MANAGERIAL ECONOMICS 11 th Edition

1. MANAGERIAL ECONOMICS 11th Edition By Mark Hirschey

2. Performance and Strategy in Competitive Markets Chapter 11

3. Chapter 11OVERVIEW • Competitive Market Efficiency • Market Failure • Role for Government • Subsidy and Tax Policy • Tax Incidence and Burden • Price Controls • Business Profit Rates • Market Structure and Profit Rates • Competitive Market Strategy

4. welfare economics social welfare producer 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 competitive strategy economic rents Chapter 11KEY CONCEPTS

5. Competitive Market Efficiency • Why is it called Perfect Competition? • Competitive markets balance supply and demand. • Competitive markets maximize social welfare

7. Deadweight Loss Problem • Any cost suffered by consumers or producers that is not transferred, but simply lost. • Deadweight Loss Illustration

9. Market Failure • Structural Problems • Above-normal profits are unwarranted if they reflect the raw exercise of market power. • Failure occurs when competitive markets do not sustain socially desirable activity. • Failure can occur in markets with few participants. • Incentive Problems • Externalities are differences between private and social costs or benefits. • A negative externality is an unpaid cost. • A positive externality is an unrewarded benefit.

10. 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 when social considerations bear heavily. • 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 economic and political power.

11. Subsidy and Tax Policy • Subsidy Policy • Subsidy policy can be indirect, like government construction and highway maintenance grants that benefit the trucking industry. • Subsidy policy can be direct, like agricultural payment-in-kind (PIK) programs. • Tradable emission permits are pollution licenses. • Deadweight Loss From Taxes • Taxes reduce economic activity and cause deadweight losses. • Pollution taxes explicitly recognizes the public's right to a clean environment.

13. Tax Incidence and Burden • Role of Elasticity • Who pays the economic burden of a tax or operating control regulation depends on the elasticity of supply and demand. • Elasticity affects the amount of social welfare lost due to the deadweight loss of taxation. • All else equal, the deadweight loss of a tax is small when supply (or demand) is relatively inelastic. • All else equal, the deadweight loss of a tax is large when supply (or demand) is relatively elastic. • Tax Cost Sharing Example • Local authorities find it difficult to tax or regulate firms that operate in highly competitive markets.

16. Price Controls • Price Floors • Price floors cause surplus production. • Costly government-set price floors persist because of powerful special interest groups

19. Price Ceilings • Price ceilings cause shortages. • Price ceilings are a popular, but ineffective, means for restraining excess demand. • Cities use price ceilings in an effort to make housing more affordable.

22. Business Profit Rates • Return on Stockholders’ Equity • ROE is net income divided by the book value of stockholders’ equity. • ROE = Net Income/Sales × Sales/Total Assets × Total Assets/Stk. Equity • High margins, turnover or leverage boost ROE. • Typical Profit Rates • ROE averages 10% to 15% per year for successful companies. • Sustained ROE ≥ 20% per year is rare.

23. Market Structure and Profit Rates • Profit Rates in Competitive Markets • Competitive markets have low profit margins. • In strong economic environments, competitive firms can earn disequilibrium profits. • In weak economic environments, 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. • In long-run equilibrium, profit rates for typical firms reflect only a risk-adjusted normal rate of return.

24. Competitive Market Strategy • Short-run Firm Performance • Profits reflect transitory influences. • Disequilibrium profits and losses reflect adjustment costs. • Long-run Firm Performance • Typical firms in competitive markets have the potential for a normal rate of return on investment. • Abnormal profits or losses often reflect transitory disequilibrium conditions. • If above-normal returns persist for extended periods, elements of uniqueness are at work. • The search for an economic advantage is called competitive strategy. • Uniquely productive firms earn above-normal profits.