Market Structures And Profit Maximization Essay.

Perfect Competition

1. Perfect Competition
It is claimed that the market for various stocks and shares represent Perfect Competition. Using the assumptions used to build the perfect competition model, justify the case that shareholders of BP represent a structure that is almost the same as perfect competition.

2. Perfect Competition
New Zealand egg market represents a perfectly competitive industry where almost all the firms are identical with identical cost structures. The industry consists of many thousands of small farms and a representative firm’s total cost is given by the equation TC = 100 + q2 + q where q is the quantity of output produced by the firm.
Eggs are sold in cartons of 125 one dozen boxes.
The market demand for eggs is given by the equation P = 1000 – 2Q where Q is the market quantity and the market supply is represented by the equation P = 100 + Q.

a. Formulate an equation to illustrate the New Zealand egg market and calculate the equilibrium quantity and price in this market.
b. Victor owns one of the egg farms in Tauranga. The firm’s MC equation is based upon its TC equation and MC = 2q + 1. Given this information and your answer in part (a), derive the firm’s profit maximizing level of production, total revenue, total cost and the profit
c. Evaluate your answer in (b) and justify whether it is short-run or long-run equilibrium. Appraise the firm’s situation in the long run
d. Predict the long-run equilibrium price and quantity that can be achieved for Victor’s egg farm. Support your answer using the theory of the firm. Assume quantity (q) is equal to 10 boxes and Average Total Cost
(ATC) = (100+q2+q)/q 
e. Given the long-run equilibrium price you calculated in part (d), predict the number of egg boxes produced in this market?

3. Perfect Competition  (Shut down point)
a. Evaluate the factors that drive profits to zero in perfectly competitive markets and the incentives that drive the market to a long run equilibrium. 
b. Analyze the following scenarios.
i. a firm choosing to operate at a loss in the short run.
ii. a firm deciding to shut down production in the short run.
c. Evaluate the perfectly competitive market, using a graph to illustrate the short run supply curve. Explain the relationship between the short run supply curve and the scenarios discussed in parts (bi)and (bii)?

4. Monopoly (Profit Maximization)
Ferry Services from Auckland to Waiheke Island in the Auckland Hauraki Gulf and the Waitemata harbour is operated by the Fullers Group of ferries. Since there are no competitors this is an example of a monopoly
Following information is provided about the cost structure of the firm
-The firm’s total cost is given by the equation TC = 100 + Q2 + Q (where Q is the quantity of output (number of trips) produced by the firm).
-The firm’s MC equation is based upon its TC equation is MC = 2Q + 1.
-Market demand for this product is given by the equation P = 1000 – 2Q (where Q is the market quantity).
a. Fullers Ferry Services is a single price monopoly,
i. construct the marginal revenue curve of the firm
ii. illustrate the profit maximizing quantity and price.
b. Using your answer in part (a) estimate the firm’s total revenue, total cost and profit at this profit maximizing price and quantity. Evaluate whether this is a short-run or long- run equilibrium.
c. Analyze the long run situation in this market

5. Monopolistic Competition (Profit Maximization)
a. Using Auckland City’s Café Market as an example, compare and contrast the characteristics of a monopolistically competitive market with that of perfect competition.
b. Demonstrate what happens to the equilibrium price and quantity in such a market if one firm introduces a new, improved product?
c. Justify the monopolistically competitive firm’s demand curve is flatter than the total market demand curve in a monopolistic competition market. 
d. Some experts have argued that there are too many brands of breakfast cereal in the market and signals a situation of inefficiency. Discuss the validity of this statement

6. Oligopoly (Kinked Demand Curve)
a. Airline industry in New Zealand Provide a good example of an Oligopoly. Evaluate the specific characteristics of the oligopoly market and demonstrate the relevance of the ‘kinked demand curve’ principle in oligopoly markets
b. Distinguish and evaluate the reasons as to why the OPEC oil cartel succeeded in raising prices substantially while the CIPEC copper cartel has not? Examine the conditions that are necessary for successful cartelization and outline the organizational problems that have to be overcomebycartel?

1. The shareholders of BP represent a perfectly competitive market structure as the characteristics of the market resembles that of a competitive one. Like perfect competition, there are various buyers and sellers in the share market. The share market has homogeneity of goods. Neither the buyers nor the sellers can influence price of the shares (Fine 2016). The sellers are price takers like competitive firms. All the participants have perfect information knowing their own choice and have information about the product purchased.

2.a. The market demand and market supply equation is given as

 

Market equilibrium is obtained where market demand equals market supply,

Equilibrium price,

Equilibrium price = 400

Equilibrium quantity = 300

b. The marginal cost function of Victor’s egg firm is given as 

Profit maximization condition for firm under perfect competition is

Profit maximization level of production is therefore 199.5

 

Given the cost function the total cost can be obtained as

c. As there is positive profit in the market, it therefore indicates a situation of short run. In the presence of positive profit new firms will enter the industry (Baumol and Blinder 2015). As industry supply increases, price goes down reducing profit. In the long run the firm will earn only normal profit.

d. In the long run, firms operate at the minimum point of average total cost

 The minimization of ATC requires,

 In the long run,

e.

 Therefore, in the market 489.5 units will be produced.

 

3.a. The mechanism of free entry and exit of firms in the competitive market is the main factor driving profit to zero in a perfectly competitive market. Firms in the perfectly competitive market can earn a supernormal profit in the short run. If there are supernormal profit in the short run, then new firms attracted by the higher profit enter the market. As no forms of barriers exist in the market entry of new firms continues. With increasing number of firms, industry supply increases. The increased supply causes a price to fall (McKenzie and Lee 2016). As price lowers, the prospects of economic profit disappear. The new firms continue to enter unless all the profits reduce to zero. Then the firms as well as the industry attains its long run equilibrium.

b.i. The short run operation of firms depends on the position of average variable cost. When firms in the short run incur loss, then price is below the average total cost. Firms can still choose to continue operation as long as price is above its average variable cost. If price is above the average variable cost, then firms after paying its variable can be able to pay some of its variable cost by continuing production. If firms choose to shut down, then it needs to pay all of the fixed costs. On the other hand, by continuing operation firms can use the excess revenue to pay for its fixed factor (Moulin, 2014). This is however a better outcome then shut down operation in the short run. This cannot be continued in the long run. The loss making firms in the long run exit the industry.

New Zealand egg market

ii. If a firm in the short run is unable to recover its variable cost then it chooses to shut down operation. Under this situation continuing production give a worse outcome than simply shut down operation and paid up for fixed factors (Rader 2014). Continuing operation results in more loss of money. It is therefore better to shut down if price is below the minimum of average variable cost.

c. In the perfectly competitive market the short run supply curve is defined as the marginal cost curve lying above the intersection of marginal cost with average variable cost. Above the intersection point the marginal cost curve is rising upward (Stoneman, Bartoloni and Baussola  2018). Firms produce in the short run only when marginal revenue can cover variable costs. This is the situation as described in b)i. When marginal revenue falls short of variable cost then firms shut down operation (situation described in b. ii)

 

Figure 1: Short run supply curve under perfect competition

4.a

i)
Figure 2: Marginal Revenue Curve

ii. The profit maximization condition for monopolist that marginal revenue to be equal to marginal cost.

b.

This is a short run situation in the market. The single price monopolists earn a supernormal profit of 83066.75.

c. Given highly restricted entry in the monopoly market, the single firm can maintain its supernormal profit even in the long run. In the long run however, the monopolist has sufficient time to expand plant size. It is possible for the monopolist to reach to the optimal scale by operating at the minimum point of long run average cost curve (Cowen and Tabarrok 2015). The optimal production cannot be guaranteed by the monopolist. The plant size degree of resource utilization depends on the market demand. the monopolist can reach the optimal scale, or might operate at suboptimal level or might operate beyond the optimum level.

5.a. The Auckland city Café market is an example of monopolistically competitive market. A market structure is defined as perfectly competitive when in the market place numerous buyers and sellers sell similar products. The market structure where numerous sellers sell involve in selling a close substitute is identified as monopolistically competitive. Like perfect competition, in monopolistically competitive market numerous sellers are present and there are no barriers to enter or exit the industry (Nicholson and Snyder 2014). Firms in a monopolistically competitive market sell a differentiated product unlike a homogenous product unlike perfect competition. Each firm in the perfectly competitive market faces a horizontal demand curve for its own product. In contrast, demand curve is downward sloping for monopolistically competitive firms. In both form of market, firms in the long run can have only a normal profit but the point of operation is different. Perfectly competitive firms operate at the minimum of average cost while monopolistically competitive firms operate to the left of minimum average cost.

Monopoly

b. The entry of new firms in a monopolistically competitive market shifts the demand curve of the existing firms inward. This reduces price received by the incumbent firms along with a reduction in quantity sold by each firms. Introduction of new, improved product in the market thus reduces price and sales of existing firms reducing profits.

c. The nature of demand curve that is whether it is flatter or steeper that depends on the elasticity faced by the firm for its product. Firms in the monopolistically competitive market face a higher elasticity for its own product as compared to elasticity of the entire market. The presence of numerous sellers in the market make it easier if buyers to switch to a close substitute product than to shift to a completely differentiated product (Mochrie 2015). This makes monopolistically competitive firm’s demand curve flatter than the total market demand curve in a monopolistically competitive market.

d. In the presence of too many brands in the market makes the market structure monopolistically competitive. Now, with too many brands with each brand having its own perceived demand curve efficiency cannot be achieved firms operate to the left of minimum average cost (Rader 2014). The market for cereals is thus become inefficient as there remain excess capacity in the market.

6. a. A form of imperfectly competitive market that is dominated by few large seller is known as an oligopoly market. Some specific characteristics of oligopoly market are as follows

Interdependence
This is the foremost important feature of an oligopoly market. Each firm follows the strategy of rival firms and thus takes interdependent decision.

Entry Barriers
The few large firms in the oligopolistic industry enjoy a considerable market power and retain its control over prices through maintaining high barriers to entry (Cowen and Tabarrok 2015). The common forms of barriers in the market include ownership over specific resources, patents, high fixed cost and different government restrictions.

Group behavior
Formation of group in the oligopoly market is an important aspect of oligopoly market. Two or more firms form a group and take joint decision in the industry. This type of oligopoly market is known as collusive oligopoly.

Competition
Intense competition exists among the few large firms in the oligopoly market. Each firm observes the strategy of its rivals and then take counter active strategy.

Kinked demand curve and Price rigidity
The model of kinked demand curve in the oligopoly market indicates that each firms in the market faces a demand curve that has a kink at the prevailing market price. When one firm decides to increase price above the market price, buyers shift their demand to the competitors’ product This implies demand is highly price elastic above the prevailing price. Below this price, demand curve is inelastic as lowering price by one firm is followed by others. The kink demand curve makes the marginal revenue curve discontinuous implying price only because of a large change in marginal cost.

b. Cartel is a form of collusive oligopoly where two or more firms collude to take a joint decision regarding industry outcome.OPEC is a cartel formed with majority of oil exporting countries and hence has a control over maximum oil reserves in the world. CIPEC is a cartel of copper and is formed with only 30% copper producing countries. There are three principle reasons explaining the success of OPEC cartel over the CIPEC copper cartel. First, OPEC is a big sized cartel consisting majority of countries. CIPEC on the other hand is a small cartel with minority of copper producing countries (Ashwin, Taylor and Mankiw 2016). Oil having a relatively inelastic demand and supply provides OPEC considerable monopoly power over prices. CIPEC on the other hand faces a relatively elastic supply and demand which reduces monopoly power of the cartel.

Based on the experience of these two cartels, it can be said that successful cartelization depends on two characteristics. In order to manipulate price through formation of cartel requires demand and supply to be relatively inelastic. The cartel should have control over most of the supply. Unless this two conditions hold, any cartel cannot be successfully control the market.

The two organizational problem that a cartel faces include design of price agreement and responsibility division among the cartel members (Rader 2014). The other problem is related to monitoring and enforcement of cartel agreement.

References

Ashwin, A., Taylor, M.P. and Mankiw, N.G., 2016. Business economics. Nelson Education.

Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Cengage Learning.

Cowen, T. and Tabarrok, A., 2015. Modern Principles of Microeconomics. Palgrave Macmillan.

Fine, B., 2016. Microeconomics. University of Chicago Press Economics Books.

McKenzie, R.B. and Lee, D.R., 2016. Microeconomics for MBAs. Cambridge University Press.

Mochrie, R., 2015. Intermediate microeconomics. Palgrave Macmillan.

Moulin, H., 2014. Cooperative microeconomics: a game-theoretic introduction. Princeton University Press.

Nicholson, W. and Snyder, C.M., 2014. Intermediate microeconomics and its application. Cengage Learning.

Rader, T., 2014. Theory of microeconomics. Academic Press.

Stoneman, P., Bartoloni, E. and Baussola, M., 2018. The Microeconomics of Product Innovation. Oxford University Press.