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Lecture Managerial economics (Ninth edition): Chapter 12 – Thomas, Maurice

Chapter 12 - Managerial decisions for firms with market power. In this chapter, we also briefly developed the theory of monopolistic competition. Of all firms with market power, a monopolistically competitive firm has the least. The barriers to entry are so low that it is easy for new firms to enter the market when economic profits are made by existing firms. | Chapter 12 Managerial Decisions for Firms with Market Power Market Power Ability of a firm to raise price without losing all its sales Any firm that faces downward sloping demand has market power Gives firm ability to raise price above average cost & earn economic profit (if demand & cost conditions permit) 12- Monopoly Single firm Produces & sells a good or service for which there are no good substitutes New firms are prevented from entering market because of a barrier to entry 12- Measurement of Market Power Degree of market power inversely related to price elasticity of demand The less elastic the firm’s demand, the greater its degree of market power The fewer close substitutes for a firm’s product, the smaller the elasticity of demand (in absolute value) & the greater the firm’s market power When demand is perfectly elastic (demand is horizontal), the firm has no market power 12- Measurement of Market Power Lerner index measures proportionate amount by which price . | Chapter 12 Managerial Decisions for Firms with Market Power Market Power Ability of a firm to raise price without losing all its sales Any firm that faces downward sloping demand has market power Gives firm ability to raise price above average cost & earn economic profit (if demand & cost conditions permit) 12- Monopoly Single firm Produces & sells a good or service for which there are no good substitutes New firms are prevented from entering market because of a barrier to entry 12- Measurement of Market Power Degree of market power inversely related to price elasticity of demand The less elastic the firm’s demand, the greater its degree of market power The fewer close substitutes for a firm’s product, the smaller the elasticity of demand (in absolute value) & the greater the firm’s market power When demand is perfectly elastic (demand is horizontal), the firm has no market power 12- Measurement of Market Power Lerner index measures proportionate amount by which price exceeds marginal cost: 12- Measurement of Market Power Lerner index Equals zero under perfect competition Increases as market power increases Also equals –1/E, which shows that the index (& market power), vary inversely with elasticity The lower the elasticity of demand (absolute value), the greater the index & the degree of market power 12- Measurement of Market Power If consumers view two goods as substitutes, cross-price elasticity of demand (EXY) is positive The higher the positive cross-price elasticity, the greater the substitutability between two goods, & the smaller the degree of market power for the two firms 12- Determinants of Market Power Entry of new firms into a market erodes market power of existing firms by increasing the number of substitutes A firm can possess a high degree of market power only when strong barriers to entry exist Conditions that make it difficult for new firms to enter a market in which economic profits are being earned 12- Common Entry .