Managerial Economics &
Business Strategy
Chapter 8
Managing in Competitive, Monopolistic,
and Monopolistically Competitive
Markets
Optimal Advertising Decisions
• Advertising is one way for firms with market power to
differentiate their products.
• But, how much should a firm spend on advertising?


Advertise to the point where the additional revenue generated from
advertising equals the additional cost of advertising.
profit-maximizing level of advertising occurs where the advertisingto-sales ratio equals the ratio of the advertising elasticity of demand
to the own-price elasticity of demand.
EQ, A
A

R  EQ, P
Can we do it??
• Number 8
• The elasticity of demand for a firm’s product is -2
and its advertising elasticity of demand is 0.1.


Determine the firm’s optimal advertising-to-sales ratio
If the firm’s revenues are $50,000, what is the profit-maximizing
level of advertising?
EQ , A
A
0.1


 0.05
R  EQ ,P
2
A EQ, A
A
0.1



 A  .05$50, 000  $2,500
R  EQ,P
$50, 000
2
Maximizing Profits: A
Synthesizing Example
• C(Q) = 125 + 4Q2
• Determine the profit-maximizing output and
price, and discuss its implications, if



You are a price taker and other firms charge $40 per unit;
You are a monopolist and the inverse demand for your
product is P = 100 - Q;
You are a monopolistically competitive firm and the inverse
demand for your brand is P = 100 – Q.
Marginal Cost
• C(Q) = 125 + 4Q2,
• So MC = 8Q.
• This is independent of market structure.
Price Taker
• MR = P = $40.
• Set MR = MC.
• 40 = 8Q.
• Q = 5 units.
• Cost of producing 5 units.
• C(Q) = 125 + 4Q2 = 125 + 100 = $225.
• Revenues:
• PQ = (40)(5) = $200.
• Maximum profits of -$25.
• Implications: Expect exit in the long-run.
Monopoly/Monopolistic Competition
• MR = 100 - 2Q (since P = 100 - Q).
• Set MR = MC, or 100 - 2Q = 8Q.



Optimal output: Q = 10.
Optimal price: P = 100 - (10) = $90.
Maximal profits:
• PQ - C(Q) = (90)(10) -(125 + 4(100)) = $375.
• Implications


Monopolist will not face entry (unless patent or other entry
barriers are eliminated).
Monopolistically competitive firm should expect other firms
to clone, so profits will decline over time.
In Summary…
• Firms operating in a perfectly competitive market take
the market price as given.



Produce output where P = MC.
Firms may earn profits or losses in the short run.
… but, in the long run, entry or exit forces profits to zero.
• A monopoly firm, in contrast, can earn persistent
profits provided that source of monopoly power is not
eliminated.
• A monopolistically competitive firm can earn profits
in the short run, but entry by competing brands will
erode these profits over time.
Chapter 8 Homework
Numbers 1, 5, 10, and 13
Chapter 8 Appendix
How does all this
relate to my other
business classes???
Show me the money
• Basic financial statements learned in BE 140
shows a company



Where the money came from
Where the money went
Where the money is now
• Focus on three main financial statements



Balance sheet
Income statement
Cash flow statement
• All of this information WE have been using in
our theory, graphs, and problems
What were those financial
statements?
Balance Sheet
Income Statement
Statement of Cash Flows
Three primary
financial
statements.
We will use a corporation
to describe these
statements.
What were those financial
statements?
Balance Sheet
Income Statement
Statement of Cash Flows
Describes
where the
enterprise
stands at a
specific date.
What were those financial
statements?
Balance Sheet
Income Statement
Statement of Cash Flows
Depicts the
revenue and
expenses for a
designated
period of time.
What were those financial
statements?
Revenues
result in
positive
cash flow.
Expenses
result in
negative
cash flow.
Either in the past, present, or future.
What were those financial
statements?
Balance Sheet
Income Statement
Statement of Cash Flows
Net income (or
net loss) is
simply the
difference
between
revenues and
expenses.
What were those financial
statements?
Balance Sheet
Income Statement
Statement of Cash Flows
Depicts the
ways cash has
changed during
a designated
period of time.
For our purpose…the income
statement is where the money is!!
• Income statement


Years ago…called Profit or Loss statement
“Sexy” portion of the financial statement
• Includes things such as  revenue, net income, earnings per share
• Shows
– How much money a company brought in  Revenue
– How much money the company spent  Costs
– The difference between the two  Profit or Loss
Terms of importance
• Revenue

Proceeds that come from the sale of the product to consumers
• Cost of Goods Sold (COGS)

Cost of production to make the good
• Gross Profit

Revenue – COGS
• Operating Expenses

Administration and marketing expenses not directly connected
to the cost of “producing” the product