Fatur Mulya Muis

29319068 – Entrée 17
Business Economics | Home Assignments
All assignments are related to Chapters 8 and 9 of the textbook by Keith and Young.

 ASSIGNMENTS 1
Please explain what is in “the Situation” and in “the Solution” of Chapters 8 & 9:

Chapter 8
The situation: The new beverage (Water pure) need a product manager but the new product to
market should be given to a seasoned manager with a proven record of accomplishments. The
first tasks that should pursue is an analysis of the optimal price of this beverage and know what
price we should charge to maximize profit in this new venture. The Management Committee has
the final say on the price of the new beverage, pricing is a very useful exercise because it forces
one to bring together all the different elements of the business. The market research will provide
you with a quantitative estimate of the demand. The general competitive analysis of the entire
beverage industry. Our production people and cost accountants will give you the cost estimates
to put a suitable price for Water pure.

The solution:
 The weekly demand for the firm’s energy drink was estimated to be:
Qd =2000−1000 p
Q d = Quantity of 12 ounce plastic bottles
P = Price per container

 Based on estimates provided by the bottling plant, Frank expressed the cost function as
TC = 150 + 0.25Q
TC = Total cost per week
Q = Output of 12 ounces plastic bottles

 Optimal price on basis of MR=MC, expressing in terms of price

P = 2 – 0.0001Q

 Substitute equation to get total revenue substitute equation (TR= P x Q) to get total revenue
TR=2q−0.0001 q 2
 Find Marginal Revenue
dTR
MR= =2−0.002Q
dQ
2−0.002Q=0.25
Q∗¿ 875 ( 875.000units per weeks )
P=2−0.001 ( 875 )
P∗¿1.125
¿ $ 1.10(rounding¿the nearest 10 cents)

 Estimate weekly profit

Although Frank Realized that he

had the optimal price for “Go-
nuts”, he also knew that there
were already companies with
established energy drinks in the
market that were selling for
about $ 1.25 a bottle

Chapter 9
The situation: Regarding about the price analysis, the concern to know optimal price. Then
needed further research to know how the reaction of competitor when launch the product. One
thing to complete list of prices the major brands as well as the smaller brands. Other key
information that we could use in making our pricing decision is the perception of our products by
potential consumers and their view of how much value our product provides them relative to our
price.

The solution:
The average price of the major national brands was $ 1.25. Recommended selling Water pure for
$ 1.00 instead of the $ 1.10 suggested based MR=MC analysis. But, if set the price at $ 1.00 and
decide to raise it $ 1.25 after it gains customer acceptance, they may not go along with the
increase. It makes use promotion and advertising more than price to build the brand in the
marketplace. So, for avoid to trigger the price war and other losses the price match $ 1.25. The
important thing also demand is based on the customer perception of value and price. Use
advertising and promotion to support the price of $ 1.25, that’s going to be the key of success
 ASSIGNMENTS 2
Please make a summary in writing of Chapters 8 and 9.

Chapter 8: Pricing and Output Decision: Perfect Competition and Monopoly

4 Basic Types of Markets

The pricing and output decision will actually be answered within the framework of
four basic types of markets: perfect competition, monopoly, monopolistic competition, and
oligopoly. The distinguishing characteristics of each of the four basic market types are presented
below:

Perfect competition and monopoly can be considered the two extreme market environments
in which a firm competes in terms of market power. Market power is simply the power of a
firm
to establish the price of its products. In perfect competition, there are so many sellers
offering the same product that an individual firm has virtually no control over the price
of its product. Moreover, there is no way for a particular firm to charge a higher price
than its competitors because everyone sells a standardized product. Instead, the interaction of
supply and demand decides the price for all participants in this type of market
structure. A firm in this market has no market power and acts only as a price taker.
In direct contrast to firms in perfect competition, the monopoly firm has a
considerable amount of market power. Because it is the only seller in this type of market, it has
the power to establish the price at whatever level it wants, subject to possible
constraints such as government regulation. It is the consummate price maker.

Key Assumptions of the Perfectly Competitive Market

Let us summarize the key assumptions made in analyzing the firm’s output decision in perfect
competition.

1. The firm operates in a perfectly competitive market and therefore is a price taker.

2. The firm makes the distinction between the short run and the long run.

3. The firm’s objective is to maximize its profit in the short run. If it cannot earn a profit, then it
seeks to minimize its loss. (See Chapter 2 for a review of the goals of a firm.)

4. The firm includes its opportunity cost of operating in a particular market as part of its total
cost of production.

For the economic analysis of a firm’s output and pricing decisions to have a unique solution, the
firm must establish a single, clear-cut objective. This objective is the maximization of profit in
the short run. If the firm has other objectives, such as the maximization of revenue in the short
run, the output that it would select would differ from the one based on this model.

A statement of the projected cost of operating in the first year follows.

To keep this example as simple as possible, we did not include depreciation and taxes.
Suppose this budding entrepreneur forecasts revenue to be $500,000 in the first year of
operation. From an accounting standpoint, her profit would be $50,000 ($500,000 2 $450,000).
But from an economic standpoint, her profit would be zero because the revenue would just equal
her total economic cost. Certainly, there would be nothing wrong with “breaking even” in the
economic sense of the term because this indicates that the firm’s revenue is sufficient to cover
both its out-of-pocket expense and its opportunity cost. Another way to view this situation is to
note that when a firm “breaks even” in the economic sense, it is actually earning an accounting
profit equal to its opportunity cost. In other words, if this entrepreneur’s annual revenue is
$500,000, she will earn an accounting profit that offsets the opportunity cost of going into
business for herself. In economic terms, she would be earning a normal profit.

The reason for using the term normal can be seen in situations in which the entrepreneur’s
revenue is higher or lower than $500,000. Suppose her revenue is $550,000. In this case, she will
earn a profit of $50,000 ($550,000 2 $500,000). We refer to this sum as “above normal,” “pure,”
or economic profit because it represents an amount in excess of the out-of-pocket cost plus the
opportunity cost of running the business.

Table 8.1 Normal Profit, Economic Profit, and Economic Loss

In the case where revenue is less than economic cost, clearly a loss is incurred. However, this
economic loss might well coincide with a firm earning an accounting profit. For example,
suppose our entrepreneur’s revenue is $480,000. The economic loss would be $20,000 ($480,000
2 $500,000), but the accounting profit would be $30,000 ($480,000 2 $450,000). Table 8.1
summarizes the three scenarios discussed previously.

Economic Profit, Normal Profit, Loss, and Shutdown

The preceding example assumed the market price was high enough for the firm to earn an
economic profit by following the MR 5 MC rule. Tables 8.6 and 8.7 and Figure 8.6 demonstrate
these possibilities.

The situation depicted in Table 8.7 and Figure 8.6b indicates a loss for the firm. Does this mean
that the firm should not be in this market? As you know, in the short run, the firm must bear
certain fixed costs regardless of the level of its output. Using the data in Table 8.7, if the firm
were to shut down its operations (i.e., if Q 5 0), it would still have a fixed cost of $100. Given the
market price of $58, we know that the best that a firm can do is to follow the MR 5 MC rule,
produce 5 units of output, and lose $72.50. But if the firm were to shut down, it would lose $100
because this is the amount of fixed cost that it would incur, whether or not it operates in the short
run. Therefore, with a market price of $58, it would be better for a firm to operate at a loss than
to cease its activities in this market. This is illustrated in Figure 8.7a. Another way to understand
this rationale is to compare the firm’s total revenue at the $58 price with its total variable cost,
assuming a production level of 5 units. The total revenue is $290 (P 3 Q), and the total variable
cost is $262.50 (Q 3 AVC). Clearly, this revenue is sufficient to cover the firm’s total variable
cost.

Table 8.6 Using Marginal Revenue (or Price) and Marginal Cost to Determine Optimal Output:
The Case of Normal Profit

Table 8.7 Using Marginal Revenue (or Price) and Marginal Cost to Determine Optimal Output:
The Case of Economic Loss
Figure 8.6 Normal Profit (a Using Table 8.6) and Economic Loss (b Using Table 8.7)

By literally following the MR 5 MC rule, the firm would be led to produce 3 units of output. But
we can see that at this level, the total revenue of $150 ($50 3 3) would not even be enough to
cover the firm’s total variable cost of $153.90 ($51.30 3 3), resulting in a negative contribution
margin of $3.90. Looking at this situation in terms of the firm’s loss versus its fixed cost, we can
see that its total loss of $103.90 is clearly greater than the fixed cost of $100 that it would incur if
it decided to shut down its operations. (As you can see, the firm’s loss is the combination of its
fixed cost and negative contribution margin.) Thus, given the market price of $50, the firm
would be better off by shutting down its operations. This is illustrated in Figure 8.7b.
Figure 8.7 Contribution Margin

Also shown in this figure is what economists refer to as the shutdown point. At this point, the
market price is at a level in which a firm following the MR 5 MC rule would lose an amount just
equal to its fixed cost of production.

In conclusion: In a competitive market, the firm’s short-run supply curve is its MC curve subject
to two caveats. The firm maximizes profits or minimizes losses by supplying at P 5 MC along the
positively sloped part of its MC curve if P  minimum AVC. If P , minimum AVC, then the firm
should shut down (set Q 5 0) in the short run.

The Competitive Market in the Long Run

The entry of firms shifts the supply curve to the right, driving down market price. The exiting of
firms shifts the supply curve to the left, placing upward pressure on market price. A firm’s
motivation to go into or get out of the market can now be examined in greater detail. There is
only one price at which firms neither enter nor leave the market. This, of course, is the price that
results in normal profits. The longrun process of entering and exiting firms is illustrated in Figure
8.8.

Figure 8.8a shows a hypothetical short-run situation in which the price (determined by supply
and demand) is high enough to enable a typical firm competing in this market to earn economic
profit.

Figure 8.8b shows the opposite case, in which a short-run loss incurred by firms in the market
causes firms in the long run to leave the market. This causes price to rise toward the level in
which the remaining firms would earn a normal profit.
Figure 8.8 Long-Run Effect of Firms Entering (a) or Exiting (b) the Market

An understanding of the conditions motivating market entry or exit over the long run should lead
the firms to consider the following points:

1. The earlier the firm enters a market, the better its chances of earning above-normal profit
(assuming a strong demand in this market).

2. As new firms enter the market, firms that want to survive and perhaps thrive must find ways to
produce at the lowest possible cost, or at least at cost levels below those of their competitors.

3. Firms that find themselves unable to compete on the basis of cost might want to try competing
on the basis of product differentiation instead, although this is extremely difficult in this type of
market.

PRICING AND OUTPUT DECISIONS IN MONOPOLY MARKETS

A monopoly market consists of one firm. The firm is the market. In conclusion, the firm that
exercises a monopoly power over its price should not set its price at the highest possible level.
Instead, it should set it at the right level. And what is this “right” level? It is the level that results
in MR 5 MC. To see how the MR 5 MC rule applies to the monopolist, see Table 8.8. Note that
the table presents only the cost data relevant to this example. For purposes of comparison, the
same cost figures used in the previous section for the perfectly competitive firm have been
selected.3 But in this case, we assume the firm is the “only game in town.” Note that the price is
not equal to the marginal revenue because the firm is a price setter and not a price taker. Its
demand schedule consists of columns 1 and 2, and the total revenue and marginal revenue
schedules are those that normally accompany a downward-sloping demand curve.

Figure 8.9 Marginal Loss in Profit from Failing to Produce at MR 5 MC

Figure 8.10 Increasing Marginal Costs in Relation to Decreasing Marginal Revenue

Table 8.8 Using Marginal Revenue and Marginal Cost to Determine Optimal Price and Output:
The Case of Monopoly

Starting from the zero output level, let us consider the price, output, marginal revenue, marginal
cost, and marginal profit as additional units of output are produced. In a perfectly competitive
market, the short-run economic profit enjoyed by the monopoly firm in this example would be
vulnerable in the long run to the entry of other firms wanting to earn similar amounts of profit.

Figure 8.11 Graphical Depiction of MR 5 MC Rule for a Monopoly Using Table 8.8

As you can see, by charging $90 for its product, the firm will receive the maximum total revenue
of $810. You can also see that this revenue-maximizing price is lower than the one that
maximizes the firm’s total profit (i.e., $90 , $120).
Figure 8.12 Relationship Between Profit Maximizing and Revenue Maximizing Price and
Quantity

THE IMPLICATIONS OF PERFECT COMPETITION AND MONOPOLY FOR

MANAGERIAL DECISION MAKING

Consideration for manager in making decisions:

Chapter 9: Pricing and Output Decision: Perfect Competition and Monopoly
In this chapter, we examine in detail the pricing and output decisions made by managers
in monopolistic competition and oligopoly. Economists also label these markets imperfect
competition. This is in reference to their relative market power, which you will recall is the
economist’s main criterion for determining the degree of competition. Perfect competition is, as
its name signifies, “perfect” because firms have no market power whatsoever. Monopoly is not
competitive because the single firm in the market has absolute market power. Monopolistic
competition and oligopoly are considered. “Imperfect” competition because firms in these
markets have the power to set their prices within the limits of certain constraints. This power and
these constraints are principal subjects of this chapter.
Monopolistic Competition
Monopolistic competition is a market in which there are many firms and relatively easy entry.
These two characteristics are very similar to those of perfect competition. What enables firms to
set their prices (i.e., to be monopolistic) is product differentiation. By somehow convincing their
customers that what they are selling is not the same as the offerings of other firms in the market,
a monopolistic competitor is able to set its price at a level that is higher than the price established
by the forces of supply and demand under conditions of perfect competition.
Monopolistic Competition. The view of a representative firm in a differentiated product market
with free entry and exit.
 First, there will be profit in the short amount time (Short-run profits). Then, competitors
come to market and there will be some loss in the short amount of time (Short-run losses).
Then after many competitors entering the market in the long run there will be show the
curve as Figure (c) below.
Oligopoly
Oligopoly is a market dominated by a relatively small number of large firms. The products they
sell may be either standardized or differentiated. Part of the control that firms in oligopoly
markets exercise over price and output stems from their ability to differentiate their products.
The action of any one firm will have an impact on all of other players in the market.
Pricing in Oligopolistic Market: Rivalry and mutual interdependence among firms in this
market means that each firm keeps an eye on everyone else. Trying not only anticipates moves
but also to have their own reaction plan in place.
Herfindahl-Hirschman Index (HH) is a commonly accepted measure of market concentration.
It is calculated by squaring the market share of each firm competing in a market and the
summing the resulting numbers. It can range from close to zero to 10,000. The formula shows
below:

Kinked Demand Curve model. The basic assumption of the Sweezy model is that a competitor
(or competitors) will follow a price decrease but will not make a change in reaction to a price
increase. The Kinked Demand Curve shows below:

If a firm lowers its price, this may have an immediate impact on the competition. This firm takes
its action to increase sales by drawing customers away from the higher-priced competitors, but
when competitors realize what is happening (i.e., their sales are declining), they will quickly
follow the price cut to maintain their market share. If this firm undertakes the opposite action—a
price increase—incorrectly assuming competitors will follow suit, its sales will drop markedly if
competitors fail to do so.

Competing in Imperfectly Competitive Markets

Non Price Competition
Non price determinants of demand include any factor that causes the demand curve to shift. They
are (1) tastes and preferences, (2) income, (3) prices of substitutes and complements, (4) number
of buyers, and (5) future expectations of buyers about product price.

Strategy and the Ideas of Michael Porter

Five Forces model, illustrates the various factors that affect the ability of any firm in the industry
to earn a profit and to know how attractive the industry.
 ASSIGNMENTS 3
In Chapter 8, there are 2 cases ("GM decides smaller is better" and "Break Even Analysis at
Lockheed and Airbus").
In Chapter 9, there are 3 cases ("Globalization of Pharmaceutical Industry", "The
brutalization of the market of bluefin tuna and "Price Discrimination by Can-Edison")
For each case, please answer the following questions in writing.
1. What are the problems in this case?
2. What is the solution that you will recommend in order to solve these problems described in the
case?
3. Any special and personal comments you want to make about the case?

Chapter 8
Case 1: General Motor decides smaller is better
1. The problem in this case is wrong decision to reorganize the company on a large scale so
that it loses its market share and defeated by competitors in the market
2. General Motor, which is a company in the oligopoly market, should take a steps to keep
optimizing production but improve the quality of human resources especially in the sales
division according to the problem in that case. Then, start thinking about making production
cost efficient by investing in technology.
3. Competition in this industry now is hardly to compete companies like Toyota and Honda
which manufactures product to meet all segments

Case 2: Breakeven analysis for Lockheed’s, Tri-Star and Europe airbus industries
1. The problem in this case is because the calculation of estimated breakeven sales is not yet
detailed. That is because the company not include among fixed costs, the cost of developing
the technology, and construction facilities to build the aircraft.
2. Conducted a complete calculation including the costs incurred both fixed costs and variable
costs and also know the market conditions and projected needs of the product, so that
investment feasibility assessments can be carried out and determine even more realistic and
accurate break-even points
3. It takes a highly skilled person to make projections in the industry looking at the many
variables that must be taken into account
Chapter 9
Case 1: The Globalization of the Pharmaceutical Industry
1. The problem with this case is that’s company merger causes a small profit margin and face
strong competition from generic drugs and also in this industry heavily monitored by the
government and lawsuits.
2. Companies before merging should take into account several mutually beneficial agreements.
And also because this industry is an important requirement for everyone, therefore there
must be some policy protection from the government.
3. Pharmaceutical companies are companies that provide important needs for everyone and
should also be considered by the government and if necessary synergy with the government
in meeting the needs of society for example such as Bio Farma and Kimia Farma in
Indonesia.

Case 2: The Brutal Economics of the Market for Bluefin Tuna

1. The problem in this case caused there many Sushi Restaurant around the world and the most
important raw material needs of the restaurant is variants of Tuna including bleufin tuna , So
the demand of Bluefin tuna is high and the market price for Bluefin tuna is skyrocketing.
2. Sushi restaurants in facing this challenge must provide alternative menu that preferred by
consumer beside tuna species. So, the dependence on these raw materials can be minimized.
3. Instance like Sushi Tei Restaurant. Although the signature of the restaurant sells sushi, it
also provides alternative menus such as chicken, ramen noodles

Case 3: Price Discrimination by Con Edison

1. The practice of price discrimination by Con Edison causes unhealthy competition between
companies. Because operational costs incurred by large companies are less so they can
reduce prices and triggered price war
2. The government must implement regulations that are appropriate to its business category
and eliminate price discrimination
3. Based on my opinion, it should be a small-medium business that get some relief and
tolerance to able compete in the industry and growing/scale up the business. Certainly
because of some consideration.