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  3. Katholieke Universiteit Leuven (KU Leuven)
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  7. Managerial Economics

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Managerial Economics Samenvatting - TEW & Handelsingenieur - 16/20 eerste zit

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Deze samenvatting omvat alle leerstof uit de lessen Managerial Economics, gegeven aan de tweedejaars studenten Handelsingenieur en Toegepaste Economische Wetenschappen (TEW) door Mattia Nardotto en Christophe Crombez. Ik scoorde met deze samenvatting een 16/20 in mijn eerste zit. Deze samenvatting ...

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MANAGERIAL‌‌ECONOMICS‌ ‌
Simon‌‌Kuhn‌‌ ‌
‌
LECTURE‌‌1:‌‌FOUNDATIONS‌ ‌
PART‌‌ONE‌ ‌
‌
WHAT‌‌IS‌‌INDUSTRIAL‌‌ORGANISATION?‌‌ ‌
Industrial‌‌Organisation‌‌i‌s‌‌a‌‌branch‌‌of‌‌economics‌‌that‌‌is‌‌concerned‌‌with‌‌the‌‌study‌‌of‌i‌mperfect‌‌
competition‌.‌‌We‌‌will‌‌look‌‌at‌‌ways‌‌for‌‌a‌‌company‌‌to‌‌escape‌‌perfect‌‌competition.‌ ‌
⇒ ‌‌through‌m ‌ arket‌‌power‌:‌ ‌
- innovation‌ ‌
- advertisement‌ ‌
- product‌‌differentiation‌ ‌
- price‌‌discrimination‌ ‌
In‌‌this‌‌course,‌‌we‌‌will‌‌use‌‌managerial‌‌economics‌‌to‌‌answer‌‌practical‌‌questions‌‌on‌‌these‌‌topics.‌ ‌
‌
HOW‌‌WE‌‌STUDY‌‌INDUSTRIAL‌‌ORGANISATION‌ ‌
We‌‌will‌‌make‌‌use‌‌of:‌ ‌
- fundamental‌‌economic‌‌principles‌‌(e.g.‌‌rational‌‌agents,‌‌optimality,...)‌ ‌
- game‌‌theory‌‌because‌‌of‌‌high‌i‌nterdependence‌b ‌ etween‌‌firms‌‌ ‌
- abstract‌‌modeling‌ ‌
‌
THE‌‌PROBLEM‌‌OF‌‌THE‌‌MANAGER‌ ‌
The‌‌Small‌‌Business‌‌Administration‌‌gives‌‌some‌‌basic‌‌guidelines‌‌on‌‌how‌‌to‌‌structure‌‌a‌‌business‌‌plan:‌ ‌
- executive‌‌summary‌‌‌→‌‌the‌‌unique‌‌selling‌‌point,‌‌what‌‌differentiates‌‌the‌‌business‌‌from‌‌others‌ ‌
- company‌‌description‌‌‌→‌‌which‌‌products‌‌and‌‌services,‌‌product‌‌differentiation,...‌ ‌
- market‌‌analysis‌‌‌→‌‌economies‌‌of‌‌scale,‌‌market‌‌concentration,‌‌sunk‌‌costs,...‌ ‌
- service‌‌or‌‌product‌‌line‌→ ‌ ‌‌explain‌‌production‌‌processes,‌‌R&D,‌‌innovation,...‌ ‌
- marketing‌‌and‌‌sales‌→ ‌ ‌‌describe‌‌the‌‌marketing‌‌strategy,‌‌price‌‌discrimination,...‌ ‌
- financial‌‌plan‌‌and‌‌funding‌‌ ‌
‌
All‌‌of‌‌these‌‌elements‌‌have‌‌to‌‌do‌‌with‌‌concepts‌‌studied‌‌in‌‌Managerial‌‌Economics‌.‌ ‌
→‌‌we‌‌will‌‌look‌‌at‌‌the‌‌economics‌‌behind‌‌these‌‌concepts‌‌within‌‌(im)perfect‌‌competition‌‌ ‌
‌in‌‌order‌‌to‌‌use‌‌them‌‌for‌‌more‌‌practical‌‌applications‌‌(e.g.‌‌a‌‌business‌‌plan)‌ ‌
‌
MARKET‌‌DEMAND‌ ‌
In‌‌Managerial‌‌Economics,‌‌we‌‌will‌‌mainly‌‌focus‌‌on‌‌firm‌‌profit-maximizing‌‌behavior‌‌and‌‌a‌‌resultant‌‌market‌‌
outcome‌‌that‌‌such‌‌behavior‌‌implies.‌ ‌
‌
Market‌‌Demand‌‌Curve‌‌d ‌ escribes‌‌the‌‌relationship‌‌between‌‌how‌‌much‌‌money‌‌(aggregated)‌‌consumers‌‌
are‌‌willing‌‌to‌‌pay‌‌per‌‌unit‌‌of‌‌the‌‌good‌‌and‌‌the‌‌quantity‌‌(aggregated)‌‌of‌‌the‌‌goods‌‌consumed.‌ ‌
→‌‌depends‌‌on:‌ ‌
- price‌ ‌
- income‌ ‌
- expectations‌‌of‌‌price‌‌movement...‌ ‌
-⇒ ‌‌Quantity = f (price, income, marketing, ...) ‌
‌
However,‌‌we‌‌will‌‌express‌‌a‌‌simplified‌‌demand‌‌curve‌‌in‌‌terms‌‌of‌‌the‌‌price:‌
1. Q = a bP ‌ −
- a‌‌=‌‌quantity‌‌demanded‌‌when‌‌price‌‌is‌‌very‌‌small‌ ‌
- a/b‌‌=‌‌the‌‌maximum‌‌willingness‌‌to‌‌pay‌ ‌
⇒‌‌this‌‌equation‌‌is‌‌used‌‌when‌‌firms‌‌have‌‌a‌f‌ ixed‌‌quantity‌‌‌but‌‌can‌‌easily‌‌
change‌‌the‌‌price‌‌(e.g.‌‌bakkery)‌‌=‌p ‌ rice-focused‌ ‌
‌
−
2. P = A B Q (‌ i‌nverse‌)‌ ‌
- A‌‌=‌‌the‌‌maximum‌‌willingness‌‌to‌‌pay‌ ‌
- A/B‌‌=‌‌quantity‌‌demanded‌‌when‌‌price‌‌is‌‌very‌‌small‌ ‌
⇒‌‌this‌‌equation‌‌is‌‌used‌‌when‌‌firms‌‌have‌‌a‌v‌ ariable‌‌quantity‌‌‌(in‌‌extremely‌‌
concentrated‌‌markets‌‌e.g.‌‌oil,‌‌gold,...)‌‌=‌q ‌ uantity-focused‌ ‌
‌

,We‌‌need‌‌to‌‌ask‌‌ourselves‌‌whether‌‌a‌‌linear‌‌market‌‌demand‌‌curve‌‌is‌‌even‌‌realistic?‌ ‌
- it‌‌has‌‌a‌f‌ unctional‌‌form‌‌ ‌
→‌‌closer‌‌to‌‌an‌‌estimation,‌‌yet‌‌fairly‌‌accurate‌‌a‌‌local‌‌level‌ ‌
‌
- it‌‌does‌‌no‌‌take‌‌into‌‌account‌‌the‌t‌ ime‌f‌actor‌ ‌
a. short‌‌run:‌‌no‌‌possibility‌‌to‌‌change‌‌production‌‌facilities‌ ‌
b. long‌‌run:‌‌firm‌‌can‌‌change‌‌its‌‌production‌‌facilities‌‌to‌‌meet‌‌demand‌ ‌
→‌‌but‌‌market‌‌demand‌‌curve‌‌does‌‌not‌‌make‌‌the‌‌distinction,‌‌though‌‌markets‌‌change‌‌constantly‌ ‌
‌
- demand‌‌is‌‌a‌‌function‌‌of‌m ‌ any‌‌aspects‌ ‌
→‌‌income‌‌(cfr.‌‌Engel‌‌Law),‌‌Giffen‌‌goods,‌‌preferences,...‌ ‌
‌
Yet,‌‌despite‌‌its‌‌limitations,‌‌we‌‌will‌‌continue‌‌to‌‌use‌‌the‌‌simple‌‌(inverse)‌‌linear‌‌demand.‌ ‌
→‌‌we‌‌need‌‌to‌‌emphasise‌‌competition,‌‌not‌‌the‌‌demand‌‌curve‌ ‌
→‌‌easy‌‌way‌‌to‌‌find‌‌the‌‌equilibrium‌‌in‌‌any‌‌market‌‌situation‌ ‌
‌
FIRM'S‌‌DEMAND‌ ‌
The‌F ‌ irm's‌‌Demand‌‌g ‌ ives‌‌a‌‌company‌‌an‌‌idea‌‌how‌‌much‌‌they‌‌can‌‌sell,‌‌given‌‌the‌‌price‌‌they‌‌ask:‌ ‌
a. if‌‌there‌‌is‌‌only‌o ⇒
‌ ne‌f‌irm‌‌ ‌‌the‌‌firm's‌‌demand‌‌is‌‌equal‌‌to‌‌the‌‌market‌‌demand‌ ‌
b. if‌‌there‌‌are‌m ⇒
‌ ultiple‌f‌irms‌‌ ‌‌the‌‌firm's‌‌demand‌‌depends‌‌on‌‌other‌‌firms:‌ ‌
⇒
‌‌QJ = f (P J , P K , income, marketing J , marketing K , ....) ‌
‌
Firms‌‌have‌‌an‌‌explicit‌‌(e.g.‌‌through‌‌quantitative‌‌market‌‌analysis)‌‌or‌‌implicit‌‌(e.g.‌‌gut-feeling)‌‌of‌‌the‌‌
⇒
market‌‌demand,‌‌and‌‌they‌‌try‌‌to‌‌increase‌‌their‌‌firm's‌‌demand‌‌ ‌‌they‌‌need‌‌Managerial‌‌Economics.‌ ‌
→‌‌a‌‌good‌‌understanding‌‌of‌‌the‌‌firm's‌‌demand‌‌is‌‌necessary:‌‌indeed,‌‌we‌‌cannot‌‌start‌‌producing‌‌before‌ ‌
‌we‌‌know‌‌what‌‌we‌‌can‌‌sell.‌ ‌
‌
PRICE‌‌ELASTICITY‌‌OF‌‌DEMAND‌‌ ‌
Elasticity:‌‌ ‌

⇒‌‌ε = ×
Δq
q Δq p Δq Δp
Δp = Δp q
‌‌with‌‌ q = percentage change in q ‌and‌‌ p = percentage change in p ‌
p

‌
- if‌‌|ε| = 1 ⇒‌‌if‌‌price‌‌reduces/increases,‌‌the‌‌quantity‌‌will‌‌reduce/increase‌‌by‌‌the‌‌same‌‌amount‌ ‌
- if‌‌|ε| < 1 ⇒‌‌increasing‌‌price‌‌increases‌‌revenues:‌d‌ emand‌‌is‌‌inelastic‌ ‌
- if‌‌|ε| > 1 ⇒‌‌increasing‌‌price‌‌reduces‌‌revenues:‌d‌ emand‌‌is‌‌elastic‌ ‌
‌
Given‌‌a‌‌demand‌‌curve,‌‌you‌‌would‌‌need‌‌to‌‌find:‌ ‌
Δq dq
- Δp = dp =‌‌the‌‌first‌‌derivative‌‌of‌‌the‌‌Q(p)‌‌function‌ ‌

- p/q =‌‌just‌‌fill‌‌in‌ ‌
‌
‌
Cross-elasticity:‌ ‌

⇒‌‌ε ×
Δq 1
q1 Δq 1 p2
1,2 = Δp2 = Δp2 q1
‌
p2

‌
- if‌‌|| ε1,2 || > 0 ⇒‌s‌ ubstitute‌‌‌goods‌ ‌
- if‌‌|| ε1,2 || < 0 ⇒‌c‌ omplement‌‌‌goods‌ ‌
‌
‌
‌
‌
‌
‌
‌
‌
‌
‌
‌

,PERFECT‌‌COMPETITION‌ ‌
In‌‌perfect‌‌competition,‌‌firms‌‌and‌‌consumers‌‌are‌p ‌ rice-takers‌ ‌
→‌‌there‌‌is‌‌no‌‌market‌‌power,‌‌no‌‌possibility‌‌to‌‌alter‌‌the‌‌price‌ ‌
→‌‌a‌‌firm‌‌can‌‌sell‌‌as‌‌much‌‌or‌‌as‌‌little‌‌as‌‌it‌‌wants‌‌at‌‌the‌‌ruling‌‌market‌‌price‌ ‌
→‌‌the‌‌demand‌‌curve‌‌for‌‌an‌‌individual‌‌firm‌‌is‌‌therefore‌‌a‌‌horizontal‌‌line‌ ‌
‌
Every‌‌player‌‌in‌‌perfect‌‌competition‌‌will,‌‌as‌‌is‌‌normal,‌‌choose‌‌an‌‌output‌‌level‌‌
that‌‌maximises‌‌their‌‌individual‌‌profit.‌ ‌
→‌‌MC‌‌=‌‌MR‌‌and‌‌because‌‌each‌‌product‌‌is‌‌sold‌‌at‌‌the‌‌market‌‌price,‌‌ ‌
M
‌ R‌‌=‌‌P‌‌=‌‌MC‌:‌‌price‌‌therefore‌‌equals‌‌marginal‌‌costs‌‌in‌‌perfect‌‌competition‌ ‌
→‌‌for‌‌every‌‌individual‌‌company,‌‌the‌‌optimal‌‌output‌‌level‌‌q‌‌will‌‌be‌‌summed‌ ‌
‌and‌‌this‌‌gives‌‌us‌‌the‌‌aggregate‌‌output‌‌level‌‌Q‌ ‌
‌
The‌‌market‌‌demand‌‌curve‌‌still‌‌has‌‌a‌‌negative‌‌slope:‌ ‌
→‌‌if‌‌the‌‌entire‌‌market‌‌output‌‌or‌‌price‌‌changes,‌‌the‌‌effect‌‌is‌‌still‌‌noticeable‌‌in‌ ‌
‌the‌‌demand‌‌curve‌ ‌
‌
(graphs‌‌are‌‌for‌o ‌ ne‌‌‌individual‌‌company‌‌left‌‌and‌‌for‌‌the‌e
‌ ntire‌‌‌market‌‌right)‌ ‌
‌
MONOPOLY‌ ‌
If‌‌there‌‌is‌‌only‌‌one‌‌firm‌‌in‌‌the‌‌market,‌‌its‌‌firm's‌‌demand‌‌curve‌‌would‌‌be‌‌identical‌‌to‌‌the‌‌market‌‌demand.‌ ‌
→‌‌it‌‌could‌‌singlehandedly‌‌influence‌‌the‌‌price‌‌as‌‌it‌‌can‌‌singlehandedly‌‌choose‌‌the‌‌supply‌ ‌
‌
As‌‌a‌‌monopolist‌‌has‌‌the‌‌opportunity‌‌to‌‌choose‌‌the‌‌quantity‌‌/‌‌price‌‌as‌‌he‌‌pleases,‌‌he‌‌is‌‌also‌‌
faced‌‌with‌‌a‌‌production‌‌dilemma:‌ ‌
−
→‌‌producing‌‌ΔQ = Q2 Q1 more‌‌units‌‌increases‌‌revenue‌‌with‌‌G‌ ‌
→‌b −
‌ ut‌‌‌decreased‌‌price‌‌with‌‌ΔP = P 1 P 2 and‌‌thus‌‌revenue‌‌with‌‌L‌ ‌
What‌‌choice‌‌should‌‌the‌‌monopolist‌‌make‌‌if‌‌he‌‌wants‌‌to‌‌maximize‌‌profits?‌ ‌
‌
Like‌‌any‌‌other‌‌firm,‌‌we‌‌need‌‌to‌‌keep‌‌the‌‌optimality‌‌condition‌‌in‌‌mind:‌‌MR‌‌=‌‌MC.‌ ‌
So,‌‌what‌‌is‌‌MR?‌ ‌
× × −
→‌‌T R = q uantity price = Q (A B Q) = AQ B 2 Q ‌ −
⇒ dT R(Q)
‌‌M R = dQ = A 2BQ ‌ −
The‌‌MR-curve‌‌of‌‌a‌‌monopolist‌‌has‌‌the‌‌same‌‌intercept‌‌as‌‌its‌‌demand‌‌curve,‌‌but‌‌twice‌‌the‌‌
slope.‌‌This‌‌means‌‌that‌‌the‌‌MR-curve‌‌will‌‌always‌‌lie‌‌beneath‌‌the‌‌demand‌‌curve.‌ ‌
‌
The‌‌main‌‌difference‌‌between‌‌a‌‌monopolist‌‌and‌‌a‌‌firm‌‌in‌‌perfect‌‌competition‌‌is‌‌that‌ ‌
the‌‌MR‌‌is‌n ‌ ot‌‌equal‌a ‌ nd‌a‌ lways‌‌less‌t‌han‌‌the‌‌actual‌‌market‌‌price.‌‌ ‌
‌
Following‌‌the‌‌optimality‌‌rule,‌‌MC=MR,‌‌the‌‌monopolist‌‌will‌‌product‌‌QM units‌‌ ‌
but‌‌will‌‌sell‌‌them‌‌at‌‌a‌‌clearing‌‌price‌‌of‌‌P M ‌
×
→‌‌the‌‌total‌‌revenue‌‌QM P M ‌is‌‌greater‌‌than‌‌the‌‌total‌‌costs‌‌AC(Q) QM ‌ ×
and‌‌thus‌‌the‌‌monopolist‌‌attains‌‌an‌e ‌ conomic‌‌profit‌.‌ ‌
‌
It‌‌is‌‌therefore‌‌interesting,‌‌for‌‌any‌‌firm,‌‌to‌‌try‌‌and‌‌achieve‌‌a‌‌certain‌‌level‌‌of‌‌market‌‌power.‌ ‌
In‌‌a‌‌perfect‌‌competition,‌‌economic‌‌profit‌‌is‌‌by‌‌no‌‌means‌‌possible‌u ‌ nless‌‌‌in‌‌the‌‌short‌‌run.‌ ‌




‌
‌
‌
‌
‌
‌
‌
‌
‌
‌
‌

,PART‌‌TWO‌ ‌
‌
In‌‌this‌‌course,‌‌we‌‌adapt‌‌a‌n ‌ eoclassical‌‌approach‌‌‌in‌‌which‌‌a‌‌firm‌‌is‌‌solely‌‌envisioned‌‌as‌‌a‌‌production‌‌
unit:‌‌the‌‌firm‌‌transforms‌‌inputs‌‌into‌‌outputs:‌ ‌
→‌g ‌ oal‌:‌‌maximize‌‌profits‌‌and‌‌hence‌‌minimize‌‌the‌‌production‌‌costs‌‌ ‌
‌
COST‌‌RELATIONSHIPS‌ ‌
A‌‌firm‌‌is‌‌characterised‌‌by‌‌a‌p ‌ roduction‌‌function‌‌‌for‌‌a‌‌single‌‌product‌‌q.‌‌This‌‌function‌‌specifies‌‌the‌‌quantity‌‌
q‌‌that‌‌the‌‌firm‌‌produced‌‌from‌‌using‌‌k‌‌different‌‌inputs:‌‌q = f (x1 , x2 , ..., xk ) ‌
‌
The‌‌relationship‌‌between‌‌the‌‌output‌‌choice‌‌(production‌‌function)‌‌and‌‌the‌‌production‌‌costs‌‌is‌‌expressed‌‌
using‌‌the‌c‌ ost‌‌function‌:‌‌C (q) + F ‌.‌‌As‌‌we‌‌are‌‌looking‌‌to‌‌maximize‌‌profits,‌‌we‌‌will‌‌solve:‌ ‌
k
M inimize ∑ wi xi ‌s.t. f (x1 , x2 , ..., xk ) = Q ‌‌with‌‌Q‌‌=‌‌the‌‌chosen‌‌production‌‌level‌ ‌
i=1
solving‌‌this‌‌linear‌‌problem‌‌for‌a
‌ ll‌‌‌quantity‌‌levels,‌‌results‌‌in‌‌the‌‌optimal‌‌cost‌‌function‌ ‌
where‌‌costs‌‌are‌‌minimized.‌ ‌
‌
There‌‌are‌‌4‌‌categories‌‌of‌‌costs:‌ ‌
1. Fixed‌‌costs‌:‌‌a‌‌given‌‌amount‌‌of‌‌expenditure‌‌that‌‌the‌‌firm‌‌must‌‌incur‌e ‌ ach‌‌p
‌ eriod‌‌‌and‌‌that‌‌is‌‌
unrelated‌‌‌to‌‌how‌‌much‌‌output‌‌the‌‌firm‌‌produces.‌ ‌
‌
2. Average‌‌costs‌:‌‌the‌‌total‌‌costs‌‌divided‌‌by‌‌output:‌ ‌
- Average F ixed Costs : F /Q ‌
- Average V ariable Costs : C(Q)/Q ‌
‌
3. Marginal‌‌costs‌:‌‌the‌‌addition‌‌to‌‌total‌‌costs‌‌that‌‌is‌‌incurred‌‌in‌‌increasing‌‌output‌‌by‌‌one‌‌unit‌ ‌
→‌‌M arginal Costs : dC(Q)/dQ ‌
‌
4. Sunk‌‌costs‌:‌‌costs‌‌that‌‌are‌‌also‌u ‌ nrelated‌‌‌to‌‌the‌‌output,‌‌but‌‌that‌‌are‌‌spent‌‌before‌‌measuring‌‌the‌‌
total‌‌costs‌‌(e.g.‌‌licences,‌‌research‌‌expenditures,...)‌‌and‌‌are‌‌also‌u ‌ nrecoverable‌‌‌if‌‌the‌‌firm‌‌
decides‌‌to‌‌exit‌‌the‌‌market.‌ ‌
‌
COST‌‌VARIABLES‌‌AND‌‌OUTPUT‌‌DECISIONS‌‌ ‌
Profit‌‌maximization‌‌over‌‌any‌‌period‌‌of‌‌time‌‌requires‌‌that‌‌the‌‌produced‌‌where‌M ‌ C‌‌=‌‌MR‌.‌ ‌
But‌‌‌it‌‌is‌‌important‌‌to‌‌note‌‌that‌‌this‌‌is‌‌only‌‌applicable‌i‌f‌‌the‌‌company‌‌produces‌.‌ ‌
‌
A‌‌company‌‌can‌‌produce‌‌in‌‌its‌‌equilibrium‌‌but‌‌the‌‌total‌‌revenue‌‌could‌‌be‌‌smaller‌‌than‌‌the‌‌
total‌‌costs.‌‌This‌‌happens‌‌when‌‌the‌‌equilibrium‌‌is‌‌under‌‌the‌‌AVC-curve.‌ ‌
→‌‌in‌‌this‌‌case,‌‌the‌‌firm‌‌would‌‌not‌‌produce‌‌and‌‌leave‌‌the‌‌market‌‌=‌s‌ hut-down‌‌decision‌ ‌
‌
In‌‌short,‌‌output‌‌decisions‌‌are‌‌based‌‌on:‌ ‌
1. Marginal‌‌Costs‌ ‌
→‌‌to‌‌decide‌h ‌ ow‌‌much‌‌‌to‌‌produce:‌‌MC‌‌=‌‌MR‌ ‌
2. Average‌‌Costs‌ ‌
→‌‌to‌‌decide‌‌if‌‌the‌‌firm‌‌will‌‌even‌‌produce‌‌in‌‌the‌l‌ong‌‌run‌ ‌
(losses‌‌in‌‌the‌‌SR‌‌are‌‌tolerated,‌n ‌ ot‌‌‌in‌‌the‌‌long‌‌run)‌ ‌
3. Average‌‌Variable‌‌Costs‌‌ ‌
→‌‌to‌‌decide‌‌if‌‌the‌‌firm‌‌will‌‌even‌‌produce‌‌in‌‌the‌s ‌ hort‌‌run‌ ‌
(price‌‌<‌‌AC‌‌can‌‌be‌‌tolerated,‌‌price‌‌<‌‌AVC‌n ‌ ot‌‌‌because‌‌then‌‌every‌‌unit‌‌is‌‌a‌‌loss)‌ ‌

‌
ECONOMIES‌‌OF‌‌SCALE‌‌ ‌
The‌‌state‌‌of‌‌affairs‌‌in‌‌which‌‌average‌‌costs‌‌fall‌‌as‌‌output‌‌increases,‌‌meaning‌‌that‌‌the‌‌cost‌‌per‌‌unit‌‌of‌‌
output‌‌declines‌‌as‌‌the‌‌scale‌‌of‌‌operations‌‌rises.‌ ‌
⇒
→‌f‌alling‌‌AC-curve‌‌ ‌ ‌MC‌‌<‌‌AC‌ ‌
‌
AC(Q)
We‌‌define‌‌S = M C(Q) ‌
- ⇒
if‌‌S‌‌>‌‌1‌‌ ‌‌economies‌‌of‌‌scale‌ ‌
- ⇒
if‌‌S‌‌=‌‌1‌‌ ‌m‌ inimum‌‌efficient‌‌scale‌‌
- ⇒
if‌‌S‌‌<‌‌1‌‌ ‌‌diseconomies‌‌of‌‌scale‌ ‌

,We‌‌conclude‌‌that‌‌the‌‌greater‌‌the‌‌extent‌‌of‌‌economies‌‌of‌‌scale,‌‌the‌‌larger‌‌the‌‌output‌‌at‌‌which‌‌the‌‌average‌‌
cost‌‌is‌‌minimized,‌‌the‌‌fewer‌‌firms‌‌that‌‌can‌‌operate‌‌efficiently‌‌in‌‌the‌‌market‌ ‌
⇒ ‌l‌arger‌‌economies‌‌of‌‌scale‌‌for‌‌a‌‌few‌‌firms‌‌will‌‌result‌‌in‌‌concentrated‌‌markets‌ ‌
‌
Now,‌‌what‌‌causes‌‌economies‌‌of‌‌scale?‌ ‌
- underlying‌‌technology‌ ‌
⇒
- greater‌‌scale‌‌of‌‌operations‌‌ ‌‌specialization‌‌and‌‌division‌‌of‌‌labor‌ ‌
- economies‌‌on‌‌inventory,‌‌repair,...‌ ‌
- capacity‌‌related‌‌solutions‌‌(e.g.‌‌volume‌‌of‌‌container‌‌that‌‌increases‌‌exponentially)‌ ‌
‌
ECONOMIES‌‌OF‌‌SCOPE‌ ‌
The‌‌state‌‌of‌‌affairs‌‌in‌‌which‌‌it‌‌is‌‌less‌‌costly‌‌to‌‌produce‌‌a‌‌set‌‌of‌‌goods‌‌in‌‌one‌‌firm‌‌than‌‌it‌‌is‌‌to‌‌produce‌‌that‌‌
set‌‌in‌‌two‌‌or‌‌more‌‌firms.‌ ‌
‌
We‌‌define‌‌S C =
−
C(q 1 , 0) + F 1 + C(0, q 2 ) + F [C(q 1 , q 2 ) + F ]
‌
C(q 1 , q 2 ) + F

- ⇒
if‌‌S‌‌>‌‌0‌‌ ‌‌economies‌‌of‌‌scope‌ ‌
- ⇒
if‌‌S‌‌=‌‌0‌‌ ‌‌critical‌‌point,‌‌indifference‌ ‌
- ⇒
if‌‌S‌‌<‌‌0‌‌ ‌‌no‌‌economies‌‌of‌‌scope‌ ‌
‌
The‌‌concept‌‌of‌‌economies‌‌of‌‌scope‌‌is‌‌an‌‌important‌‌one,‌‌as‌‌it‌‌provides‌‌the‌‌central‌‌technological‌‌reason‌‌
for‌‌the‌‌existence‌‌of‌‌multiproduct‌‌firms.‌‌There‌‌are‌‌two‌‌causes‌‌for‌‌economies‌‌of‌‌scope:‌ ‌
1. Shared‌‌inputs‌ ‌
→‌‌e.g.‌‌shared‌‌R&D,‌‌equipment‌‌that‌‌can‌‌be‌‌used‌‌for‌‌multiple‌‌products,...‌ ‌
‌
2. Cost‌‌complementarities‌‌ ‌
→‌‌producing‌‌one‌‌good‌‌reduces‌‌the‌‌cost‌‌of‌‌another‌ ‌
‌
MARKET‌‌STRUCTURE‌‌ ‌
The‌M ‌ arket‌‌Structure‌‌i‌s‌‌defined‌‌as‌‌the‌‌amount‌‌and‌‌size‌‌of‌‌firms‌‌within‌‌that‌‌market‌‌+‌‌other‌‌factors.‌ ‌
How‌‌to‌‌measure‌‌the‌‌market‌‌structure?‌‌ ‌
- summary‌‌measures‌‌(e.g.‌‌number‌‌of‌‌firms,‌‌market‌‌share‌‌of‌‌each‌‌firm,...)‌ ‌
- concentration‌‌curve‌ ‌
- concentration‌‌ratios‌‌(e.g.‌‌C Rn )‌ ‌
- Herfindahl-Hirschman‌‌Index‌‌(HII)‌ ‌
‌
Summary‌‌measures‌ ‌
‌
Most‌‌of‌‌the‌‌times‌‌fairly‌i‌n‌accurate‌‌as‌‌is‌‌hard‌‌to‌‌list‌‌all‌‌competitors‌‌within‌‌one‌‌
market.‌ ‌
‌
‌
‌
Concentration‌‌Curve‌‌ ‌
‌
How‌‌large‌‌are‌‌the‌‌largest‌‌firms?‌‌→‌‌cfr.‌‌steepness‌‌of‌‌curve‌ ‌
How‌‌quickly‌‌do‌‌we‌‌reach‌‌100%?‌ ‌
…‌ ‌
‌
‌
‌
‌
Concentration‌‌Ratios‌ ‌
e.g.‌‌C R4 =‌‌ratio‌‌that‌‌tells‌‌you‌‌how‌‌much‌‌market‌‌share‌‌the‌‌4‌‌largest‌‌firms‌‌in‌‌a‌‌market‌‌have‌‌combined.‌ ‌
‌
Herfindahl-Hirschman‌‌Index‌‌(HHI)‌ ‌
N
H HI = ∑ si2 ‌‌=‌‌sum‌‌of‌s
‌ quared‌m
‌ arket‌‌shares‌‌of‌‌each‌‌company.‌ ‌
i=1
‌

, MARKET‌‌DEFINITION‌ ‌
We‌‌understand‌‌that‌‌it‌‌is‌‌impossible‌‌to‌‌calculate‌‌metrics‌‌on‌‌the‌‌market‌‌structure,‌‌if‌‌we‌‌have‌‌no‌‌clear‌‌
definition‌‌of‌‌the‌‌market‌‌we‌‌are‌‌studying.‌‌But‌‌defining‌‌a‌‌market‌‌is‌‌no‌‌easy‌‌thing‌‌to‌‌do:‌ ‌
‌
1. define‌‌by‌‌substitutability‌‌in‌p ‌ roduction‌ ‌
→‌‌standard‌‌approach,‌‌based‌‌on‌‌industry‌‌codes‌‌ ‌
→‌‌but‌‌limitations‌ ‌
‌
2. define‌‌by‌‌substitutability‌‌in‌c ‌ onsumption‌‌ ‌
→‌‌=‌d ‌ emand‌‌substitutability‌‌ ‌
→‌‌based‌‌on‌‌cross-price‌‌elasticity‌‌ ‌
‌
We‌‌should‌‌also‌‌ask‌‌ourselves:‌w ‌ hat‌‌drives‌‌potential‌‌market‌‌concentration?‌‌ ‌
a. economies‌‌of‌‌scale‌‌/‌‌economies‌‌of‌‌scope‌ ‌
→‌‌larger‌‌firms‌‌become‌‌more‌‌efficient,‌‌concentration‌‌rises‌ ‌
‌
b. network‌‌externalities‌ ‌
→‌‌concentrated,‌‌even‌‌though‌‌there‌‌could‌‌be‌‌no‌‌economies‌‌of‌‌scale‌‌/‌‌scope‌ ‌
‌
c. government‌‌and‌‌antitrust‌‌policy‌ ‌
→‌‌by‌‌limiting‌‌entry,‌‌patent‌‌system,‌‌blocking‌‌of‌‌mergers,...‌ ‌
‌
‌
PART‌‌THREE‌ ‌
‌
THE‌‌CONCEPT‌‌OF‌‌DISCOUNTING‌ ‌
Both‌‌the‌‌competition‌‌and‌‌monopoly‌‌models‌‌are‌‌somewhat‌‌vague‌‌with‌‌respect‌‌to‌‌time.‌ ‌
As‌‌we‌‌know‌‌money‌‌has‌‌a‌‌time‌‌value,‌‌the‌‌meaning‌‌of‌‌profit‌‌or‌‌break-even‌‌is‌‌less‌‌clear.‌ ‌
→‌‌we‌‌need‌‌a‌‌way‌‌to‌‌convert‌‌tomorrow's‌‌money‌‌into‌‌today's‌‌money‌ ‌
⇒ ‌‌we‌‌will‌‌make‌‌use‌‌of‌‌discounting‌‌and‌‌Net‌‌Present‌‌Value‌ ‌
‌
(Net)‌‌Present‌‌Value‌‌is‌‌directly‌‌relevant‌‌to‌‌profit‌‌maximization:‌ ‌
- for‌o ‌ ne-period‌p ‌ roblems,‌‌we‌‌just‌‌continue‌‌to‌‌use‌‌the‌M‌ R‌‌=‌‌MC‌‌‌optimality‌‌constraint‌ ‌
‌
- for‌m ‌ ultiperiod‌p ‌ roblems,‌‌we‌‌need‌‌to‌‌make‌‌sure‌‌that‌‌the‌‌present‌‌value‌‌of‌‌future‌‌income‌‌streams‌‌
must‌‌at‌‌least‌‌cover‌‌the‌‌present‌‌value‌‌of‌‌the‌‌expenses‌‌in‌‌establishing‌‌the‌‌project:‌P ‌ V‌‌-‌‌I‌‌>‌‌0‌‌ ‌
‌
EFFICIENCY‌‌AND‌‌SURPLUS‌ ‌
Why‌‌are‌‌monopolies‌‌often‌‌blocked?‌‌ ‌
→‌r‌ eason‌:‌‌monopolies‌‌are‌i‌n‌efficient.‌ ‌
‌
Efficiency‌:‌a ‌ ‌‌market‌‌outcome‌‌is‌‌efficient‌‌when‌‌it‌‌is‌‌impossible‌‌to‌‌find‌‌a‌‌small‌‌change‌‌in‌‌the‌‌allocation‌‌of‌‌
capital,‌‌labor,‌‌goods‌‌or‌‌services‌‌that‌‌would‌‌improve‌‌the‌‌well-being‌‌of‌‌individuals‌‌without‌‌hurting‌‌others.‌‌ ‌
→‌‌an‌‌analysis‌‌of‌‌surpluses‌‌will‌‌give‌‌us‌‌an‌‌idea‌‌of‌‌why‌‌a‌‌monopoly‌‌is‌‌inefficient‌‌and‌‌thus‌‌unwanted‌ ‌
‌
PERFECT‌‌COMPETITION‌ ‌
Efficiency‌‌is‌‌basically‌‌a‌‌measure‌‌of‌‌well-being.‌ ‌
a. Consumer‌‌surplus‌:‌t‌he‌‌difference‌‌between‌‌the‌‌maximum‌‌amount‌‌a‌‌consumer‌‌is‌‌
⇒
willing‌‌to‌‌pay,‌‌and‌‌the‌‌amount‌‌actually‌‌paid‌‌ ‌C ‌ S‌‌‌(aggregated)‌ ‌
‌
b. Producer‌‌surplus‌:‌t‌he‌‌difference‌‌between‌‌the‌‌amount‌‌a‌‌producer‌‌receives‌‌from‌‌a‌‌
⇒
sale‌‌and‌‌the‌‌amount‌‌that‌‌the‌‌sale‌‌cost‌‌him‌‌ ‌P ‌ S‌‌‌(aggregated)‌ ‌
‌
In‌‌this‌‌diagram‌‌(perfect‌‌competition),‌‌we‌‌can‌‌see‌‌that‌‌both‌‌surpluses‌‌are‌‌maximized.‌ ‌
→‌‌the‌‌competitive‌‌equilibrium‌‌is‌e ‌ fficient‌‌‌and‌‌welfare‌‌is‌‌maximized‌



‌
‌

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