LONG-RUN MARKET PROJECTIONS: EFFECT ON PRICE

MANAGERIAL DECISION MAKING MONOPOLIES & MONOPOLISTICALLY COMPETITIVE FIRMS THE SITUATION You're the manager of a motorcycle manufacturer with engineers who have invented a motorcycle engine called the Hydro-gine. It's a hydro-powered engine that runs on water instead of gas. You're the first to market with this product, and you've got a patent on your design. So, for now, you're the only player in the game. But you know, just as with hybrid and electric engines in the car market, that it won't be long before the competition catches up. To take advantage of your position in the market, you have three primary challenges ahead of you. One, figure out how to maximize your profits while you still have a monopoly. Two, try to maintain your monopoly as long as possible. And three, make sure you have a strategy to compete in the likely event that other firms eventually start competing in this market. UNDERSTANDING THE CRITERIA FOR A MONOPOLY The company is obviously excited by this revolutionary breakthrough, but the Hydro-gine puts you all on unfamiliar ground: you've never had a monopoly on a product, so the marketing and pricing strategy of the Hydro-gine will be different from anything you've done before. You want to make sure everyone is on the same page. You start by outlining what exactly a monopoly is. You are tasked with preparing a PowerPoint presentation for your team that outlines the criteria for a monopoly. Circle the three criteria for a monopoly below that you will present to your team Insurmountable barriers to entering the market Only a few sellers of product Only a few variations of same product No close substitute for product Some barriers to entering the market Single seller of product UNDERSTANDING THE CRITERIA FOR A MONOPOLY: DOES YOUR PRODUCT MEET THE CRITERIA? Use your chosen criterion from above, as the heading for the three boxes below. Now that your team knows the basic criteria for a monopoly, you explain exactly how the Hydro-gine fits. Write the number of each description to its proper criterion; deposit any descriptions that do not fit into the trash 1. 2. 3. 4. 5. Your company is the only one that will be selling a hydro-powered motorcycle engine. The government has provided market subsidies for your product. The Hydro-gine is the only engine that runs on water instead of gasoline or electricity, both of which are far more expensive than water. Research and development are very time-consuming and expensive, and you have a patent on your design. You have the ability to make a few different versions of the engine, so it can be installed in a variety of motorcycles. TRASH DETERMINING THE DEMAND CURVE FOR THE HYDRO-GINE The first thing you need to do is get a general sense of the market demand for the Hydro-gine. Given that you're currently operating as a monopoly, the general demand curve for the Hydro-gine that you draw up for your team looks like one of the graphs below. Select the graph that most accurately shows demand curve you will face. DETERMINING THE DEMAND CURVE FOR THE HYDRO-GINE: MONOPOLY VS. A PERFECTLY COMPETITIVE FIRM You've established for your team what the demand curve will look like as a monopoly. But you want to make sure they understand the difference between this demand curve, with your firm as the single seller, versus the demand curve in a competitive market. In short, you want to make sure they're thinking in monopolistic terms. You ask them, "How is this demand curve different from what we would face if we were a perfectly competitive firm?" How should they respond? MARGINAL REVENUE IN RELATION TO DEMAND Adding to your demand curve, you draw in what the marginal revenue might look like: Sasha, one of the newer managers on your team, looks puzzled. She spent time in the agricultural industry, in which markets are perfectly competitive. She asks, "In agriculture, price typically equals marginal revenue. Why isn't that the case here?" How do you respond to Sasha's question? DETERMINING PROFIT-MAXIMIZING OUTPUT AND PRICE: SOLVING FOR PRICE The market research firm you hired provides you with the market demand for a hydro-engine. They've tried to keep things as simple as possible for you and created a linear demand equation, where Qd is the number of motorcycles demanded per year: Qd = 10,000 - 0.5P Due to the mechanization of your production process, your marginal cost per engine is a constant $2,000 per engine. Solve this demand curve for P (inverse demand). DETERMINING PROFIT-MAXIMIZING OUTPUT AND PRICE: MARGINAL REVENUE FUNCTION What is the marginal revenue function corresponding to this demand curve? DETERMINING PROFIT-MAXIMIZING OUTPUT AND PRICE: QUANTITY You've spent millions creating a state-of-the-art production line that helps keep your labor costs down. The annual fixed costs of your operation are $4,000,000. The marginal cost of producing every engine is $2,000 per engine with your current production line. Given these numbers and the demand and marginal revenue for your engine, how many engines should you produce? DETERMINING PROFIT-MAXIMIZING OUTPUT AND PRICE: PRICE Given this level of output, what price should you charge for each of your engines? PRICE ELASTICITY OF DEMAND What is the price elasticity of demand at your profit-maximizing price? (HINT: Point elasticity) DETERMINING ECONOMIC PROFIT Now you and your team have to determine how much economic profit you will make this year at your current quantity and price. Calculate total revenues, total costs, and the amount of annual profit. PROTECTING THE MONOPOLY BY ERECTING BARRIERS TO ENTRY Now that you've come up with a profit-maximization strategy, you want to make sure that you protect your monopoly for as long as possible. Your team provides you with some options to block competitors from entering the market. Rank them in terms of how effective they may be. Rank the options 1 - 3, 'Most to Least Effective' Try to control vital inputs to the hydro-engine, such as the metals used to construct it. Continue to protect existing patents, trade secrets, and trademarks for the Hydro-gine. Lobby the government to increase licensing fees and regulations for new hydro-powered engine technologies. ADAPTING TO MONOPOLISTIC COMPETITION For years, your firm was able to protect its monopoly of the Hydro-gine, but over time, some other big firms were able to crack the market, and now there are many firms competing in the hydro-engine market. Each of your competitors is making its similar version of your pioneering engine. You've made pricing strategy adjustments over the years, but now it's time to fully reassess your plan for moving forward in this new market. Some new managers have come on board recently, and you want to be sure that they fully understand the parameters of monopolistic competition. Of the following, circle the three parameters defining monopolistic competition that you will be discussing. Single seller of product Many sellers of product No barriers to entering the market Firms make variations of same product No close substitute for product Insurmountable barriers to entering the market SHORT-TERM PROFIT MAXIMIZATION Because yours was the first such engine to exist, and you've spent some money in the past on advertising and branding, you can still charge a price above marginal cost, but the days of monopoly profits are behind you. Now that you have your team oriented to this new competitive market, you need to figure out how to maximize profits in the short term. Your market research company has revised the demand to be the demand for your company's Hydro-gine, not the overall market demand for motorcycle engines that run on water, as Qd = 8,000 - 0.8P You've correctly determined that the associated MR function is MR = 10,000 - 2.5Q. Your fixed cost has not changedit's still $4 million. Your marginal cost also has not changed; it's still $2,000 per engine, so you have calculated that MR = MC at a quantity of 3,200 engines per year. These engines, however, now sell for a price of only $6,000. How much is your economic profit this year? LONG-RUN MARKET PROJECTIONS: MARKET ENTRY You've established your short-term goals, but you want to make sure everyone on your team is also thinking about the long run. The market has already changed dramatically since the Hydro-gine was introduced, and it will continue to change. You want to make sure to anticipate as much as you can so that you can continue to operate efficiently and maximize profitability. In order to present this long-term vision for your team, you need to assess the market for yourself first. You ask yourself a series of core questions, the first of which is: Are more firms likely to enter the market, or are firms likely to leave the market? Briefly explain. LONG-RUN MARKET PROJECTIONS: EFFECT ON OUTPUT Over time, will the total market output increase, decrease, or remain unchanged? Briefly explain. LONG-RUN MARKET PROJECTIONS: EFFECT ON INPUT Based on how you expect these long-run changes to affect your production in the future, how should you change the number of inputs you will order in the future? Briefly explain. 1. Increase 2. Decrease 3. Remain unchanged LONG-RUN MARKET PROJECTIONS: EFFECT ON PRICE Now you need to consider how your price should change in the future. Based on the long-run market adjustments, how should you change your price for the Hydro-gine over time? Briefly explain. 1. Increase 2. Decrease 3. Remain unchanged LONG-RUN MARKET PROJECTIONS: EFFECT ON PROFIT Will the economic profit you earn for the Hydro-gine be likely to increase, decrease, or remain unchanged over time? Briefly explain