Introduction to Business Analysis

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Introduction to Business Analysis

• Market Structure Market Power

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Market Structure

• A classification system for markets.
• Based on 3 Key Traits

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1) Number of Firms

• Actual who participate in market
• Relative size of firms

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2) Similarity of products

• Homogenous Product
• Products are identical
• Differentiated Product
• Products are different
• Real Difference
• Perceived Difference
• Unique Product
• Only product in market
• Very differentiated

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3) Ease of Entry or Exit

• Easy or Difficult to start a new firm?
• Easy or Difficult to leave market once in?
• Determinates
• Law / Licensing / Franchise
• Patent
• Ownership of Vital Resource
• Start up costs
• Practices of current market members
• Limit Pricing

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The Market Structures

• 4 main categories of markets
• Generalizations, not necessarily a perfect fit

Agriculture
Very Easy
Homogenous
Large of Small
Perfect Competition
Diamonds, Utilities
Impossible
Unique
One
Perfect Monopoly
Retail, Restaurants
Easy
Differentiated
Many but small
Monopolistic Competition
Autos, Planes, Gas
Difficult
Homogenous or Differentiated
Few
Oligopoly
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Market Power

• The ability of an individual firm to
  set/manipulate
• Market price
• Market quantity
• Hence, Profit
• More Market Power
• The Fewer Larger the firms
• More Differentiated the product
• Harder to enter
• In Order of Power
• Monopoly, Oligopoly, Monopolistic Competition,
  Perfect Competition

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Perfect Competition

• The Basic Business Model

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Perfect Competition

• Large of Small Firms
• Homogenous Product
• Very Easy Entry Exit
• Firms have no market power
• Firms are Price Takers
• A seller that has no control over the price of
  the product it sells.
• Price is set by the market.

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Perfectly Competitive Firms as Price Takers

• Once the Market sets the price, the Firm will
  sell any Q at that price
• If Firm tries to Raise PriceNo one will buy
• If Firm tries to lower Price Everyone will buy
  and firm is to small

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Firms Goal

• Maximize Profit
• Information needed
• Revenue
• Costs
• Have that information from last chapter
• Specific Firm Problem
• What Q should be produced to maximize profit.

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Profit Max Problem

• First, Well look at totals
• Total Revenue
• Since P is P, TR? as Q?.
• Straight Line
• Total Cost
• Same TC curve as before
• Profit/Loss
• The area between a TR and TC.

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Profit Max Problem (Totals)

• Draw TR TC

• Find Profit Loss areas

• Find Q that yields Max Profit
• Need to find biggest gap between TR TC

• Q is this firms max Profit Quantity for P

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Marginal Analysis

• With totals Q is hard to see
• Lets look at marginal information to find profit
• Marginal Revenue (MR)
• The change in Total Revenue from the sale of one
  additional unit of out put
• MR DTR / DQ
• For perfect competitive firm P D
• Marginal Cost
• Include ATC AVC for more information

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Marginal Analysis Rules(Back to the 2nd lecture)

• To Find optimal location follow these rules
• IF MB gt MC, Increase Activity
• IF MB lt MC, Decrease Activity
• If MB MC, Found optimal location
• Application to Firm analysis
• MB for a firm is Marginal Revenue
• MC for a Firm is Marginal Cost
• Activity for a Firm is production
• Optimal Location for a firm is Profit Maximizing
  Point.

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Profit Max Problem (Marginals)

• Draw Costs

• Draw MR

• Find Q that yields Max Profit
• Where MR intersects MC

• Now Lets find profit

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Profit Max Problem (Marginals)

• Find TR
• P Q

• Find TC
• ATC Q

• Find Profit
• TR TC
• The area of TR not covered by TC

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Profit Maximizing Firm

• Any Time P is above the Min point of ATC,
• Choose Q to max profit
• Size of profit varies
• Look stays the same
• What if P is below?
• Loss Minimization by
• Producing
• Shutting Down

• Note These are all short-run outcomes

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Loss Minimization

• Draw Costs MR
• Find Q

• Find Profit or Loss

• So firms making a loss
• Stay open or Shutdown?
• Compare loss for Each
• We know stay open loss
• Find loss for shutdown
• This loss is TFC
• TFC AFC Q

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Loss Minimization

• Since loss for staying open is smaller than
  shutdown loss
• Firm Should stay open
• In the short-run
• When P is in between the min point on ATC and the
  min point on AVC, firms should always stay open
  and produce.

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Loss Minimization (Shutdown)

• Draw Costs MR
• Find Q

• Find Profit or Loss

• So firms making a loss
• Stay open or Shutdown?
• We know stay open loss
• Find loss for shutdown

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Loss Minimization (Shutdown)

• Since loss for shutting down is smaller than loss
  if firm stayed open
• The firm should shutdown
• Even though the firm needs to pay TFC in the
  short-run
• When P is below the min point on AVC, firm should
  always shutdown
• Logic
• Firm cant even cover material cost

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Perfectly Competitive Firm (Profits)

• Profit, Loss, or Shutdown in the short-run.
• No economic profit in the long-run
• Competition will drive profit away
• If loss in the short-run firms will shutdown

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Monopoly

• Model for a market with one seller.

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A Monopolys Characteristics

• One Seller
• Unique Product
• Impossible entry
• Market Power
• Ability to set Price

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Why Monopolies?

• Legal Barriers to Entry
• USPS (not as true w/ more carriers)
• Local Cable Company
• Ownership of a vital resource
• Alcoa (Aluminum Company of America)
• Pro Sports
• Economies of scale
• Decreasing LRAC as Q increases
• Creates a Natural Monopoly

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Natural Monopoly

• A monopoly that forms b/c one firm can provide a
  product more cheaply than many firms.
• Caused by decreasing LRAC

This is the most common Typically Govt
Regulated
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Monopolists Decision

• Uses same ideas as Perfect Competition
• Need to add Market Power
• Monopolist is a Price Maker
• Sets own price
• Examine how

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Market Demand Individual Demand for a
Monopolists

• Monopolists individual demand same as the market
• Need to take into account law of demand

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Monopolists Marginal Revenue (Table)
Marginal Revenue
Total Revenue
Price
Quantity
6
6
6
1
4
10
5
2
2
12
4
3
0
12
3
4
-2
10
2
5
-4
6
1
6
Note MR decreases twice as fast Price. ? MR
curve twice as steep as demand
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Monopolists Marginal Revenue (Curve)

• MR curve is twice as steep as demand.
• Intersect X axis at Demands Midpoint
• Remember Elasticities?

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Profit Max/ Loss Min Decision

• Use this MR curve w/ Cost curves to find
• Profit Maximizing Quantity
• corresponding Profit Max Price
• Possibilities
• Profit Max
• Same as before
• Loss Min
• Same as before
• Shutdown
• NO LONGER AN OPTION Impossible exit.

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Profit Maximization

• Draw D, MR Costs

• Find Q by MR MC intersection

• Find P At Q find P on demand curve

• Find Profit 1st need Costs, than the area
  between P and ATC up to Q

• Monopolist Makes a Profit if ATC at any point is
  inside demand

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Loss Minimization

• Draw D, MR Costs

• Find Q by MR MC intersection

• Find P At Q find P on demand curve

• Find Loss 1st need Costs, than the area between
  P and ATC up to Q

• Monopolist Makes a Loss if ATC is never inside
  Demand

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Profit Short-run vs. Long Run

• Short-Run
• Monopolist may earn profit or loss
• Long-Run
• Since no competition
• Since no entry or exit
• There is no change in the market
• Monopolists continues to earn Profit in the
  long-run
• Long run profit called Monopoly Profit.

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Monopolies (profit)

• Profit/Loss in the short-run.
• Profit in the long-run
• Called Monopoly profit

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MonopoliesPros/Cons

• Cons
• Higher Prices
• Redistributes wealth to monopoly owners
• Less Technology?
• Pros
• More Technology
• More Efficient
• Economic (Rate of return) Regulation

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Two other market types

• Oligopoly
• Monopolistic Competion

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Monopolistic Competition

• Many Firms
• Differentiated Products
• Easy Entry/Exit

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Differentiated Products

• Packaging
• Advertising
• Service
• Quality
• Provides market power depending on the strength
  of the name brand.

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Oligopoly

• Few firms
• Product? Differentiated or Homogeneous
• Difficult Entry
• Characterized by Mutual Interdependence
• Actions of one firm have a direct impact on the
  market condition of another firm