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Lecnotes06

# Lecnotes06 - ECON 696 Managerial Economics and Strategy...

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ECON 696: Managerial Economics and Strategy Lecture Notes 6: Competitors and Competition Behaving strategically means knowing who your competitors are and how they will respond to changes in your behavior. This chapter discusses different types of markets, how firms in them behave and the effects of this behavior on profitability. The chapter starts with a discussion about the tricky processes of defining a market and identifying competitors. It also introduces the concept of market concentration. The chapter then discusses the four standard market structures: perfect competition, monopoly, monopolistic competition and oligopoly. Oligopoly includes two types of competition: Cournot or quantity competition and Bertrand or price competition. Finally, the relationship between market structure and profitability is examined. Identifying Competitors and Defining Markets 1. Identifying competitors The text describes pretty clearly what a competitor is, or how you determine whether a particular firm is a competitor. There are two important definitions. The first definition is mathematical and is derived from the formula for elasticity. The usual form for an elasticity calculation is the percentage change in quantity divided by the percentage change in price, which may be written in a variety of ways: 1 2 1 2 1 2 1 2 P P P P Q Q Q Q P P Q Q P % Q % + - + - = = = η In determining whether or not goods are substitutes for each other, you might calculate the percentage change in the quantity of one is divided by the percentage change in the price of the other. This version of elasticity is called the cross price elasticity . If two goods, x and y, are being considered, the cross price elasticity of these may be described either as y x xy P % Q % = η or as

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x y yx P % Q % = η If two goods are substitutes, an increase in the price of one should be accompanied by an increase in the quantity of the other, holding other things constant. As a result, if two goods are substitutes, their cross price elasticity will be positive. The second definition is descriptive and focuses on the characteristics of the product being sold. The book discusses some specifics, but in practical terms, any option that a reasonable consumer is likely to consider when making a purchase is a substitute. This will typically include goods which: serve the same function have similar characteristics (including price) are available in the same general location. The second definition of substitutes is more intuitive and perhaps more useful, but the first is more precise. You might agree that margarine and butter are substitutes, but what about margarine and cooking oil or vegetable shortening? Both may be used for frying, but vegetable shortening is generally not used on toast. If data could be obtained on the prices and quantities sold of margarine and vegetable shortening, a definite answer could be offered as to whether or not they are substitutes by calculating the cross price elasticity.
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Lecnotes06 - ECON 696 Managerial Economics and Strategy...

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