up when income is higher and for which demand goes down when income is lower. Inferior Goods are goods for which demand falls when income rises. Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up. Perfect substitutes are identical products. Einstein College of Engineering • Complements are goods that ? go together? ; a decrease in the price of one results in an increase in demand for the other, and vice versa.
Shift of Demand versus Movement along a Demand Curve • • • A change in demand is not the same as a change in quantity demanded. In this example, a higher price causes lower quantity demanded. Changes in determinants of demand, other than price, cause a change in demand, or a shift of the entire demand curve, from DA to DB. A Change in Demand versus a Change in Quantity Demanded • When demand shifts to the right, demand increases. This causes quantity demanded to be greater than it was prior to the shift, for each and every price level. Einstein College of Engineering • •
Demand for a good or service can be defined for an individual household, or for a group of households that make up a market. Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service. • Assuming there are only two households in the market, market demand is derived as follows: Einstein College of Engineering Supply in Output Markets CLARENCE BROWN’S SUPPLY SCHEDULE FOR SOYBEANS QUANTITY SUPPLIED (THOUSANDS OF BUSHELS PER YEAR) 0 10 20 30 45 45 A supply schedule is a table showing how much of a product firms will supply at different prices.
Quantity supplied represents the number of units of a product that a firm would be willing and able to offer for sale at a particular price during a given time period. PRICE (PER BUSHEL) $ 2 1. 75 2. 25 3. 00 4. 00 5. 00 • A supply curve is a graph illustrating how much of a product a firm will supply at different prices. Price of soybeans per bushel ($) 6 5 4 3 2 1 0 0 10 20 30 40 50 Thousands of bushels of soybeans produced per year The Law of Supply • • The law of supply states that there is a positive relationship between price and quantity of a good supplied.
This means that supply curves typically have a positive slope. Determinants of Supply • • The price of the good or service. The cost of producing the good, which in turn depends on: • • The price of required inputs (labor, capital, and land), The technologies that can be used to produce the product, Einstein College of Engineering • The prices of related products. A Change in Supply versus a Change in Quantity Supplied • • • A change in supply is not the same as a change in quantity supplied. In this example, a higher price causes higher quantity supplied, and a move along the demand curve.
In this example, changes in determinants of supply, other than price, cause an increase in supply, or a shift of the entire supply curve, from SA to SB. A Change in Supply versus a Change in Quantity Supplied • When supply shifts to the right, supply increases. This causes quantity supplied to be greater than it was prior to the shift, for each and every price level. Einstein College of Engineering A Change in Supply versus a Change in Quantity Supplied • • The supply of a good or service can be defined for an individual firm, or for a group of firms that make up a market or an industry.
Market supply is the sum of all the quantities of a good or service supplied per period by all the firms selling in the market for that good or service. Market Supply • As with market demand, market supply is the horizontal summation of individual firms’ supply curves. Einstein College of Engineering Market Equilibrium • • • The operation of the market depends on the interaction between buyers and sellers. Equilibrium is the condition that exists when quantity supplied and quantity demanded are equal. At equilibrium, there is no tendency for the market price to change.
Market Equilibrium • Only in equilibrium is quantity supplied equal to quantity demanded. Einstein College of Engineering • At any price level other than P0, the wishes of buyers and sellers do not coincide. Market Disequilibria • • Excess demand, or shortage, is the condition that exists when quantity demanded exceeds quantity supplied at the current price. When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is restored. • • Excess supply, or surplus, is the condition that exists when quantity supplied exceeds quantity demanded at the current price.
When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium is restored. Einstein College of Engineering PRICE, INCOME AND CROSS ELASTICITY • • • • • • • • • • Elasticity – the concept The responsiveness of one variable to changes in another When price rises, what happens to demand? Demand falls • BUT! How much does demand fall? If price rises by 10% – what happens to demand? We know demand will fall By more than 10%? By less than 10%? Elasticity measures the extent to which demand will change
Elasticity 4 basic types used: • • • • Price elasticity of demand Price elasticity of supply Income elasticity of demand Cross elasticity Price Elasticity of Demand – – – The responsiveness of demand to changes in price Where % change in demand is greater than % change in price – elastic Where % change in demand is less than % change in price – inelastic Einstein College of Engineering If the answer is between -1 and infinity: the relationship is elastic Note: PED has – sign in front of it; because as price rises demand falls and vice-versa (inverse relationship between price and demand) Einstein College of Engineering
Elasticity • If demand is price elastic: • Increasing price would reduce TR (%? Qd > % ? P) • Reducing price would increase TR (%? Qd > % ? P) • If demand is price inelastic: • Increasing price would increase TR (%? Qd < % ? P) • Reducing price would reduce TR (%? Qd < % ? P) Income Elasticity of Demand: • • • • • – The responsiveness of demand to changes in incomes Normal Good – demand rises as income rises and vice versa Inferior Good – demand falls as income rises and vice versa Income Elasticity of Demand: A positive sign denotes a normal good A negative sign denotes an inferior good
Cross Elasticity: • • • The responsiveness of demand of one good to changes in the price of a related good – either a substitute or a complement Goods which are complements: – Cross Elasticity will have negative sign (inverse relationship between the two) Goods which are substitutes: – Cross Elasticity will have a positive sign (positive relationship between the two) Price Elasticity of Supply: – The responsiveness of supply to changes in price – If Pes is inelastic – it will be difficult for suppliers to react swiftly to changes in price Einstein College of Engineering – If Pes is elastic – supply can react quickly to changes in price
Determinants of Elasticity • • • • Time period – the longer the time under consideration the more elastic a good is likely to be Number and closeness of substitutes – the greater the number of substitutes, the more elastic The proportion of income taken up by the product – the smaller the proportion the more inelastic Luxury or Necessity – for example, addictive drugs Importance of Elasticity • • • • Relationship between changes in price and total revenue Importance in determining what goods to tax (tax revenue) Importance in analysing time lags in production Influences the behaviour of a firm
CONSUMER MARKETS AND CONSUMER BUYER BEHAVIOR Consumer Buying Behavior • Consumer Buying Behavior refers to the buying behavior of final consumers (individuals & households) who buy goods and services for personal consumption. • Study consumer behavior to answer: ? How do consumers respond to marketing efforts the company might use?? Buyer’s Black Box Einstein College of Engineering Factors Affecting Consumer Behavior: Culture • • • Most basic cause of a person’s wants and behavior. Values Perceptions
Subculture • Groups of people with shared value systems based on common life experiences. • Hispanic Consumers • African American Consumers • Asian American Consumers • Mature Consumers Social Class • • • • • People within a social class tend to exhibit similar buying behavior. Occupation Income Education Wealth Einstein College of Engineering Einstein College of Engineering Psychological Factors Einstein College of Engineering Types of Buying Decisions The Buyer Decision Process Einstein College of Engineering The Buyer Decision Process Step 1.
Need Recognition Need Recognition Difference between an actual state and a desired state The Buyer Decision Process Step 2. Information Search Einstein College of Engineering The Buyer Decision Process Step 3. Evaluation of Alternatives The Buyer Decision Process Step 4. Purchase Decision Einstein College of Engineering The Buyer Decision Process Step 5. Post purchase Behavior Cognitive Dissonance Stages in the Adoption Process AWARENESS INTEREST EVALUATION TRIAL ADOPTION Adoption of Innovations Einstein College of Engineering Influences on the Rate of Adoption of New Products
ECONOMIES & DISECONOMIES OF SCALE Production and Cost in the Long Run • • The key difference between the short run and the long run is that there are no diminishing returns in the long run. Diminishing returns occur because workers share a fixed facility. In the long run the firm can expand its production facility as its workforce grows. WHAT IS SCALE? • • • • • By scale of an enterprise or size of a plant we mean the amount of investment in fixed factors of production Costs of production are lower in larger plants than in smaller ones This is due to economies of large-scale production The term ? conomies‘ refers to cost advantages When these economies are over-exploited the result may be cost disadvantages, i. e. diseconomies. ECONOMIES OF SCALE • • • Economies of scale: a situation in which an increase in the quantity produced decreases the long-run average cost of production. Economies of scale refer to cost savings associated with spreading the cost of indivisible inputs and input specialization. When economies of scale are present, the LAC curve will be negatively sloped. Einstein College of Engineering
Long-run Average Cost • • Long-run average cost (LAC) is total cost divided by the quantity of output when the firm can choose a production facility of any size. The LAC curve describes the behavior of average cost as the plant size expands. Initially, the curve is negatively sloped, and then beyond some point, it becomes horizontal. Long-run Average Cost • When long-run total cost is proportionate to the quantity produced, long-run average cost does not change as output increases. The long-run average cost curve is horizontal for 7 or more rakes per hour.
Labor Specialization • In a large operation, each worker specializes in fewer tasks thus is more productive than his or her counterpart in a small operation. • Higher productivity (more output per worker) means lower labor costs per unit of output, thus lower production costs (ever-decreasing average cost). Minimum Efficient Scale • The minimum efficient scale describes the output at which economies of scale are exhausted and the long-run average cost curve becomes horizontal. • Once the minimum efficient scale has been reached, an increase in output no longer decreases the long-run average cost.
DISECONOMIES OF SCALE • A firm experiences diseconomies of scale when an increase in output leads to an increase in long-run average cost—the LAC curve becomes positively sloped. • Diseconomies of scale may arise for two reasons: – Coordination problems – Increasing input costs Einstein College of Engineering • • • After firm has reached its efficient scale, further increases in number of workers will lead to inefficiency. Co-ordination of different processes becomes difficult and decision-making process becomes slow Supervision of workers becomes difficult, management problems get out of hand with adverse effects on managerial efficiency.
TYPES OF ECONOMIES OF SCALE External Economies Economies available to all firms in the industry. For eg. Construction of roads, railways in an area reduces costs for all firms in that area Discovery of a new technique, rise of industries using by-products, availability of skilled labour through the establishment of special technical schools – External economies usually occur when an industry is heavily concentrated in a particular area.
Internal Economies of Scale Internal economies are available to a particular firm and give it an advantage over other firms engaged in the industry Arise from the expansion of the size of a particular firm From a managerial point of view internal economies are most important as they can be effected by managerial decisions of an individual firm to change its size/scale Internal economies arise due to a firm‘s own expansion while external economies arise due to expansion of some other industry or due to some external factor. Labour Economies Reduction in labour costs per unit due to increasing division/specialization of labour Arise due to increase in the skill of workers and saving of time involved in changing from one operation to another Many operations may be performed mechanically rather than manually Economies are maximum where products are complex and the manufacturing processes can be sub-divided. Technical Economies Derived from the use of scientific processes and machines that a large production firm can afford.
Managerial Economies -With the increase in the size of a firm, the efficiency of management increases because of greater specialization in managerial staff Einstein College of Engineering – -Experts in a large firm can be hired to look after various divisions like purchasing, sales, production, financing, personnel. Marketing Economies A large firm can obtain economies in purchasing and sales as it has bulk requirements and can hence get better terms It gets the advantage of prompt deliveries, careful attention and special facilities from its suppliers A large firm can also spread its advertising cost over bigger output.
Economies of Vertical Integration Larger firm can integrate a number of stages of production Production is better planned and this leads to cost control Eg. Oil refining companies controlling distribution, i. e. owning petrol pumps-forward integration, or controlling oil reserves through oil exploration backward integration Financial Economies Larger firms get credit more easily and also on better terms Better image, easier access to capital/stock markets.
Economies of Risk-spreading Larger size of business, greater scope for spreading of risks through diversification Diversification can be either of products or of markets. COST ANALYSIS The Object of Cost Analysis • • • • Managers seek to produce the highest quality products at the lowest possible cost. Firms that are satisfied with the status quo find that competitors arise that can produce at lower costs. The advantages once assigned to being large firms (economies of scale and scope) have not provided the advantages of flexibility and agility found in some smaller companies.
Cost analysis is helpful in the task of finding lower cost methods to produce goods and services. Einstein College of Engineering Meaning of Cost There are Many Economic Cost Concepts • Opportunity Cost — value of next best alternative use. • Explicit vs. Implicit Cost — actual prices paid vs. opportunity cost of owner supplied resources. Depreciation Cost Measurement. Accounting depreciation (e. g. , straight-line depreciation) tends • to have little relationship to the actual loss of value • » To an economist, the actual loss of value is the true cost of using machinery.
Inventory Valuation Accounting valuation depends on its acquisition cost. • » Economists view the cost of inventory as the cost of replacement. Unutilized Facilities. Empty space may appear to have “no cost? • » Economists view its alternative use (e. g. , rental value) as its opportunity cost. Measures of Profitability. Accountants and economists view profit differently. • » Accounting profit, at its simplest, is revenues minus explicit costs. • » Economists include other implicit costs (such as a normal profit on invested capital).
Economic Profit = Total Revenues Explicit Costs Implicit Costs Sunk Costs — already paid for, or there is already a contractual obligation to pay • Incremental Cost – – extra cost of implementing a decision = D TC of a decision • Marginal Cost — cost of last unit produced = ¶ TC/ ¶ Q SHORT RUN COST FUNCTIONS • TC = FC + VC fixed & variable costs • ATC = AFC + AVC = FC/Q + VC/Q Einstein College of Engineering Einstein College of Engineering Einstein College of Engineering
BA 912 ECONOMIC ANALYSES FOR BUSINESS Unit III MARKET STRUCTURE In economics, market structure (also known as market form) describes the state of a market with respect to competition. Basic market structures ? ? ? ? ? ? Perfect competition, in which the market consists of a very large number of firms producing a homogeneous product. Monopolistic competition, also called competitive market, where there are a large number of independent firms which have a very small proportion of the market share.
Oligopoly, in which a market is dominated by a small number of firms which own more than 40% of the market share. Oligopsony, a market dominated by many sellers and a few buyers. Monopoly, where there is only one provider of a product or service. Natural monopoly, a monopoly in which economies of scale cause efficiency to increase continuously with the size of the firm. A firm is a natural monopoly if it is able to serve the entire market demand at a lower cost than any combination of two or more smaller, more specialized firms.
Monopsony, when there is only one buyer in a market. The imperfectly competitive structure is quite identical to the realistic market conditions where some monopolistic competitors, monopolists, oligopolists, and duopolists exist and dominate the market conditions. The elements of Market Structure include the number and size distribution of firms, entry conditions, and the extent of differentiation. These somewhat abstract concerns tend to determine some but not all details of a specific concrete market system where buyers and sellers actually meet and commit to trade.
Competition is useful because it reveals actual customer demand and induces the seller (operator) to provide service quality levels and price levels that buyers (customers) want, typically subject to the seller‘s financial need to cover its costs. ? Einstein College of Engineering In other words, competition can align the seller‘s interests with the buyer‘s interests and can cause the seller to reveal his true costs and other private information.
In the absence of perfect competition, three basic approaches can be adopted to deal with problems related to the control of market power and an asymmetry between the government and the operator with respect to objectives and information: (a) subjecting the operator to competitive pressures, (b) gathering information on the operator and the market, and (c) applying incentive regulation. The correct sequence of the market structure from most to least competitive is perfect competition, imperfect competition, oligopoly, and pure monopoly.
The main criteria by which one can distinguish between different market structures are: the number and size of producers and consumers in the market, the type of goods and services being traded, and the degree to which information can flow freely. Most markets fall between the two extremes of monopoly and perfect competition • An imperfectly competitive firm – – – would like to sell more at the going price faces a downward-sloping demand curve recognises its output price depends on the quantity of goods produced and sold
IMPERFECT COMPETITION • An oligopoly – – • an industry with a few producers Each recognising that its own price depends both on its own actions and those of its rivals. In an industry with monopolistic competition – – there are many sellers producing products that are close substitutes for one another Each firm has only limited ability to influence its output price. Einstein College of Engineering MARKET STRUCTURE
Number Ability to Entry Example of firms affect barriers price Perfect competition Imperfect competition: Monopolistic competition Oligopoly Monopoly Many Few One Small Medium Large None Some Huge Corner shop Cars Post Office Many Nil None Fruit stall The minimum efficient scale and market demand ? ? The minimum efficient scale (mes) is the output at which a firm‘s long-run average cost curve stops falling. The size of the mes relative to market demand has a strong influence on market structure. Monopolistic competition • Characteristics: Einstein College of Engineering any firms no barriers to entry product differentiation • so the firm faces a downward-sloping demand curve – The absence of entry barriers means that profits are competed away… Monopolistic competition (2) – – – • • • • Firms end up in TANGENCY EQUILIBRIUM, making normal profits. Firms do not operate at minimum LAC. Price exceeds marginal cost. Unlike perfect competition, the firm here is eager to sell more at the going market price. Oligopoly • • • A market with a few sellers. The essence of an oligopolistic industry is the need for each firm to consider how its own actions affect he decisions of its relatively few competitors. Oligopoly may be characterized by collusion or by non-co-operation. Collusion and cartels COLLUSION An explicit or implicit agreement between existing firms to avoid or limit competition with one another. CARTEL • Is a situation in which formal agreements between firms are legally permitted? e. g. OPEC Collusion is difficult if • There are many firms in the industry • The product is not standardized • Demand and cost conditions are changing rapidly • There are no barriers to entry • Firms have surplus capacity • Einstein College of Engineering The kinked demand curve • •
Consider how a firm may perceive its demand curve under oligopoly. It can observe the current price and output, but must try to anticipate rival reactions to any price change. The kinked demand curve (2) • • • The firm may expect rivals to respond if it reduces its price, as this will be seen as an aggressive move. So demand in response to a price reduction is likely to be relatively inelastic. The demand curve will be steep below P0. The kinked demand curve (3) Einstein College of Engineering • But for a price increase rivals are less likely to react, so demand may be relatively elastic above P0 so the firm perceives that it faces a kinked emand curve. The kinked demand curve (4) • • • Given this perception, the firm sees that revenue will fall whether price is increased or decreased, So the best strategy is to keep price at P0. Price will tend to be stable, even in the face of an increase in marginal cost. Game theory: some key terms • Game o A situation in which intelligent decisions are necessarily interdependent. • Strategy o A game plan describing how the player will act or move in every conceivable • situation. Dominant strategy o Where a player‘s best strategy is independent of those chosen by others.
Nash-Cournot equilibrium Einstein College of Engineering • • • RA and RB are the reaction functions for firms A and B respectively. Each shows the best each firm can do given its expectations about the other E is the Nash-Cournot equilibrium At E, each firm‘s guess about its rival is correct and neither will wish to change its behaviour Contestable markets • A contestable market is characterised by free entry and free exit – no sunk costs • – allows hit-and-run entry Contestability may constrain incumbent firms from exploiting their market power.
Strategic entry deterrence • Some entry barriers are deliberately erected by incumbent firms: – threat of predatory pricing – spare capacity – advertising and R&D – product proliferation • Actions that enforce sunk costs on potential entrants IMPERFECT COMPETITION Imperfect Competition and Market Power ? An imperfectly competitive industry is an industry in which single firms have some control over the price of their output. ? Some examples are Monopoly, Oligopoly and Monopolistic competition. Einstein College of Engineering ? Market power is the imperfectly competitive firm‘s ability to raise price without losing all demand for its product.
Price: The Fourth Decision Variable ? Firms with market power must decide: 1. how much to produce, 2. how to produce it, 3. how much to demand in each input market, and 4. what price to charge for their output. Monopoly A market structure in which only one producer or seller exists for a product that has no close substitutes Characteristics of Monopoly ? The degree of control over price that is held by the monopolist ? The individual supply of the monopolist coincides with the market supply ? Market demand equals the demand for the monopolist‘s product or service ? The monopolist is a ? rice maker? Sources of Monopoly Economies of scale ? In capital intensive industries, the economies of large-scale production may lead to a small number of firms producing the product Natural monopolies: Public utilities ? In cases where one or two firms can adequately supply all the service needed, it may be desirable to limit the number of firms within a given territory ? Government regulation of these monopoly franchises. Control of raw materials ? An effective barrier to entry is ownership or control of essential raw materials ? Effective for years in the production of aluminum ?
ALCOA and its control of bauxite Patents ? The exclusive right to use, keep, or sell an invention for a period of 20 years Einstein College of Engineering ? Threat of infringement suits. Competitive tactics ? Aggressive production and merchandising techniques ? Illegal predatory pricing policies ? Aggressive innovation techniques Determining Monopoly Price ? The monopolist‘s demand curve slopes downward to the right because it is the market demand curve of all consumers ? The first question the monopolist asks is, ? How many units of my good can I expect to sell at various prices??
Price and Output Decisions in Pure Monopoly Markets ? With one firm in a monopoly market, there is no distinction between the firm and the industry. In a monopoly, the firm is the industry. ? The market demand curve is the demand curve facing the firm, and total quantity supplied in the market is what the firm decides to produce. Price and Output Decisions in Pure Monopoly Markets ? The demand curve facing a perfectly competitive firm is perfectly elastic; in a monopoly, the market demand curve is the demand curve facing the firm. The Monopolist’s Demand Curve The Monopolist’s Cost Curves ?
The monopolist‘s cost curves reflect the law of diminishing marginal productivity ? Thus, the cost curves have the same general shape and characteristics as the cost curves in a competitive industry Marginal Revenue Curve Facing a Monopolist Einstein College of Engineering ? For a monopolist, an increase in output involves not just producing more and selling it, but also reducing the price of its output to sell it. ? At every level of output except one unit, a monopolist‘s marginal revenue is below price. Cost and Revenue Curves for a Monopoly Facts about Monopoly ?
A monopoly firm has no supply curve that is independent of the demand curve for its product. ? A monopolist sets both price and quantity, and the amount of output supplied depends on both its marginal cost curve and the demand curve that it faces. ? Since entry is blocked, the monopolist can earn economic profits in the long run. ? Monopolists can earn losses in the short run if demand is not sufficient or if costs are too high. Price and Output Choices for Monopolist Suffering Losses in the Short-Run Einstein College of Engineering ? It is possible for a profit-maximizing monopolist to suffer short-run losses. If the firm cannot generate enough revenue to cover total costs, it will go out of business in the long-run. Perfect Competition and Monopoly Compared ? Relative to a competitively organized industry, a monopolist restricts output, charges higher prices, and earns positive profits. Monopolistic Competition ? Monopolistic competition is a common form of industry (market) structure, characterized by a large number of firms, none of which can influence market price by virtue of size alone. ? Some degree of market power is achieved by firms producing differentiated products. New firms can enter and established firms can exit such an industry with ease. Product Differentiation Establishment of real or imagined characteristics that identify a firm‘s product as unique. Product Differentiation ? Based on the monopolistic Reduces the Elasticity of Demand Facing a Firm availability of substitutes, the demand curve faced by a competitor is likely to be Einstein College of Engineering less elastic than the demand curve faced by a perfectly competitive firm, and likely to be more elastic than the demand curve faced by a monopoly. Substitution Effect ? A change in quantity demanded of a substitute goods ood due to a change in the price relative to ? Increased sales at the expense of other firms Monopolistic Competition in the Short Run ? In the short-run, a monopolistically competitive firm will produce up to the point where MR = MC. Oligopoly ? A market structure in which relatively few firms produce identical or similar products ? Two basic characteristics: ? Each firm has some ability to influence price ? The interdependence among firms in setting their pricing policies ? Entry barriers exist. Competition in Oligopoly ? Firms in oligopolies tend to concentrate on nonprice competitive policies like advertising ? Frequently se administered prices ? A predetermined price set by the seller rather than a price determined solely by demand and supply in the marketplace ? Use of nonprice competition eg rebates, promotional deals, etc.. Measurements of Concentration ? Concentration ratio ? A measure of market power calculated by determining the percentage of industry output accounted for by the largest firms ? Herfindahl Index Einstein College of Engineering ? A measure of market power calculated by summing the squares of the market shares of each firm in the industry ? Gives much great weight to firms with large market shares. A HI value of