ManEconCh07 - MANAGERIAL ECONOMICS: THEORY, APPLICATIONS,...

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MANAGERIAL ECONOMICS: THEORY, APPLICATIONS, AND CASES W. Bruce Allen | Keith Weigelt | Neil Doherty | Edwin Mansfield CHAPTER  7 Monopoly and Monopolistic  Competition
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OBJECTIVES Explain how managers should set price and output  when they have market power With monopoly power, the firm's demand curve is  the market demand curve. A monopolist is the only  seller of a product for which there are no close  substitutes and which is protected by barriers to  entry. Monopolistically competitive firms have market  power based on product differentiation, but  barriers to entry are modest or absent.
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PRICING AND OUTPUT  DECISIONS IN MONOPOLY Example   Demand: P = 10 – Q Total revenue: TR = PQ = 10Q – Q 2 Marginal revenue: MR = 10 – 2Q Total cost: TC = 1 + Q + 0.5Q 2 Marginal cost: MC = 1 + Q MR = 10 – 2Q = 1 + Q = MC => Q = 3 P = 10 – 3 = 7 Profit = Q(P – ATC)
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PRICING AND OUTPUT  DECISIONS IN MONOPOLY Marginal revenue Unlike perfect competition, MR is less than price  and depends on Q. MR = P[1 + (1/ η )] = P[1 – (1/| η |)] = P – P/| η |
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PRICING AND OUTPUT  DECISIONS IN MONOPOLY MR = P[1 + (1/ η )] = P[1 – (1/| η |)] = P – P/| η (Continued) A profit-maximizing monopolist will not produce  where demand is inelastic; that is, where | η | < 1,  because MR < 0. MC = MR = P[1 – (1/| η |)]; so the profit-maximizing  price is
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COST-PLUS PRICING Cost-plus pricing: Simplistic strategy that  guarantees that price is higher than the estimated  average cost    Studies of pricing behavior suggest that many managers  who use cost-plus pricing do not price optimally.  Markup = (Price – Cost)/Cost Price = (Cost)(1 + Markup) Example: Price = 6, Cost = 4, Markup = 0.50
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COST-PLUS PRICING Profit margin: The price of a product minus  its cost Profit margin = Price – Cost
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COST-PLUS PRICING Target Return: What managers hope to earn and  what determines the markup P = L + M + K + (F/Q) + ( π A/Q) L = unit labor cost M = unit material cost K = unit marketing cost F = total fixed costs Q = units to produce A = gross operating assets 2200 π  = desired profit rate (%)
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COST-PLUS PRICING Allocation of indirect cost among products Often done on the basis of average variable costs Example Indirect costs = $3 million Variable costs = $2 million Indirect cost allocation = 3/2 = 150 percent of variable cost. If a product's variable cost is $10, then the allocated indirect 
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ManEconCh07 - MANAGERIAL ECONOMICS: THEORY, APPLICATIONS,...

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