Post on 22-May-2018
LCEconomicswww.thebusinessguys.ie©
Oligopoly
Before,whenwelookedatPerfectandImperfectCompe@@on,weno@cedthatfirmsinthesemarketsactedindependentlyofeachother.
Thatis,eachfirmdidnottaketheac@onsofotherfirmsintheindustryintoaccount.However,ifwelookattheairlineorbankingindustry,weseethattherearemanybuyerspurchasingfromonlyafewlargefirms
andeachfirmisconsciousofwhattheotherfirmsaredoing.Ifonebanklowersitscharges(price),weseethatotherbanksrespondtothischange
byeitherchangingtheirpricesorbyofferingsomeotherincen@vetoaHractcustomers.
Fromthiswesaythatthesefirmsareinterdependent.When
thereisamarketcontainingasmallnumberoflargefirmsac@nginterdependently,itiscalledanOligopoly.
Assump-ons
1)FewSellersintheIndustry:Becauseofthiseachsellercaninfluence
thepriceofthecommodityortheoutputsold.
2)InterdependencebetweenFirms:Firmsinoligopolydonotact
independentlyofeachother.Theywilleachtakeintoaccountthelikelyreac@onsoftheircompe@tors,hencepricestendtoberigid.
3)ProductDifferen-a-onOccurs:Thecommodi@eswhichfirmssellare
closesubs@tutes.Firmswillengageinadver@singtopersuadeconsumerstobuytheirproductratherthanacompe@tor’sproduct.
4)BarrierstoEntry:Thesearecommoninanoligopolis@cmarketasexis@ngfirmswillwishtomaintaintheirshareofthemarket.Examplesof
barriersinclude:highcostsofseTngupintheindustry,brandprolifera@onetc.
AnOligopolis-cMarket:isamarketwithalargenumberofbuyerspurchasingfromasmallnumberoflargefirms,andthesefirmsmakedecisionstoincreasesaleswhiletakingintoaccountthepossiblereac@onsofcompe@tors.
ProductDifferen-a-on:meansthatproductssoldbycompe@ngfirmsaresimilarbuthavedifferences.Thereareclose(butnotperfect)subs@tutesavailable.
JonathanTraynor
LCEconomicswww.thebusinessguys.ie©
5)CollusionmayOccur:Firmswithintheindustrymaymeettocontrol
theoutputintheindustryorcontrolpricese.g.OPEC.
6)Non-PriceCompe--onisMoreCommonthanPriceCompe--on:Duetothefearofhowcompe@torswillreact,firmstendnottoengagein
pricecompe@@onbutrathertheyengageinnon-pricecompe@@ontogainconsumers.
ExamplesofNon-PriceCompe--on
a)SponsoringCommunityEvents
b)FreeGi\s
c)Specialintroductorypricefornewcustomers
d) Increasingthequalityoftheservice
BarrierstoEntry:Aretheforcesatworkwhichpreventordeterotherfirmsfromenteringintotheindustry
Collusion:isanyac@ontakenbyseparateandrivalcompaniestorestrictcompe@@onbetweenthemwithaviewtoincreasingtheirtotalprofits
LimitPricing:occurswhenexis@ngfirmsinanOligopolis@cmarketchargeapricelowerthanthepricetheycouldchargeinordertodiscouragetheentryofnewfirmsintothemarketortoforceunwantedentrantsoutofthemarket.
Non-PriceCompe--on:occurswhenfirmstrytoincreasetheirmarketsharewithoutchangingtheirprice.
PriceCompe--on:iswhenfirmscompetewithotherfirmsonthebasisofprice
JonathanTraynor�2
LCEconomicswww.thebusinessguys.ie©
BarrierstoEntry
Intheassump@onswesaidthatbarrierstoentryexistinanOligopolis@cmarket.Thesearethethingsthatstopotherfirmsenteringtheindustry.WewillnowlookatwhatbarrierstoentryexistinOligopoly.
1) HighStartUpCosts:SomeOligopolis@cfirmsoperateonsuchalargescalethatthecostsofstar@ngupintheindustryfacedbypoten@alentrantsissohighthatitwouldbeunprofitabletosetupanewfirminopposi@ontotheexis@ngones.
2) LimitPricing:Whennewfirmsentertheindustry,exis@ngOligopolis@cfirmsmayallagreetoeachlowertheirprice,inthehopethatthenewentrantisunabletomatchthispriceandassuchisforcedoutoftheindustry.
3) EconomiesofScale:Exis@ngfirmsmayenjoyhugeeconomiesofscaleinadver@singwhichinducesbrandloyaltyandreducescustomer’swillingnesstotrynewbrands.
4) ChannelsofDistribu-on:Exis@ngfirmsmaycontrolthesupplyofgoodstoretailersandrefusetosupplyretailersthatcarrytheproductsofnewfirms.
5) BrandProlifera-on:Thisiswhereeachexis@ngfirmproducesandadver@sesseveralbrandsthuslimi@ngthemarketavailabletopoten@alnewentrants.E.g.BothProctorandGamble;andUnileverproducewashingdetergent.
Proctor and Gamble produces
Daz Ariel
Tide Dre\
Bold Fairyandmore
Unilever Produces
Surf Oms
Persil Luxandmore
JonathanTraynor�3
LCEconomicswww.thebusinessguys.ie©
NOTE:ProctorandGambleandUnileveroperateinwhatiscalledaduopololy.Itisanoligopolywithonlytwofirms.
ItisimportanttonotethatthereisnoonetheoryofOligopolythataccuratelydescribestheequilibriumofanOligopolis@cfirminallcases.Thisisunliketheothermarketstructuresthatwehavestudied(PerfectCompe@@on,ImperfectCompe@@onandMonopoly)wherewecanaccuratelypredicttheirac@onsandequilibriuminboththeShortRunandtheLongRun.
ThebehaviourofanyOligopolis@cfirmdependsontheindustryitisin(banking,petroleum,insurance,foodchains)andhowitreactstoitscompe@torsdecisionsandhowitbelievesitscompe@torswillreacttoitsdecisions.
WewillnowlookatanumberofideasthathavebeenputforwardtotrytoexplainthedifferentaspectsofOligopolis@cmarkets.
BrandProlifera-on:iswhereeachexis@ngfirmproducesandadver@sesseveralbrandsthuslimi@ngthemarketavailabletoanewentrant.
JonathanTraynor�4
LCEconomicswww.thebusinessguys.ie©
Explana-onforS-ckyPrices–TheKinkedDemandCurve
(SweezyModel)
Theexplana@onthatfollowsispurelytohelpyouunderstandthetheoryoftheKinkedDemandCurvefacedbyanOligopolis@cfirm.Youdonot
needtolearnthisatall.Justunderstanditandthenlearnofftheexplana@onoftheKinkedDemandCurvethatfollows.
Intheassump@onswesaidthatpricesinanOligopolis@cmarkettendto
berigid(tendnottochangeover@me).AnexpressionusedtodescribethisaHributeisthatOligopolis@cmarketstendtohaves@ckyprices.In
ordertotrytoexplainthisphenomenon,economistPaulSweezyputforwardtheideaoftheKinkedDemandCurve.Seegraphbelow.
JonathanTraynor�5
Price
Quan@ty
AR/D
PEq
QEq
LCEconomicswww.thebusinessguys.ie©
Wewillnowderivehowhecametothisconclusion.
1)Weknowfromtheassump@onsthatfirmsactinterdependentlyandas
sucheachfirmtakestheac@onsoftheotherfirmsintoaccount.Thereforeifonefirmdecreasespricetotrytogainagreatershareofthe
market,otherfirmswillalsodecreasetheirprice.Assuch,thereisnobenefittoanyofthefirmsfollowingapricedecrease.Therefore,inrela@ontodecreasingprices,Oligopolis@cfirmsfaceanInelas@cDemand
Curve(AverageRevenueCurve).Seegraphbelow.
Inelas-cAverageRevenueandMarginalRevenueCurves
JonathanTraynor�6
Price
Quan@ty
AR/DMR
LCEconomicswww.thebusinessguys.ie©
2)Also,ifafirmincreasesitsprice,otherfirmswillreacttothisbynotchangingtheirprice.Assuchtheotherfirmswillbesellingasimilargood
foracheaperpriceandenjoyanincreasedmarketshare.Assuchthefirmthatincreaseditspricewilllosealotofcustomerstoitscompe@ngfirms.
Therefore,inrela@ontoincreasingprice,oligopolis@cfirmsfaceanElas@cDemandCurve(AverageRevenueCurve).Seegraphbelow.
Elas-cAverageRevenueandMarginalRevenueCurves
3)Therefore,Oligopolis@cfirmsreallyfacetwodifferentAverageRevenue
Curves(DemandCurves).TheInelas@cDemandCurveforpricedecreasesandtheElas@cDemandCurveforpriceincreases.Seegraphoverleaf.
JonathanTraynor�7
Price
Quan@ty
AR/D
LCEconomicswww.thebusinessguys.ie©
4)Therefore,allfirmsarereluctanttochangetheirpricesasanychangeinpriceresultsinalossinrevenue.AssuchallfirmswillseHleforthepricewherethetwoDemandCurves(AverageRevenueCurves)intersect.
Evenifanindividualfirmsuffersanincreaseincosts,thefirmwouldprefertoabsorbthisdropintheirprofitsinsteadofincreasingtheirprice
andlosesales.Ifcostsfall,thefirmwillnotpassonthelowerpricetotheconsumerasthismaycauseapricewarwithcompe@tors.ThisreluctanceofOligopolis@cfirmstochangepriceiswhatisknownasPriceRigidity.
5)ThefirmknowsthatifitincreasesitspriceabovePEq,itwillfacethe
Elas@cDemandCurve(AverageRevenueCurve).Therefore,theInelas@cAverageRevenueandMarginalRevenueCurvesabovethispricenolongerapplytothefirm.
PriceRigidity:referstothetendencyforpricesnottochange,evenifthefirm’scostschange,inordertoavoidreac@onfromcompe@tors.
JonathanTraynor�8
MR
Price
Quan@ty
AR/DEL
AR/DInel
PEq
QEq
LCEconomicswww.thebusinessguys.ie©
6)Also,thefirmknowsthatifitdecreasespricebelowPEq,itwillfaceanInelas@cDemandCurve(AverageRevenueCurve).Therefore,thoseparts
oftheElas@cAverageRevenueandMarginalRevenueCurvesbelowthispricenolongerapplytothefirm.
7)Thisleavesthefirmfacingwhatiscalleda“KinkedDemandCurve”anda“KinkedMarginalRevenueCurve”.Seethegraphbelow.
KinkedAverageandMarginalRevenueCurves
8)IfwelookattheMarginalRevenueCurveabove,weseethatbetween
pointaandbitisaver@callinedown.Thereasonforthisisthat,foradownwardslopingAverageRevenueCurve,mathema@cally,MarginalRevenuemustbeslopingsteeperthanAverageRevenue.AsAverage
RevenuedropssosteeplyatpointX,thiscausesMarginalRevenuetofallver@callyforapor@on(thedistancebetweenaandb).Thewholeline,
JonathanTraynor�9
Price
Quan@ty
AR/DMR
X
a
b
LCEconomicswww.thebusinessguys.ie©
includingthever@caldrop,istheMarginalRevenueCurvefacedbyanOligopolis@cfirm;it’sjustanunusualshape.
9)AssumingthatthefirmisaProfitMaximiser(whichaswesaidintheassump@onsisnotalwaystrue),thefirmwillproducewhereMC=MR
andMCisrising.Thisgivesthequan@tyQEqandpricePEq.Seegraphbelow.
KinkedDemandCurvewithPriceandQuan-tyforanOligopolis-cFirm
10)AriseinMarginalCosts,fromMC1toMC2,doesnotchangeeitherthe
pricechargedorthequan@tysupplied.ThisisbecausethefirmisaProfitMaximiser(forthismodelofOligopolyatleast)andproduceswhereMC=MRandMCisrising.Duetothever@calsegmentintheMRcurve
(thesegmentfrompointatopointb),ariseinMCs@llresultsinquan@tyQEqbeingsuppliedandpricePEqbeingcharged.Seegraphoverleaf.
JonathanTraynor�10
Price
Quan@ty
AR/DMR
X
a
b
!
MC
QEq
PEq
LCEconomicswww.thebusinessguys.ie©
OligopolistAbsorbingCostIncreases
11)Fromthisra@onale,weseethatanOligopolis@cfirmmayabsorba
riseincostwithoutincreasingpriceasaresult.
12)Ifafirmwastoincreasepriceduetoanincreaseincosts,itwouldlosemorerevenueasaresultofthepriceincreasethanitwouldfrom
absorbingthecost.ThisgivesrisetowhatisknownasPriceConstancy
JonathanTraynor�11
Price
Quan@ty
AR/DMR
X
a
b
!MC1
!MC2
PEq
QEq
LCEconomicswww.thebusinessguys.ie©
L.C.QUsingaClearlyLabeledDiagram,Explaintheshapeofthe‘kinked’demandcurvefacingafirminOligopoly
ShapeoftheDemandCurve
Demandcurve-AB
Ifthisfirmincreasesitspriceotherswillleavetheirpricesunchangedso
thisfirmwilllosemanycustomers–thispor@onoftheDemandCurveiselas@c.
Demandcurve–BC
Ifthisfirmlowersitspriceotherswillmatchthispricedecreasesothisfirmwillgainfewaddi@onalcustomers–thispor@onoftheDemand
Curveisinelas@c.
JonathanTraynor�12
Price
Quan@ty
AR/D
P1
A
B
C
LCEconomicswww.thebusinessguys.ie©
UsingaClearlyLabelledDiagram,Explainthelongrunequilibriumposi-onofanOligopolis-cfirm
TheLongRunEquilibriumPosi-onofanOligopolis-cfirm
1) Equilibrium:EquilibriumoccursatpointGwhereMC=MR(andMCisrising).
2) PriceandQuan-ty:ThefirmwillproduceQ1andsellthisoutputat
priceP1
3) Costs:Thefirm’scostofproduc@onisshownatpointG.
4) RiseinCosts:ShouldcostsrisebetweenpointsDandEthenmarketpricetendstoremainconstantatP1.
5) Profits:ThisfirmisearningSNPsbecauseARexceedsACandbarriers
toentryexist.
JonathanTraynor�13
Price
Quan@ty
AR/D
P1
A
B
C
Q1
!MC
!
AC
MR
LCEconomicswww.thebusinessguys.ie©
PriceConstancy
LikePriceRigidity,PriceConstancyinvolvesleavingthepriceofthegood
unchanged.ItdiffersfromPriceRigidityinthatthereasonfornotchangingthepriceisthatitmayactuallycostmoretochangetheprice
ratherthantakeasmalldentinprofits.
E.g.Iftheownerofarestaurantfindsthathiscostsarerising,butonlyslightly,hemaynotincreasethepriceschargedasthiswouldinvolve
reprin@ngallthemenusandchangingadver@sedprices.Thiscouldprovetobemoreexpensivethanhisslightincreaseincostsandassuchthe
ownerleavesthepricesunchanged.
Evalua-onoftheSweezyModel
1)TheSweezymodelaccuratelydescribedOligopolis@cmarketsinthe1930’s(therewasagreatdepressionandfirmshadexcesscapacity).
2)However,duetotheoilshocksinthe1970’sand80’s,highinfla@onandincreaseinwages,Oligopolis@cfirmsraisedpriceswithoutsufferingagreatlossindemand.
3)Anotherproblemwiththismodelisthatitdoesnotexplainhowtheini@alequilibriumprice,PEq,wasset.
Inindustrieswhereitisdifficultforfirmstoraisepriceswithoutsufferingaseriousdeclineinrevenue,thereisanincen@vetoengageincollusion
towhichwenowturnouraHen@on.
JonathanTraynor�14
LCEconomicswww.thebusinessguys.ie©
FormsofCollusion
Intheassump@onswesaidthatcollusionmayexistinanOligopoly.Wewillnowlookatthedifferentformsofcollusionthatcantakeplace.
1)PricingPolicy/LimitPricing:Onefirm,withthetacitagreementofothers,couldreducepricesforcingunwantedentrantsoutoftheindustry.
2)Produc-on/OutputPolicy:Firmscouldjointogethertolimitoutputtocertainagreedamounts.
3)SalesTerritories:Firmscoulddivideupthemarketsbetweenthemandagreenottocompeteineachother’smarketsegments.
4)Refusaltosupplyfirms:Firmsmaynotsupplythosefirmswhobuy
fromfirmsnotinthecartel.
5)ImplicitCollusion:Eachfirmrecognisesthatbehavingasiftheywere
branchesofasinglefirm,theirjointprofitswouldbehigher.SofirmsdonotprovoketheirrivalsbycuTngprices.Insteadtheytrytoincreasemarketsharebyengaginginnon-pricecompe@@vemeasures.
MostoftheformsofcollusionaboveareknownasExplicitCollusion
However,inmanyOligopoliesaroundtheworld,firmsmaynothaveanexplicitarrangement,butbyfollowingeachother’sac@ons,maycometoanimpliedagreementwhichreducescompe@@onandraiseseachoftheir
profits.ThistypeofcollusionisknownasImplicitCollusion.
Collusion:isanyac@ontakenbyseparateandrivalcompaniestorestrictcompe@@onbetweenthemwithaviewtoincreasingtheirtotalprofits
ExplicitCollusion:occurswhenseparatecompaniesjointlydecideonaspecificcourseofac@on,toreducecompe@@onbetweenthem,withaviewtoincreasingtheirtotalprofits.I.e.thereisanagreedarrangement.
ImplicitCollusion(TacitCollusion):occurswhenthereisnoformal
agreementbetweenfirms,buteachfirmactsinanon-compe@@vewayinordertoincreaseprofits.
JonathanTraynor�15
LCEconomicswww.thebusinessguys.ie©
PriceLeadership
Thismeansthatthemostdominantfirmintheindustrysetsitspriceand,inordernottoengageinPriceCompe@@on,thesmallerfirmsinthe
industrysetthesamepricefortheirgoodswithoutanyexplicitagreement.
TheideaofPriceLeadershiphasbeenusedinconjunc@onwithorasanalterna@vetotheKinkedDemandCurve.WhenitisusedwiththeKinked
DemandCurveModel,itisgivenasthemethodbywhichthemarketreachestheequilibriumprice.Whenitisusedasanalterna@vetotheKinkedDemandCurve,itissaidthatitisPriceLeadershipalonethat
causesPriceRigidityandnottheKinkedDemandCurve.
Aswesaidintheassump@ons,firmstendnottoengageinPrice
Compe@@on.Thisisduetothefactthatifonefirmlowerstheirprice,allotherfirmsadoptthesametac@cresul@nginnoincreaseinmarketsharetoanyfirm.Therefore,eachfirmiss@llsellingthesameamountofgoods
astheywerebeforethepricedecrease,butnowtheyaresellingthesegoodsatalowerpriceandassucheachfirmisworseoffasaresult.This
givesrisetothefactthatOligopolis@cfirmsengageinNon-PriceCompe@@on.WewillnowdiscusstheProsandConstotheconsumerofNon-PriceCompe@@on.
PriceLeadership:occurswhenthelargestsuppliersetsitspriceandthesmallerrivalsfollowitslead.
PriceCompe--on:iswhenfirmscompetewithotherfirmsonthebasisofprice
JonathanTraynor�16
LCEconomicswww.thebusinessguys.ie©
BenefitstotheConsumerofNon-PriceCompe--on
1) PriceStability:Non-PriceCompe@@onresultsinconstantpricesthusmakingiteasierfortheconsumertobudgetforthesegoods.
2) Be[erQualityProducts:Asfirmsdonotwishtocompeteon[rice,theonlywaytheycancompeteisbythequalityoftheirproductandtheira\ersalesservice.Thisresultsinahigherstandardofproduct
deliveredtotheconsumer.
3) BenefitsofAdver-sing:Asaformofadver@sing,differentfirms
sponsorspor@ngclubs,chari@esetc.Whenaconsumeravailsoftheseameni@es,theyareincurringabenefitfromNon-PriceCompe@@on.
4) ConsumersaremoreInformed:Asaresultoftheadver@sing
employedbyeacholigopolis@cfirm,consumersbecomemoreinformedabouteachpoten@alproductandassucharebeHerableto
buythegoodthatbestsuitstheirneeds.
5) ConsumerLoyaltyisRewarded:Acertaintypeofcreditcanaccruetothecustomerfromconstantlyshoppinginonebusinessorconstantly
buyingthesamegood.E.g.ClubcardpointsinDunnes
ThelistaboveisthebenefitstoconsumersofNon-PriceCompe@@on.Howeverineverycase,PriceCompe@@onisbeHerfortheconsumer.WewillnowlookatwhyconsumerspreferPriceCompe@@on.
ReasonswhyConsumersPreferPriceCompe--on
1) CheaperPrices:Thefirstandmostimportantaspectofwhy
consumerspreferPriceCompe@@onisthatitensurescheaperprices,resul@nginanincreaseinconsumer’srealincome.
2) GreaterChoice:UnderPriceCompe@@on,nonefficientfirmsare
forcedoutoftheindustry.Assuch,thesepeoplewhofindthemselvesunemployedsearchforanicheinthemarkettogainemployment.
Whentheyfindthisnichetheyeithersetuptheirownfirmorworkin
Non-PriceCompe--on:occurswhenfirmstrytoincreasetheirmarketsharewithoutchangingtheirprice.
JonathanTraynor�17
LCEconomicswww.thebusinessguys.ie©
abusinessthatprovidestheconsumerwithdifferentgoodsgivingthemagreaterchoice.
3) HigherCostsinNon-PriceCompe--on:The“extras”thatareofferedtotheconsumerunderNon-PriceCompe@@oncauseariseinthe
priceofthegoodwhichresultsinareduc@oninconsumer’srealincome.
4) UnwantedExtras:Manyoftheextraoffersthatareincludedwiththe
goodinNon-PriceCompe@@onarenotdesiredbytheconsumerandassuchareofnobenefitthem.
5) ExtrasnotUsed:Consumersfrequentlydonotusethevouchersorgi\tokensthattheyreceiveinNon-PriceCompe@@onandassuchthese“extras”aresomethingthattheconsumerneverreceives.
Objec-vesoftheFirmotherthanProfitMaximisa-on
Uptothispointinourcoursewehaveassumedthatthemainobjec@ve
ofeveryfirmistomaximiseprofits.Inrealitythisisagoodassump@onasitaccuratelyrepresentsthemainobjec@veofthevastmajorityoffirmsopera@ngintheIrisheconomy.However,therearereasonswhyfirms
mightnotwishtomaximiseprofitsandweshallnowlookatthesereasons.
Types of Non-Price Competition
SpecialOffers “X%ExtraFree”
Compe@@ons LocalandNa@onalSponserships
FreeGi\s FreeSamples
Coupons LoyaltyPoints
JonathanTraynor�18
LCEconomicswww.thebusinessguys.ie©
ReasonswhyfirmsmaynotpursueProfitMaximisa-on
or
Objec-vesthatOligopolis-cfirmsmayhaveotherthanProfitMaximisa-on
1) FearofGovernmentInterven-on:FirmsmayfearthatverylargeSuperNormalProfits(SNP)mightaHractgovernmentaHen@onintheformoffurtherregula@onsorincreasedtaxes.Inordertoavoidthis,thefirmsmaydecidetoproduceacertainlevelofoutputotherthanthatlevelofoutputwhichmaximisesprofits.(WhereMC=MRandMCisrising).
2) FearCompe--on:AfirmmayfearthatverylargeSuperNormalProfits(SNP)mightaHractnewfirmsintotheindustry.Topreventthis,thefirmmightengageinLimitPricing,seTngpricessolowinordertodiscouragenewfirmsfromenteringtheindustry.Thefirmsufferslowerprofitsintheshortruninordertogainsustainedprofitsinthelongrun.
3) LessWork:Theownersofthebusinessmayprefertoearnstable/moderatelevelsofprofitsratherthanconstantlystrivingforlargesupernormalprofitsasthisiswhattheyaresa@sfiedwith.
4) LackofIncen-ve:Wherethemanagersarenotownerstheymaytendtowardsamoreconserva@veapproachratherthanadynamicdrivetoprofitmaximisa@on.
5) SalesMaximisa-on:Onceaminimumlevelofprofitisearnedtorewardshareholders,providefundsforreinvestmentetc.thefirmmayconcentrateonmaximisingsales;increasingitsshareofthemarket.Itmaywishtoachieveeconomiesofscale;decreasethelevelofsalesofrivalfirms;becomethemostdominantfirminthemarket.
JonathanTraynor�19
LCEconomicswww.thebusinessguys.ie©
TheBaumolModelofSalesMaximisa-on
Aswesaidintheprevioussec@on,somefirmsmaywishtopursuepoliciesofsalesmaximisa@onratherthanprofitmaximisa@on.Thatis,thefirmwillsetanini@allevelofprofitthattheywishtoearnandsellasmanygoodsaspossibleconsistentwiththislevelofprofit.ThisideawasfirstputforwardbyProfessorWilliamBaumol.Seegraphbelow.
Ifwelookatthegraphabove,weseethatthelinePIrepresentstheini@allevelofprofitsetbythefirm.ThecurvePrepresentstheprofitfunc@on.Atlowlevelsofoutputtheprofitfunc@onrises,showingthatanincreaseinoutputresultsinanincreaseinprofit.(WhereMR>MC).
Theprofitfunc@on/curve,reachesitspeakatquan@tyQMAX.Thisisthemaximumlevelofprofitthatthefirmcanearn.Ifthefirmproducesonelessgoodoronemoregoodthanthisprofitmaximizingquan@ty,afallin
JonathanTraynor�20
Price
Quan@ty
!ProfitCurve(P)
QMAX
PI
Q1 Q2QBE
LCEconomicswww.thebusinessguys.ie©
profitswouldresult.MaximumProfitoccursatthelevelofoutputwhereMC=MRandMCisrising.
Beyondquan@tyQMAX,weseethattheprofitfunc@onstartstofallagain.Showingthatanincreaseinoutputresultsinadecreaseinprofits.(WhereMC>MR).
NOTE:Atverylowlevelsofoutputthefirmissufferingaloss.ThisisduetothefactthatFixedCostsareincurredevenifthefirmproducesnothing.Thefirmdoesnotbreakevenun@lthequan@tyQBE.A\erquan@tyQBEthefirmbeginstoearnaprofit.
Ifwedropaperpendicularlineformwheretheini@alprofitline(PI)cutstheprofitcurve(P);wefindthetwoquan@@esthatthefirmcouldproduceinordertoearntherequiredlevelofprofit.Thesetwoquan@@esoccuratQ1andQ2respec@vely.Ifthefirmistryingtomaximisesales,theywillproducethequan@tyQ2,thisisthelevelofoutputthatearnsthefirmthegreatestmarketshareconsistentwiththeini@allevelofprofit.
Ifthefirmisaprofitmaximiser,theywillproducequan@tyQMAX.
Ifthefirmwishestojustreachtheini@alprofitlevelandisnotconcernedwithprofitmaximisa@onormarketshare,thentheywillproducethequan@tyQ1.
JonathanTraynor�21