Chapter 11
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MANAGERIAL ECONOMICS
MANAGERIAL ECONOMICS
12
12
ththEdition
<sub> Edition</sub>
By
By
Mark Hirschey
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Performance and Strategy
Performance and Strategy
in Competitive Markets
in Competitive Markets
Chapter 11
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Chapter 11
Chapter 11
OVERVIEW
OVERVIEW
Competitive Market Efficiency
Market Failure
Role for Government
Subsidy and Tax Policy
Tax Incidence and Burden
Price Controls
Business Profit Rates
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Chapter 11
Chapter 11
KEY CONCEPTS
KEY CONCEPTS
welfare economics
social welfare
producer surplus
consumer surplus
deadweight loss problem
welfare loss triangle
market power
market failure
failure by market structure
externalities
failure by incentive
economic efficiency
economic regulation
social equity
consumer sovereignty
limit concentration
subsidy policy
tradable emission permits deadweight
loss of taxation
tax incidence
tax burden
price floor
price ceiling
return on stockholders’ equity (ROE)
profit margin
total asset turnover
leverage
reversion to the mean
disequilibrium profits
disequilibrium losses
economic luck
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Competitive Market Efficiency
Why is it Called Perfect Competition?
Competitive markets balance supply and
demand.
Competitive markets maximize social welfare
Deadweight Loss Problem
Deadweight losses occur when market
imperfections reduce transaction volume.
Any benefit enjoyed by consumers or
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Market Failure
Structural Problems
Failure can occur in markets with few participants.
If above-normal profits reflect the raw exercise of
market power they can be unwarranted.
Incentive Problems
Externalities create incentive problems due to
differences between private and social costs or
benefits.
• A negative externality is an unpaid cost.
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Role for Government
How Government Influences Competitive Markets
Tax policy or regulation is efficient if expected benefits
exceed expected costs.
Fairness must be carefully weighed.
Broad Social Considerations
Consumer sovereignty is an important benefit of
competitive markets.
Public policy can control unfairly gained market power.
Tax and regulatory policy limit concentration of
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Subsidy and Tax Policy
Subsidy Policy
Subsidies can be indirect, like government highway
spending that benefits the trucking industry.
Subsidies can be direct, as in agricultural programs.
Deadweight Loss From Taxes
Taxes reduce economic activity and cause
deadweight losses.
Pollution taxes explicitly recognize the public's right
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Tax Incidence and Burden
Tax Incidence and Burden
Tax incidence is the point of tax collection.
Tax burden is borne by party who ultimately pays the tax.
Role of Elasticity
Who pays the economic burden of a tax or operating control
depends on the elasticities of supply and demand.
Customers pay tax when demand is inelastic (supply constant).
Producers pay tax when demand is elastic (supply constant).
Elasticity affects the deadweight loss of taxation.
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Price Controls
Price Floors
Price floors cause surplus production.
Price floors persist because of special
interests.
Price Ceilings
Price ceilings cause shortages.
Price ceilings are an ineffective means for
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Business Profit Rates
Return on Stockholders’ Equity
ROE is net income divided by stockholders’ equity.
ROE = Net Income/Sales × Sales/Total Assets ×
Total Assets/Stk. Equity
High margins, rapid turnover or leverage boost ROE.
Typical Profit Rates
ROE averages 10% to 15% per year for successful
companies.
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Market Structure and Profit Rates
Profit Rates in Competitive Markets
Competitive markets have low profit margins.
During economic booms, competitive firms can earn
disequilibrium profits.
During economic recessions, competitive firms can
suffer disequilibrium losses.
Mean Reversion in Profit Rates
Expansion from entry and firm growth cause
above-normal profits to regress toward the mean.
Contraction from bankruptcy and exit allow
below-normal profits to rise toward the mean.
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Competitive Market Strategy
Short-run Firm Performance
Profits reflect transitory influences.
Disequilibrium profits and losses reflect adjustment
costs.
Long-run Firm Performance
If above-normal returns persist for extended periods,
elements of uniqueness are at work.
The search for economic advantage is called
competitive strategy.
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