In economic theory, a monopolist would determine the price and output that would maximise his profits. Discuss whether firms in the real world would always set prices at profit-maximising levels. [25]

This essay argues that, while according to economic theory, a rational monopolist would set MC = MR to maximise his profits, in the real world, firms sometimes do not want to maximise their profits because they sometimes have alternative aims like revenue maximisation, or are often unable to because of imperfect information and bounded rationality and depend on "rules of thumb" like cost-plus pricing.

On the one hand, a monopolist would rationally seek to maximise profits, using the MC = MR rule, or the profit maximisation rule (also known as the marginalist way or principle). A monopoly is defined as one dominant firm that produces a unique good with no close substitutes, for instance, De Beers in terms of diamonds or Microsoft in terms of the software that it produces. The market structure that a monopolist faces generally has very high barriers to entry, either in terms of natural barriers to entry like large economies of scale, or man-made barriers to entry like powerful legislation and patent rights, price setting power due to the large market share commanded by the monopolist, and often imperfect information exists in the market, just like it does in software and high capital-intensive technologies.

On the other hand, in the real world, firms often do not want to maximise profits. They may want to maximise their growth or revenue instead of profits. 

To maximise their growth and expansion, they could produce where AR = 0, which would maximise output, so as to extend their lead in the market and would thus promote the growth of their firm. 

To maximise revenue, firms could easily produce where MR = 0. This economic theory is particularly interesting. According to the famous economist William Baumol, if the aim of a firm is to maximise its sales instead of profits, one possibility is that it would produce where MR = 0. This is due to the issue of the division between ownership and control of a firm. With the separation of ownership and control in modern corporations, the issue is that managers of a firm, like the Chief Executive Officer or Managing Director, may seek prestige and higher salaries by trying to expand sales even if it were at the expense of profits, which would be shareholders’ interests. According to Baumol and Williamson, managers may seek to maximise their own utility rather than profit-maximise, which would benefit the firm. And according to Bearle and Means, the ownership of companies is spread out over a large number of shareholders with little individual power, while control and decision-making is in the hands of a few managers. 

However, some firms would aim to maximise their revenues but this would still be subject to "satisficing" – which means to reach at least a minimum level of profit, but a level which is lower than pure profit maximisation.

Another reason why firms may not maximise profits is that they are unable to do so, even if they are willing. According to Herbert Simon, decision makers face the situation of imperfect information and have to make decisions under uncertainty in the real world. Even though they may be rational or try to be, they eventually use what is known as “bounded rationality”, and therefore make decisions using the information that is available to them. Using Simon’s theory of bounded rationality necessitating satisficing, Cyert and March argued that real world firms aim for satisficing behaviour and even found empirical data to support their view. 

One alternative way of making pricing and output decisions is to use cost-plus pricing, which is basically to take P = AC + a mark up, which is why this method is called cost-plus pricing. Hall and Hitch would agree, as they argued that company executives often make decisions using “rules of thumb” rather than the marginalist way of MC = MR.

In conclusion, to a large extent firms in the real world do not aim at profit maximisation in the sense that they set MC = MR, and often are unwilling or unable to set MC = MR. They often operate under conditions of imperfect information and make bounded rational decisions, and may often use cost-plus pricing. However, to a large extent, firms that do not care at all about profits would not survive in the long run, and it is not a far stretch of the imagination to say that either by luck or by skill, in the long run, all firms would approximately reach a level of pricing and output that is profit maximising because firms that did not make profits would not have survived in the long run against their more rational and efficient competitors.

Economics Tutor's Comment - This is an excellent effort for the A levels that answers the economics question comprehensively. Also, the use of economic theory is very strong in this economics essay. Do think of which economics diagrams are needed to be drawn and explained in this essay to make it an even stronger paper that supports your case that you are making. Thank you for reading, and cheers.

JC Economics Essays - This useful and relevant economics essays site can help students studying economics do well at the A-Levels (Cambridge, A1/S, A2, H1/H2/H3 levels), and the international AS level economics examinations. IB students can also benefit from the top-quality economics content here. This economics website contributes useful economics content, lesson materials, examination tips and techniques, and model economics essays that students in both Singapore and the UK, as well as also all around the world, can use to excel in economics.

This excellent economics essay was jointly written and contributed by both SS and WT, the first, our editor of JC Economics Essays, and the second, our resident Economics expert who helps students understand the beauty of Economics and its applications in real life. (Some of the economics content for alternative theories of the firm was also learnt from economics modules/lessons at the University of Manchester - Business Economics in 2008.) Thank you for reading and cheers! 

Explain how, according to economic theory, a monopolist would determine the price and output that would maximise his profits. [8]

This essay explains how a rational monopolist would determine the price and output that would maximise his profits. A monopoly is defined as one dominant firm in a market that produces a unique good with no close substitutes, for instance, De Beers in terms of the diamond market or Microsoft in terms of software. The market structure that a monopolist faces generally has high barriers to entry, either in terms of natural or man-made barriers to entry, price setting power where the monopolist would set price and take the resulting output or set output and take the resulting price, and often imperfect information exists in the market. 

A profit maximising firm, not just a monopoly, would set its pricing and output decisions where MC = MR, the profit maximising rule or loss minimising rule. 

[What economics diagram would you draw here? And how would you explain this economics diagram? Economics tutor’s hint – draw a monopoly diagram and be careful to explain how this diagram answers the question posed.]

According to the diagram, the monopolist will set price and output at MC = MR, and the P > AC, thus earning the monopolist supernormal profits. The optimal price would be P* and the optimal output would be Q*, and the shaded area would be the supernormal profits generated from setting MC = MR. 

In conclusion, according to economic theory, rational firms which want to maximise their profits will set MC = MR and a monopolist is no exception. 

Economics Tutor's Comment - This is an excellent explanation for how the monopolist maximises his profits. It was based on an actual question set for the Economics at A levels. Also, the use of economic theory is strong in this economics essay, but the real question is: how could the theory be used even better with real world examples for each point to illustrate the context? Thank you for reading, and cheers. 

JC Economics Essays - This economics essays site is useful, accessible, and relevant for students studying economics, especially students taking the A-Levels (Cambridge, A1/S, A2, H1/H2 levels), and the international AS level economics examinations. And IB students can also benefit from the top-quality economics content in JC Economics Essays. This economics blog provides a range of useful economics content, materials, examination tips and techniques, and model essays that students in Singapore and the United Kingdom, as well as all around the world, can use to excel in their economics examinations. 

This top-quality model essay with sample comments was contributed by WT, our resident Economics expert who helps students understand the beauty of Economics and its applications in real life. WT has a strong interest in Econometrics, Economic History, International Trade, and Game Theory, especially applications to real life. This economics post was edited by S. S., the editor of JC Economics Essays. Thank you for reading. 

Explain how the different features of monopolistic competition and oligopoly affect price and output determination in these market structures. [10]

This is a special contribution by WY in response to the ‘A’ Level H2 Economics November 2011, Essay Question 3 on monopolistic competition and oligopoly

This paper explains how the characteristics of the monopolistic competition and oligopoly firms account for their levels of price and output. There are five main characteristics which serve as assumptions for these two market structures. They include the number of buyers and sellers in the market, type of product sold, level of barriers to entry, price setting ability of the firms, and information level. These traits of each market structure would determine what level of price and output they produce at.

A monopolistic competitive firm refers to a firm that sells a slightly differentiated product with many close substitutes, in a market with many buyers and sellers, with relatively low barriers to entry and exit of the market, and imperfect information in the market. We take each of the features to be explained in turn. Product differentiation can be based on real or imaginary differences. Real differences mean that the product is actually different in terms of its design, composition of materials, and substance. Imaginary differences, on the other hand, mean that the product is perceived to be different, due to persuasive advertising, branding, and marketing differences, which create a psychological difference. Monopolistic competitive firms are price setters, but have limited price setting ability due to the presence of many other competitors in the market selling differentiated but similar products.

What economics diagram would you draw here, and why?

According to the diagram, a profit maximising monopolistic competitive firm would produce at marginal cost (MC) = marginal revenue (MR), at price P and output level Q. In the short run, the firm could earn supernormal profits as long as average cost (AC) is below P. However, in the long run, because of the relatively low barriers of entry and exit of the market, the supernormal profits of the short run would be competed away due to many competitors entering the market. Therefore in the long run, monopolistic competitive firms earn normal profits.

A monopolistic competitive firm operates in a market with many buyers and sellers. Barriers to entry refers to any man-made or natural barriers to entry which are strong enough to prevent new rival firms from competing on an equal basis with existing firms, and prevent these firms from entering or exiting the industry. There are two types of barriers to entry, namely natural and artificial barriers to entry. Natural barriers to entry refer to barriers which are intrinsic to the industry, such as economies of scale. Artificial barriers to entry refer to laws, legislations, patents, and other obstacles to entering or exiting an industry, and are not intrinsic to an industry itself. Low barriers to entry and exit of a monopolistic competitive industry also allows potential entrepreneurs to capitalise profitable opportunities by providing easy access into the market, resulting in the presence of many sellers in the market. These conditions – many buyers and sellers in the market, low barriers to entry and firms selling slightly differentiated product – coupled with imperfect information in the market allows for  monopolistic competitive to have limited price setting ability. 

An illustration of monopolistic competitive firms would be chicken rice stalls located in the multitude of food courts and coffee shops in Singapore. There are many consumers of chicken rice and many chicken rice sellers, each selling a slightly differentiated form of chicken rice – Hainanese chicken rice, and lemon chicken rice, for instance. Low barriers to entry exist because of the relatively low rental and start-up costs of chicken rice stalls in coffee shops, as compared to those of restaurants, which would have to spend relatively more to hire more qualified employees such as chiefs and waiters for instance. Imperfect information could be illustrated in the form of special recipes withheld by different stall owners, and this coupled with the abovementioned conditions, allows for each chicken rice stall to have small market power and thus some degree of price setting ability. These conditions together, results in monopolistic competitive firms producing at MC=MR, at price P and output level Q and earning normal profits in the long run.

On the other hand, an oligopoly refers to a firm that sells either a homogenous or differentiated product depending on the particular or specific industry, in a market with many buyers but relatively few sellers, each mutually interdependent on each other, with relatively high barriers to entry and exit of the market, and imperfect information in the market. Due to the high barriers to entry and market power of the firms, oligopolies are price setters with high degree of pricing power. Mutual interdependence means that each of the firm in a oligopolistic industry will take into account each other’s price and non-price behaviour when making their strategies. This strategic or game theoretic behaviour occurs because each firm in such an industry is not a competitor, but rather a rival to the other firms. Oligopolies can be either collusive or non-collusive, where collusive means that the firms act in a concerted manner and co-operate with each other, while non-collusive means that each oligopoly operates on its own accord, taking care to strategically consider their rival’s likely behaviour. As collusive oligopolies will form a cartel and behave just like a monopoly, it would not be discussed in this essay.

What economics diagram would you draw here, and why?

Non-collusive oligopolies also produce at the maximising point MC=MC, at price P and output Q. Taking into account their rival’s actions, these oligopolies would not raise their prices as their rivals would simply benefit from such actions. On the other hand, they would not lower their prices and cause a price war as their rivals would have little choice but to follow. According to the kinked-demand curve model, due to rival’s strategic behaviour and mutual interdependence, there would be a situation of sticky prices at price P, where oligopolies would not have any incentive to raise nor lower prices. The only way in which a price war is sustainable is if the MC curve fell for a firm, due to innovation or dynamic efficiency. That way, an oligopoly could lower its prices and trigger a price war with the other firms, and if its rivals are unable to match its lower marginal costs, it would win in the long run. Therefore, due to high barriers to entry and market power of the firms, oligopolies earn supernormal profits in the long run.

Non-collusive oligopolies operate in an industry where there are many buyers but relatively few sellers, due to high barriers to entry. This, coupled with imperfect information in the industry, and the type of product sold – homogenous or differentiated – results in oligopolies having a high degree of pricing power. In the e-commerce industry, examples of non-collusive oligopolies include firms like Amazon, Alibaba, eBay etc. Barriers to entry in the e-commerce industry is relatively high, because it requires a lot of capital to set-up the firm, such as the search engine required to cater to global demand, and the logistics required to handle the delivery and shipping of thousands of product worldwide. Hence, only a few oligopolies dominate this industry, each selling a myriad of differentiated products. Imperfect information could exist in the industry where firms have no information regarding the operations of their rivals, such as how they innovate for instance. Therefore, these five characteristics of non-collusive oligopolies lead to these firms producing at MC=MR, at price P and output level Q, thereby earning supernormal profits in the long run.

In conclusion, the five characteristics of the two market structures ultimately determine their pricing strategy and what level of price and output they produce.

JC Economic Essays – This is a H2 Economics essay response on a market structure question, for the N2011 economics examination, Essay Question 3. Special thanks once again to WY for his kind contribution, which will help many economics students learn economics through model economics essays. Thank you to WY and SS for their kind contributions of economics essays.

This economics answer is really good, albeit detailed. As a model, this essay is clearly structured, focuses on the features (“structure”) of the market structures (both of them), and argues about the resultant P and Q. There is a good and strong use of examples, and economics diagrams as well. This economics response also refers explicitly to the P and Q, which are the focus of the question.

Just for discussion and improvement: What could the author have done differently to make this economics essay sharper and more focused? What could he have done slightly differently, or better, to make improvements to his response? There is always room for improvement. Always think of how you could have approached the economics question, and what you could have learnt from reading this model essay, and from other economics essays on this site. What synthesis or syntheses can you make? 

Thank you for reading and cheers.

Explain how the degree of market dominance affects the amount of profits earned by a firm. [10]

This paper explains how the degree of market dominance, which results from the level of barriers to entry in an industry, will affect the amount of profits earned by a firm, which is assumed to be a profit-maximising entity.

First, it has to be observed that a firm with market dominance will have a downward sloping demand curve. The higher the market dominance a firm has, the higher its price setting ability, and this results in a more price inelastic demand curve. The higher the ability of the firm to increase total revenue (TR, which is equal to P x Q), since an increase in price would lead to a less than proportionate fall in its quantity demanded, the more likely this would in turn indicate more profits for the firm, assuming no change in the total cost (TC). Market dominance and price setting ability arise because of the presence of barriers to entry.

What are barriers to entry? Barriers to entry refer to any man-made or natural barriers which are strong enough to prevent new rival firms from competing on an equal basis with the existing firms. A perfectly competitive and monopolistically competitive market structure both have no and low barriers to entry and exit respectively. Thus, a perfectly competitive firm possesses no market dominance and a monopolistically competitive firm possesses low market dominance. There are substantial barriers to entry and exit in an oligopolistic market and for a monopoly it has the highest level of barriers to entry and exit. Thus, an oligopoly and monopoly possess a high degree of market dominance. Due to the varying degrees of barriers to entry, the different market structures will see a different impact on the amount of profits earned in the long run. The amount of profits can take the form of supernormal profits (TR>TC), normal profits (TR=TC) or subnormal profits (TR<TC). In a perfectly competitive market, there are no barriers to entry. This implies that firms are free to enter and exit the market.

Explain using diagrams, how the PC firm eventually makes normal profits

In contrast, should a perfectly competitive firm be earning subnormal profits initially, this will cause some firms to leave the industry and decrease the market supply. This will in turn increase the market price and diminish the magnitude of subnormal profits. Firms will continue to leave the industry until the remaining firms earn normal profits in the long run.

Similarly, in a monopolistically competitive market, there are low barriers to entry in reality.

Explain using diagrams, how the MC firm eventually makes normal profits

In contrast, a monopoly faces high barriers to entry. If the monopolist is making supernormal profit initially, new firms cannot easily enter the market even when there are supernormal profits to be made. There will be no change to the firm’s demand and it can continue to retain its supernormal profits. Likewise for a firm in an oligopolistic market, it also faces considerable barriers to entry. As it is difficult for firms to enter or exit easily, an oligopolistic firm’s supernormal profits will not be whittled away and can continue to retain its supernormal profits in the long run.

In conclusion, the higher the degree of market dominance as a result of higher barriers to entry, the higher the degree of profits earned by the firm in question, which usually means ultimately that oligopolies and monopolies earn supernormal profits while perfectly competitive and monopolistic firms earn normal profits. 

JC Economics Essays - This economics essay was contributed by a student from a certain Junior College in Singapore. It was not written under timed examination conditions, but is supposed to reflect the best possible answer given by a candidate to the economics question about the degree of market dominance and how it affects a firm's profitability. Special thanks to S for his contribution to this economics blog. 

What comments would an economics tutor make about this essay response? First, take note that this is a purely theoretical question. Many times, candidates have to determine if the question is asking a purely theoretical question (usually the small part questions of CSQ or the 10 mark questions are about theory), or if the real world context is required. Often, the larger essay questions require application of economics to the context, or real world examples. In this case, this economics question seems to be a pure theory question testing if students understand the concepts of market structure, market dominance, barriers to entry, and the type of profits. While this essay is excellently crafted, perhaps there could be a more efficient way of writing it? While the material is sound and accessible to A level students, could there be a more parsimonious way of writing this paper, given that it is only 10 marks? Are there alternative approaches to answering this economics question? On the other hand, the level of detail is excellent and this paper deserves a very high grade for its targeted yet detailed response. Think about how you would approach this essay. Thanks for reading and cheers!

Explain, with relevant economic theories and with the use of diagrams, the factors affecting the price and output decisions of an oligopoly firm. [10]

An oligopolistic market refers to a market that is dominated by a few firms, each possessing a significant market share. What are the assumptions for an oligopoly? There are four assumptions for an oligopoly firm. There are few sellers and many buyers, high barriers to entry, imperfect information and either homogeneous or differentiated product. There is mutual interdependence or rivalry between firms in an oligopolistic market, which leads to strategic, game theoretic behaviour of firms. Mutual interdependence or rivalry refers to a situation where a firm has to consider the reactions of its competitors when making its decisions, in which it might make strategic, game theoretic pricing and output decisions. This economics essay thus attempts to explain how mutual interdependence or rivalry affects a firm’s price and output decisions, and how collusion and advertising affect a firm’s decisions.

Oligopolies tend to have sticky prices that are rigid and are often unchanged. In an oligopoly, when a firm lowers its price, it will draw a significant number of customers away from its rivals. These rival firms are unlikely to sit back and do nothing but will instead lower their prices in response to avoid losing a big portion of their sales.

However, should a firm raise its price, it will instead lose much of its customers to its rivals. Since its rivals benefit by not reacting they will probably not raise their price in response. Based on such observations, oligopoly pricing behavior based on the kinked demand curve was derived, showing price rigidity.

[Insert a diagram on oligopoly’s kinked demand curve model]

The oligopolistic firm will set the price at MC = MR. The firm will not produce at any output where MC > MR as they generate losses. Hence, the profit maximizing or the loss minimizing point is when MC = MR. This kinked demand curve model shows that there tends to be price rigidity in an oligopoly due to mutual interdependence. Firms tend to stick to the prevailing price and are reluctant to change to alter prices.

An oligopoly firm will only alter its price if its marginal costs change substantially, and if the marginal costs fall significantly there could be a price war - an oligopoly will decide rationally that it could lower prices, increase output, and thus put some rivals out of business.

[Insert a diagram on oligopoly’s kinked demand curve model - showing a price war]

There are other factors affecting the decision of price and output by oligopolistic firm. For instance, collusion may affect the oligopolistic market and help make it become a monopoly market.

Collusion refers to the act of firms jointly determining the price or output. There are two types of collusion, namely explicit collusion and tacit collusion. Collusion can be explicit where firms formally gather to fix prices or output. A formal collusion oligopoly is called a cartel. Tacit collusion could still occur as firms cooperate informally by following a price leader. Both explicit and tacit collusion can work like a monopoly market which can control output and set the price.

[Insert diagram on collusive oligopoly - monopoly diagram]

           

A collusion oligopoly can be a price setter as a monopoly at maximum profit point i.e. MC = MR and set the price without the limit of price rigidity of an oligopolistic firm.

When there is a price war, the oligopolistic firms retaliate by cutting prices, triggering successive rounds of price cuts. Such an occurrence is known as a price war, which is generally detrimental to all firms as heavy losses are incurred throughout the market. A firm might want to punish its rival for taking unilateral actions. In addition, the reasons for price wars are less strategic and more short-term in nature. For example, due to an unexpected recession, managers might desperately slash prices in order to make sales targets or to raise revenue to overcome cash flow problems.

In conclusion, the factors affect the price and output of a firm in an oligopolistic market is mainly price rigidity which depends on the market itself. Collusion oligopoly will give the firm more market power to set its price beyond the limitation of price rigidity. A price war may result in decreasing prices of the firm. Therefore, the price and output of a firm in an oligopolistic market are affected by many factors in different conditions.

JC Economics Essays - H2, H3 Economics essays - tutor's comments: This economics essay deals with oligopolies, strategic behaviour, and pricing and output decisions of firms, with a simple hint of game theory, assuming that firms are rational and thus make rational decisions. Game theory is an important mathematical tool that can help in general economics analysis, but specifically, especially for H3 examinations, undergraduate economics courses, and economics in general. However, there was very little depth of game theory in this economics paper. There are many important elements of this economics essay which make it worth many marks and a rather good examination grade. However, the usual questions for improvement still apply: how could you make this essay answer better? Could examples have been used? Always try to answer the question, and think of how you could make your answers better when dealing with economics questions. 

Explain, with relevant economic theory, how the pricing and output decisions between a monopoly firm and a perfectly competitive firm differ because of their differences in barriers to entry. [10]

This paper explains how the pricing and output decisions of a monopoly and a perfectly competitive firm differ due to the differences in the nature of their barriers to entry. What is a monopoly? A monopoly is a market where there is only one seller of a uniquely differentiated product with no close substitutes. What is a perfectly competitive firm? A perfectly competitive firm is one where there are many buyers and sellers of one homogeneous product. What are barriers to entry? Barriers to entry are obstacles or barriers that deter new firms from entering the market. There are two main types of barriers, artificial (man-made barriers) and natural (such as huge economies of scale)

After having defined the various concepts, this essay seeks to first state the assumptions of each firm before illustrating with a diagram how each firm's pricing decision is made. It would then show how differences in barriers to entry affect this important pricing decision of a monopoly and perfectly competitive firm.

[Insert an economics diagram on Monopoly]

The assumptions of a monopoly are high barriers to entry which deters firms from entering, highly differentiated product with no close substitutes and a situation where there are many buyers but only one seller who dominate the market. For a monopoly, the profit maximizing point is where MC = MR. This shows how pricing decision is made for a monopoly which aims to maximize profits.

[Insert economics diagram on a Perfectly Competitive firm]

On the other hand, the assumptions of a perfectly competitive firm are low or no barriers to entry, a homogeneous product, many buyers and sellers in the market, as well as perfect information. The profit maximising point for this firm is also where MC = MR. This also shows how the pricing decision is made for a perfectly competitive firm, and it is different from a monopolist's decision because the price is lower and the equilibrium output is higher - that is, P is lower, the Q is higher, compared to a monopoly.

In conclusion, when considering barriers to entry, having established how the pricing decision is made by both a monopoly and a perfectly competitive firm, this distinction helps to explain how the differences in these barriers to entry affect their pricing decisions. It is evident that with high barriers to entry, in the case of a monopoly, the monopoly is a price setter since firms are deterred and prevented from entering the market easily. Conversely, with low barriers to entry, which is in the case of a perfectly competitive firm, such a firm is a price taker since new firms can enter the market very easily, explaining why the firm follows the price set in the market. 

JC Economics Essays – H2 A levels – Economics tutor’s comments: This A level economics essay answers the question of barriers to entry and market structure directly, but a lot more thought is required.

What are the main strengths of this economics essay? Think about it. What are the main weaknesses of this economics essay? Think about this question also. The main good thing about this essay that makes it useful in learning economics is that it addresses the question directly, through the use of relevant, clear cut diagrams. Economics diagrams are very important to answering a question, and there should be a well developed paragraph assisting the economics diagram to do its job well.

However, perhaps this economics paper could be better developed with real life examples and other illustrations that could show the theory. While the question asks for the "relevant economic theory", and this essay has done precisely that, this economics essay could be helped further by developing the paragraphs with some real life examples. How else could this essay have been improved? Think of how you could help to make this a better essay than it already is.

Special thanks and cheers to model students SS, AG, and JC for their kind yet invaluable contributions. Special thanks to SS for his editing and vetting of this sample essay to make it even better than it was originally. Thank you for reading, and cheers. 

Examine how automobile producers might use price elasticity and income elasticity of demand concepts (PED, YED concepts) to help determine their pricing and output decisions. [15]

In order to maximize profits, price and income elasticity of demand concepts can be applied by firms in order to come up with their business strategies. Hence, this essay aims to discuss about the impact of price and income elasticity of demand on automobile firms' decision and how the extent of elasticity can be applied to the relatively monopolistic automobile market. 

Price elasticity of demand measures the responsiveness of quantity demanded of a good to a change in its price, ceteris paribus. The demand for the good is said to be elastic if the change in price results in a more than proportionate change in quantity demanded. Conversely, the demand for the good is said to be inelastic if the change in price results in a less than proportionate change in quantity demanded. Hence, if a firm expects the demand for its good to be price elastic, then it should lower the price. 

[Insert a diagram with both demand elastic and inelastic curves]

A decrease in price will result in a more than proportionate increase in quantity demanded if demand is elastic. Therefore, total revenue is raised.

Conversely, if the firm expects its demand for good to be price inelastic, it should raise the prices to increase its revenue. This is because an increase in price will result in a less than proportionate decrease in quantity demanded.

Firms may also want to differentiate their goods in order to make the demand more price inelastic and hence raising their profits. This is because it enables firms to charge a higher price but yet sell more output, thus raising its total revenue. Product differentiation can be real differences or imaginary differences. Real differences include differences in size, colour and taste, specifications and quality of physical product. These can be altered often through research and development. Imaginary differences include brand loyalty and packaging. These can be done through persuasive advertising and innovative packaging.

Income elasticity of demand measures the responsiveness of the demand for a good to change in income, ceteris paribus. Positive income elasticity of demand of a good means that the demand for the good increases as income increases, conversely as income falls, demand for good falls. These goods are known as normal goods. These normal goods can then be classified into normal-necessity goods and normal luxury goods. Conversely, negative income elasticity of demand of a good means that the demand for the food decreases as income increases. These goods are known as inferior goods. Understanding income elasticity help firms decide in the type of goods to sell under different economic conditions. If a country is facing strong economic growth, firms should sell more normal goods, especially normal luxury goods where an increase in income will result in a more than proportionate increase in demand. However, during an economic downturn, the demand for normal goods falls. Normal necessities fall less than proportionately while normal luxuries fall more than proportionately. Firms may then want to consider producing and selling more inferior goods instead.

In the context of the automobile market which faces monopolistic competition, although there is product differentiation, demand is likely to be price elastic due to high availability of substitutes. Hence, the firms should lower its prices to raise its revenue. However, in terms of product differentiation, a monopolistic market may not have the economies of scale to spread cost overheads. Hence low cost innovation is possible but not high investments on research and development. In the long run, automobile market only earns normal profits.

Secondly, automobiles are considered to be normal luxury good that increases more than proportionately if income increases. Thus if economic growth is strong, they should decrease the price.

However, there are limitations of applying demand elasticity concepts. The estimates are based on past dates and resources hence, the data may not be applicable to current business environment as business conditions would have changed. Changes include a more affluent society due to greater economic growth and hence can represent status quo instead.

In conclusion, automobile producers are able to make use of price and income elasticity to help determine the pricing and output decisions. This allows the firms to raise output more easily and capture a greater market share. Therefore, there are a lot of possible uses for PED and YED concepts as applied to business. 

JC Economics Essays: H1 H2 'A' level Economics Essay part (b): economics tutor's comments - For A level Economics, elasticity concepts are very important - as immediate revision, try to recall the definitions, the mathematical formulae, and what the magnitude of the numbers (or the sign, negative or positive, of the numbers) mean. This would be good economics revision for elasticity questions, and a very useful skill to have during examinations. Then, after recalling the economics material, try to apply the concepts to a particular context - in this case, the context of the economics exam question. Remember that students need to use real world examples in conjunction with economic theories. Economics tutors and examiners always appreciate good examples that are relevant, clear, and well known; however, this economics paper has actually done a rather good theoretical job without having relevant examples of car companies (in the USA, or Europe, etc). How else could this economics paper be better developed or improved? Thanks to students for contributions. 

Explain how the pricing decision between a monopoly firm and a perfectly competitive firm differs because of differences in the levels of barriers to entry. [10]

A monopoly refers to a market where there is only one seller of one product that has no close substitutes. In perfect competition, there are many sellers and buyers selling one homogeneous product. A monopoly is a price setter while firms in perfect competition are price takers. A monopoly is a price setter while firms in perfect competition are price takers. A monopoly exists because barriers to entry are very high, whereas a perfectly competitive firm exists because barriers to entry are very low or even non existent. In this Economics essay, I will explain the reasons for high and low barriers to entry for a monopoly and firms in perfect competition respectively, and how the price decision will thus differ between the two market structures.

A monopoly exists because barriers to entry are so high such that new firms are totally deterred from entering the market, and therefore there is only one dominant or major firm in the market. There are two types of barriers to entry: natural barriers and artificial barriers to entry. Natural barriers refer to inherent characteristics of the market which deter the entry of firms into a market. For example, the monopoly of diamond market, De Beers controlled more than 98% of the diamond resources last time and was able to deter any other firms from entering the market. Localised monopoly also has very high barriers to entry due to the fact that limited population does not demand so many firms for one good or service. Hence, in a small town, one firm is enough to fulfill the demand. For example, hairdressing shops can be considered localised monopolies.

Artificial barriers refer to deliberate actions taken by governments of firms to deter entry into a market. Governments may sell licenses to firms which want to enter a market in very high prices. For example, setting up one casino is very hard in most of the countries because governments will consider the negative externalities of opening a casino. Existing firms will set their prices lower than entering prices to deter new firms from entering the market. 

In perfect competition, barriers to entry are low so it is relatively easy for new firms to enter the market to produce. Therefore, so many small firms with each having an insignificant market share are present in perfect competition. Each firm’s market share is negligible due to the low barriers to entry and exit. Changes in a single firm’s output will not have effect on the market’s total supply and hence the market price.

Hence, as price takers, firms in perfect competition will take the price attained from intersection of demand and supply of the whole market. 

[Insert diagram for the Industry (Market)]

[Insert diagram for the Firm]

As shown in the diagrams above, the price decision in a perfect competition is taken by all the small firms at P0. P0 is the same as PE which is the intersection equilibrium price of demand curve D and supply curve S in the industry. 

If the industry has only one firm which is monopoly, it can decide the price as it wants due to the fact that there is no other firm to hinder its great market power. 

[Insert diagram on monopoly]

As shown in the diagram above, the price is determined when maximum profits can be generated. i.e. at the point where MC = MR. 

In conclusion, a monopoly firm and a perfectly competitive firm differs in terms of pricing because the barriers to entry confer market power (or the lack thereof), which leads to price setting ability or a price taking result. 

JC Economics Essays (H2 'A' Level Standard Economics Essay, part (a)): Economics tutor's comments - There are many important essay writing lessons that students can learn from this economics essay on monopoly, perfect competition, and profit maximisation. What is good, and what is bad, about the essay introduction? Was the introduction clear, addressing the topic, and defining key terms and concepts needed? What is good about the economic analysis in this particular paper, in the body of the essay? Did the analysis address the requirements of the economics question? What is good or less good about the writing style and approach taken in this economics essay? Is the essay well written? To a large extent, this is an excellently crafted essay, well written and clear, but there are some ways in which it could have been further developed and made even better - what are those ways? How would you do essay editing for this paper, if you were the economics tutor? How would you apply more of the economics knowledge, insights and analysis to make this paper more developed? Also, how would you mark this economics essay, if you were the examiner? Thanks for reading and cheers. Special thanks to contributions from students. 

Discuss, using examples from the United Kingdom, whether high levels of research and innovation are best achieved in competitive compared to monopolistic markets. (25 marks)

This Economics paper argues that high levels of research and innovation are best achieved in monopolistic markets, compared to competitive markets, because dynamic efficiency is best achieved when companies have the willingness and ability to conduct costly research and development (R & D).

First, what is dynamic efficiency? Dynamic efficiency means that companies can invest in education, research, innovation, and other creative processes that help them increase their efficiency over time, and in the long run will help them earn supernormal profits above opportunity costs and explicit costs. Competitive markets are markets with low barriers to entry, and can be idealised using the model of perfect competition.

What is perfect competition? Perfect competition is the market structure where there are many buyers and sellers of a single homogeneous product with perfect substitutes, low barriers to entry, suggesting that they earn normal profits in the long run, and where there is perfect information.

This is in contrast with monopoly, which in theory is a firm that sells a product with few close substitutes, with high barriers to entry, and which thus earns supernormal profits in the long run.

It can be argued that competition might not lead to research and development. Taking perfect competition to benchmark competitive firms in the UK, because they earn normal profits in the long run, they have neither the incentive nor the willingness to invest in research and innovation. For instance, small shops along the streets of London, especially monopolistic competitive firms, will not engage in research. 

However, having said that, if these firms are able to borrow from capital markets or get funding, or perhaps even due to external events causing temporary supernormal profits due to changes in demand and supply, they could have the willingness to invest in innovation so that they can because more “monopolistic”, when they produce a highly differentiated product.

It can be argued that monopolistic markets have firms that earn supernormal profit, because of their high barriers to entry. They therefore have both the ability and willingness to innovate to keep their monopolistic position. First, they have the ability because they earn supernormal profits, and can allocate massive funds to R&D. Second, they have the willingness because if they are in monopolistic markets that could potentially be contested by more efficient firms that could displace them to take over their market, they need to innovate to maintain their long term dynamic efficiency. 

For instance, Rolls Royce which manufacturers engines and aeroplane systems is a dynamic company probably because it has incentive and ability to innovate. BAE Systems plc is also another such company, and in fact both Rolls Royce and BAE are multinational companies, companies that span international borders with their unique product chains that require high levels of research and development. In fact, it can be said that some monopolies are monopolies because they have developed a product that is unique, differentiated, and wanted by consumers.

However, having said that, on the other hand contestable markets are usually perfectly competitive or competitive in nature, and as such competitive markets could help dynamic efficiency better in that respect. Thus competition might also lead to research and innovation, but the level could be lower than that of monopolies that have incentive and ability to do research and innovation.

Also, there are problems with monopolies. It can be argued that monopolies sometimes have x-inefficiency, where they do not act energetically to curb costs, and they could therefore become slothful and inefficient firms. This is because they may preserve their position through the use of patents, laws, legislation, and other legal means that have nothing to do with their level of technology or the sophistication of their product.

In the final analysis, this paper argued that high levels of research and innovation are best achieved in monopolistic markets, compared to competitive markets, because dynamic efficiency is best achieved when companies have the willingness and ability to conduct costly research and development, even though there are indeed some limitations to monopolies such as x-inefficiency. Competitive markets may have the incentive to conduct some research, but their levels are lower, and most of the time they neither have willingness nor ability due to the lack of barriers to entry which ensure supernormal profit. 

JC Economics Essays (H2, H3 A levels): Economics Tutor's Comments - This Economics paper on research and development and comparison of monopolistic and competitive firms was crafted under model examination conditions and has a few good points that one can learn from, but also some problematic areas, such as simplistic analysis and lack of many other relevant examples from UK manufacturing or service industries. Do think: if you were an Economics tutor, what advice would you give this student to help him make the Economics essay better? Perhaps you could focus on an area of improvement, such as the structure or organisation of this essay. Think of how this Economics paper could be made better. Thanks for reading and cheers!

Consider Singapore retailers and discuss if oligopoly or monopolistic competition best explains these retailers’ market behaviour. (rephrased adapted question)

- Adapted from an actual A level Economics examination question

Introduction

Does oligopoly or monopolistic competition better explain the market behaviour of Singapore retail firms? First, a few definitions are in order.

What are retailers? First, retailers are firms that do not produce their goods that are sold, but only sell goods which are actually manufactured by manufacturers or producers.

What is an oligopoly? Second, oligopoly is a market structure characterised by many buyers but few sellers, each of the sellers interacting strategically against their rivals, which are the other firms competing in the oligopolistic industry, and there are high barriers to entry, usually caused by high economies of scale. Economies of scale refer to the situation where LRAC (Long Run Average Costs) fall as scale increases, when output increases.

What is monopolistic competition? Third, monopolistic competition is a market structure where there are many buyers and sellers, few barriers to entry, and slightly differentiated products that are quite different from other competitors, but psychologically or physically different. For example, NTUC and Giant hypermarket are examples of oligopoly, because of their market share and situation of rivalry and strategic behaviour, while clothing retail shops such as Charles and Keith are examples of monopolistic competition, because of their many buyers and sellers and slightly differentiated products of fashionable accessories and clothing items.

Pricing and Output, Strategic Behaviour?

Also, price stability, furthermore, could be due to collusion, which means that oligopolies tend to gang up or collude against the public interest by raising prices together, whether through explicit or implicit means.

On the other hand, there is no price stability in monopolistic competition because according to the economic model of monopolistic competition they operate using the profit maximising rule only to make their pricing decisions, where marginal cost equals to marginal revenue (MC=MR), which differs from firm to firm due to their changing marginal costs and marginal revenues.

Non-price Competition - Oligopoly and Monopolistic Competition?

Secondly, oligopolies tend to prefer non-price competition like advertising, freebies and lucky draws, whereas monopolistic competitive firms are more likely to compete based on prices (and output). Due to their large scale, with massive internal EOS, running down along their LRAC, oligopolies are able to use huge, large scale, media-based, newspapers and multimedia advertising, where for example supermarkets like Giant or NTUC often advertise in newspapers. On special occasions, they also have products sold at lower prices or at special discounted, special occasion based prices. These oligopolies also have loyalty programmes, freebies, and even sometimes lucky draws with attractive prizes that make people want to go there, which demonstrates that non-price competition and advertising are important for oligopolies. Non-price competition is of course competitive behaviour unrelated to pricing or output decisions, and is distinct from competing based on MC = MR, the profit maximising rule.

First, monopolistic competitive firms can make independent decisions on pricing and output, whereas oligopolies are mutually interdependent because they are rivals rather than competitors. There is price stickiness in oligopoly, shown by the oligopoly kinked demand curve model, which shows there is no incentive for firms to raise or lower prices as long as their rivals do not do so. This is because raising price leads to losses in revenue along the inelastic part of the demand curve, and lowering price leads to a price war because the other rivals will join in the fray metaphorically.

Also, it should be argued that there is product differentiation for monopolistic competition, because different clothing retail shops have different clothing designs, for instance, Charles and Keith clothing shops specialise in women’s clothing and special types of clothes we love to buy. These monopolistic competitive clothing shops typically engage in price competition which implies that they do and will lower their prices all round if they are able to bring their marginal costs down, for instance by having better and cheaper supply chain management. It finally can be strongly argued that monopolistic competitive firms are more open to price competition in contrast to oligopolies. While monopolistic competitive firms also advertise, they tend to rely on low cost methods such as handing out flyers or using free newspapers rather than broadsheet newspapers and these advertising methods are certainly not their main strategy unlike oligopolies.

JC Economics Essays: Economics Tutor's Comments - This Economics essay is quite interesting and reasonably answers the question set, and certainly could be done reasonably well by many students during the examination timing and under stressful conditions. The student clearly knows his Economics materials, and his Economics tutors have certainly done a lot of good work, and he can also be proud of the Economics content that he has learnt!

However, it does not have a conclusion and seems quite rambling at certain points. It also seems rather dis-organised. In fact, this economics essay could actually have fared so much better if it did have an evaluative conclusion that made a justification on an evaluation made. Also, the essay is a bit short, and lacks well-labelled Economics diagrams (this one is a unique essay because normally I don't include the diagrams drawn in the essays presented, but this one does not actually have any essays drawn, although the student SHOULD, dare I say MUST, have at least one diagram, and in this case two diagrams. Think: what diagrams? See the text.) The student could also have told us what he was going to tell us before telling us what he was going to tell us.

Yet, there are of course good points that we can learn from it. Question is: what are the other good points that you could learn from this essay, other than the criticisms and the comments written here? Thanks for reading and cheers. 

Explain the possible alternative aims of firms. [25]

According to economic theory, firms are supposed to be profit maximising entities, where MC = MR. However, in real life, this does not seem to be always the case. Explain the possible alternative aims of firms. [25]

According to economic theory, firms are supposed to be profit-maximising entities, producing output where their marginal cost of production equals to marginal revenue (MC = MR). However, in real life, this does not seem to be always the case. This paper explains some of the possible alternative aims of firms: profit satisficing, sales maximisation, and growth maximisation. This is due to the central idea that firms may want to maximise profits, but either they do not know how to due to imperfect information, or they do not want to due to alternative goals and aims. This paper does not discuss those areas of analysis but instead focuses on a few alternative possible aims.

Alternative Aims of Firms: Profit Satisficing

One alternative aim of firms is profit satisficing. In many firms, there is separation of ownership and control. Those who own the company (the shareholders) often do not get involved in the day-to-day running of the company. This is a problem because although the owners may want to maximise profits, the managers, who run the company, have much less incentive to maximise profits because they do not get the same rewards as the shareholders do. Therefore, managers may create a minimum level of profit to keep the shareholders happy, but then maximise other objectives relevant to them such as enjoying work, maximising prestige, and other private goals. This is the problem of separation between ownership and manager and can possibly be overcome, to some extent, by giving mangers share options and performance-related pay to align their incentives, although in some industries it is difficult to measure performance.

Alternative Aims of Firms: Sales Maximisation

Sales maximisation is another possible goal and occurs when the firm sells as much as possible without making a loss, rather than maximising profits. Firms often seek to increase their market share by increasing their sales even if it means less profit. This could occur for various reasons. First, increased market share increases monopoly power and may enable the firm to put up prices and make more profit in the long run. Secondly, managers prefer to work for bigger companies as it leads to greater prestige and higher salaries. Thirdly, increasing market share may force rivals out of business; for example, supermarkets have lead to the demise of many local shops. Some firms may actually engage in “predatory pricing” which involves making a loss to force a rival out of business. As long as their costs are covered, firms may reduce their prices to drive their rivals out of the market.

Alternative Aims of Firms: Growth Maximisation

Another possible aim of a firm other than profit maximisation might be growth maximisation. This is the idea of expansion and growth, and is similar to sales maximisation and may involve mergers and takeovers. A merger is a union of two companies, and can be hostile or friendly. A takeover is an acquisition of another company by a firm. First, similar to sales maximisation, increased market share increases monopoly power and may enable the firm to put up prices and make more profit in the long run. Secondly, managers prefer to work for bigger companies as it leads to greater prestige and higher salaries. Thirdly, increasing market share may force rivals out of business; for example, supermarkets have lead to the demise of many local shops. Some firms may actually engage in “predatory pricing” which involves making a loss to force a rival out of business. As long as their costs are covered, firms may reduce their prices to drive their rivals out of the market.

Conclusions

In conclusion, while firms are supposed to be profit-maximising entities according to theory, producing where their marginal cost of production equals to marginal revenue, in real life, this does not seem to be always the case. This paper explained profit satisficing, sales maximisation, and growth maximisation as possible alternative aims of firms in the real world. However, in the long run, profit maximisation of theory should be the long term aim of firms, because if they do not maximise profits in the long run, they will find themselves outcompeted by firms that have followed a more rational pattern of behaviour, and in the competitive marketplace, “only the fittest survive”.

JC Economics Essays – Tutor's Commentary: Right off the bat, there are a few things missing from this particular "alternative aims of the firm" essay, which you should know and write about: the diagram of the Baumol model could be included. Furthermore, the standard Economics perfect competition diagram could also be added too. Let’s do an intellectual exercise here: think about how your Economics tutors in school would judge this Economics essay. What were its strengths and weaknesses, and why do you think those parts of the essay were strengths or weaknesses? If you were this student’s Econs tutor, how would you suggest advice so that you could make the student improve on his or her writing skills, and answering techniques? Be sure to ask critical and thinking questions; and always draw an Economics diagram (or two diagrams or more, if the need arises)! Thanks for reading and cheers. 

(b) Examine how the car producers might use the price and income elasticity of demand concepts to help determine pricing and output decisions. [15]

Singapore’s car population grew by almost 40% from 370 000 in 1997 to 515 000 today. - Adapted from Singapore’s Ministry of Transport

(b) Examine how the car producers might use the price and income elasticity of demand concepts to help determine pricing and output decisions. [15]

Car producers can use the price and income elasticity of demand concepts to help determine pricing and output decisions. This essay discusses how car producers can use the concepts. First, PED measures the responsiveness of the quantity demanded of a good for a given change of its price, ceteris paribus. On the other hand, YED is defined as the responsiveness of the demand of a good to a change in income, ceteris paribus.

First, PED can be used to help firms. Let us assume that firms aim to maximise total revenue. If demand is price elastic, as prices fall, this will lead to a more than proportionate increase in quantity demanded, which leads to a rise in total revenue. On the other hand, if demand is price inelastic, as prices rise, there will be a less than proportionate fall in quantity demanded, hence raising total revenue also. The implication here for car producers is that they can make use of this knowledge to determine their pricing strategies.

For example, the many major car producers have competitors producing similar products e.g. Toyota, Volkswagen and Hyundai. Therefore, such cars are relatively elastic in demand because they have many substitutes. Therefore such producers should lower the price to increase total revenue.

On the other hand, some exotic or luxurious car producers such as Ferrari or Rolls Royce have fewer competitors and very a differentiated product, so the demand for their cars is relatively price inelastic. Hence, such car producers should lower raise the price to increase total revenue.

YED is also useful to car producers. Normal goods have positive YED, where a normal necessity has a YED between 0 and 1, whereas a normal luxury good has a YED of more than 1. A normal good is defined as any good whose demand increases as income increases, where a necessity has a demand curve that increases less than proportionately to an increase in income, whereas a luxury has a demand curve that increases more than proportionately to an increase in income. Hence firms should produce more normal goods in general if the general level of income rises in an economy.

On the other hand, inferior goods have negative YED. An inferior good is defined as any good whose demand increases as income decreases. Hence, firms should produce more inferior goods when there weak economic growth and income decreases.

Also, the higher the magnitude of YED, the greater the extent of the change in demand and hence the more the firm should respond in producing output. For example, Geely and Cherry QQ are inferior goods and more should be produced in a downturn, whereas Nissan and Toyota are normal (can be considered normal necessity) goods and more should be produced in an upturn, and Ferrari and Porsche are normal luxuries, and even more should produced in an economic upturn. Therefore, even the extent of the change matters when it comes to producing output.

In conclusion, PED and YED are very useful concepts for car producers. On the other hand, it is more likely that producers may aim to maximise profits than revenue, hence, knowing elasticity is insufficient because we also need to consider costs. Total profit is equal to total revenue minus total cost. Furthermore, elasticities are estimated based on past data, and therefore may not be very useful if current economic conditions have changed drastically. Hence, in my opinion, elasticity concepts – while important – need to be understood in their nuances.

Junior College Economics Essays - Tutor's Commentary: This is the second part (part (b)) of the question addressed earlier, written by the same hardworking, clever student of mine, and was written under timed, stressful, examination-like conditions. (Of course, he did write the paper after consultation with me, and then I did work through the paper again to clean it up and improve upon our joint project... but that's another story.) The real question is: is it possible to write this under examination conditions? The ANSWER: It is definitely possible to craft a paper of this standard or EVEN better whilst under examination conditions during the A levels. However, do remember to add in diagrams (what diagrams would be really useful here?) and explain those diagrams to convince your Economics examiner to give you a really good grade.