Chapter 12 Managerial Decisions For Firms With Market Power

Chapter 12 Managerial Decisions for Firms with Market Power Market power is the ability of all price setting firms to raise price without losing all sales, which causes the price setting firm’s demand to be downward-sloping. When firms with market power raise price, even though sales do not fall to zero, sales do decrease because of the law of demand. The effect of the change in price on the firm’s sales depends to a large extent on the amount of its market power, which can differ greatly among firms. This chapter show how managers of price-setting firms with downward-sloping demands can choose price, output, and input usage so as to maximize the firm’s profit. The profit maximization rule is to choose price and output so that the revenue from the last unit sold is equal to the marginal cost of producing and selling that unit. Understanding the complexities of decision making when rivals can undermine a planned price change will require the tools of strategic decision making. The major proportion of this chapter is devoted to the theory of monopoly. Monopoly is a firm that produces a good for which there are no close substitutes in a market that other firms are prevented from entering because of a barrier to entry. A monopoly has more market power than any other type of firm. A market consisting of a large number of firms selling a differentiated product with low barriers to entry is called monopolistic competition. Monopoly and monopolistic competition are very different market structures, but firms in both of these market structures possess some degree of market power.

12.1 MEASUREMENT OF MARKET POWER The better the substitutes for the product sold by a firm, the less market power the firm possesses. But there is no single measurement of market power that is totally acceptable.
Market Definition A market definition identifies the producers and products or service types that compete in a particular geographic area, which is just large enough to