Study sheet: Managerial Economics: Markets and Strategy

📋 Course Outline

1. Relevant Costs and Decision Rules
2. Cost Curves and Scale Economies
3. Profit Maximization
4. Perfect Competition and Supply
5. Long-Run Competitive Equilibrium
6. Monopoly Pricing
7. Elasticity and Markups
8. Strategic Interaction and Games
9. Sequential Games and Entry
10. Oligopoly Competition
11. Demand Estimation and Shifts
12. Market Equilibrium and Welfare

📖 1. Relevant Costs and Decision Rules

★ Must-know

📌 Sunk costs have already been incurred and cannot be recovered, whereas opportunity costs are the returns forgone by using resources in their next-best alternative.

📌 Economic cost equals accounting cost plus opportunity cost, so a project should be undertaken when its revenue exceeds its full economic cost.

Further detail

• The opportunity cost of attending school includes the earnings forgone from the individual’s previous job as well as other relevant alternatives.

💡 Memory Hook

Ignore sunk costs, include opportunity costs.

📖 2. Cost Curves and Scale Economies

🔑 Key Concepts & Definitions

• Economies of scale : occur when average cost decreases as output increases
• Diseconomies of scale : occur when average cost increases as output increases

★ Must-know

📌 Marginal cost is the cost of an additional unit, whereas average cost is total cost per unit.

📌 Marginal cost crosses average variable cost and average cost at their respective minimum points.

Further detail

• Sources of economies of scale include:
  • fixed costs
  • specialization
  • indivisible inputs

💡 Memory Hook

Fixed costs and specialization can lower average cost, creating economies of scale.

📖 3. Profit Maximization

★ Must-know

📐 Formula — Profit equals total revenue minus total cost: $\Pi = TR - TC$.

📌 A firm should increase output when marginal revenue exceeds marginal cost and decrease output when marginal revenue is below marginal cost.

📌 Profit is maximized at the output where marginal revenue equals marginal cost, provided the marginal cost condition identifies the top of the profit curve.

Further detail

• Fixed costs do not affect the profit-maximizing output because they do not change marginal revenue or marginal cost.

💡 Memory Hook

Compare MR and MC: increase, decrease, or stop at equality.

📖 4. Perfect Competition and Supply

🔑 Key Concepts & Definitions

• Perfect competition : characterized by homogeneous products, free entry and exit, and price-taking firms that are too small to influence market price

★ Must-know

📐 Formula — For a competitive firm, price equals marginal revenue, so the supply decision satisfies $P = MR = MC$.

📌 In the short run, a competitive firm shuts down when price is below minimum average cost.

Further detail

• The market price is determined by aggregate demand and aggregate supply, while each competitive firm chooses its output at the given price.

💡 Memory Hook

Competitive firms take price; monopolists choose price through demand.

📖 5. Long-Run Competitive Equilibrium

★ Must-know

• Long-run competitive adjustment occurs through entry when firms earn positive profit and exit when firms earn negative profit.

📌 Long-run competitive equilibrium requires active firms to maximize profit and earn zero economic profit, so price equals both marginal cost and average cost.

Further detail

• In long-run competitive equilibrium, firms cover all costs including the entrepreneur’s opportunity cost.

💡 Memory Hook

Entry raises supply and lowers price until firms earn zero economic profit.

📖 6. Monopoly Pricing

★ Must-know

📐 Formula — Total revenue equals price times quantity: $TR = P(Q)Q$.

📐 Formula — For a monopolist with inverse demand $P(Q)$, marginal revenue is $MR = P(Q) + \frac{dP}{dQ}Q$.

📌 A monopolist chooses quantity where marginal revenue equals marginal cost and then obtains price from the inverse demand curve.

Further detail

• Fixed costs determine whether the business is profitable but do not determine the monopoly pricing decision.

💡 Memory Hook

A monopolist faces MR below price because lowering price affects all units.

📖 7. Elasticity and Markups

🔑 Key Concepts & Definitions

• Price elasticity : measures the responsiveness of quantity demanded to a change in price: $E = -\frac{dQ}{dP}\frac{P}{Q}$

★ Must-know

📌 A price increase raises total expenditure when demand is inelastic and lowers total expenditure when demand is elastic.

📐 Formula — The monopoly markup rule is $\frac{P-MC}{P}=\frac{1}{E}$.

Further detail

• A monopolist operates on the elastic portion of demand because marginal revenue must be positive when marginal cost is positive.

💡 Memory Hook

More elastic demand limits the markup and lowers the profit-maximizing price.

📖 8. Strategic Interaction and Games

🔑 Key Concepts & Definitions

• Game theory : studies rational behavior in interactive or interdependent situations in which each player’s outcome depends on the actions of others
• Dominant strategy : gives a player a higher payoff regardless of what the other player does
• Nash equilibrium : is a combination of strategies in which no player has a unilateral incentive to change strategy

📝 Essential Points

• A Nash equilibrium is not necessarily efficient, as illustrated by the Prisoner’s Dilemma.

💡 Memory Hook

A decision depends only on one’s own choice; a game depends on others’ choices.

📖 9. Sequential Games and Entry

🔑 Key Concepts & Definitions

• Backward induction : solves a sequential game by determining optimal actions at the final decision nodes and then reasoning backward to earlier decisions

★ Must-know

📌 A threat in a sequential game matters only when it is credible, meaning that carrying it out is optimal when the relevant decision node is reached.

• To solve a sequential game, start with the last move, determine the player’s best action, eliminate inferior branches, and repeat backward.

Further detail

• In the market-entry game, the monopolist’s threat to fight entry is noncredible when accommodation gives the monopolist the better response after entry.

💡 Memory Hook

Look forward, reason back, and eliminate noncredible threats.

📖 10. Oligopoly Competition

🔑 Key Concepts & Definitions

• Oligopoly : is a market with a finite number of firms whose decisions affect one another strategically
• Stackelberg game : is a sequential competition model in which the leader moves first and anticipates the follower’s reaction curve

📝 Essential Points

📌 Cournot competition involves simultaneous quantity choices, whereas Bertrand competition involves simultaneous price choices.

• With homogeneous products, price competition can lead firms to undercut one another until price equals marginal cost.

💡 Memory Hook

Cournot firms choose quantities, Bertrand firms compete in prices, and Stackelberg firms move sequentially.

📖 11. Demand Estimation and Shifts

★ Must-know

• Demand depends on:
  • own price
  • prices of other goods
  • income
  • tastes

📌 An increase in the price of a substitute increases demand for the good, whereas an increase in the price of a complement decreases demand for the good.

📌 An increase in income increases demand for a normal good but decreases demand for an inferior good.

Further detail

• Demand estimation specifies a demand equation, collects data, and fits the equation using regression techniques.

💡 Memory Hook

A price change moves along demand; income, tastes, and other prices shift it.

📖 12. Market Equilibrium and Welfare

🔑 Key Concepts & Definitions

• Consumer surplus : is the area below the demand curve and above the market price, representing buyers’ gains from trade
• Producer surplus : is the area above the supply curve and below the market price, representing sellers’ gains from trade

📝 Essential Points

📐 Formula — Market equilibrium occurs where quantity demanded equals quantity supplied: $Q_d = Q_s$.

📌 A per-unit tax on sellers shifts the supply curve upward by the tax amount, while a per-unit tax on buyers shifts the demand curve downward by the tax amount.

• A sales tax reduces total welfare by creating deadweight loss from unrealized gains from trade.

💡 Memory Hook

Consumer surplus benefits buyers, producer surplus benefits sellers, and taxes create deadweight loss.

📊 Synthesis Tables

Cost Concepts

Concept	Meaning	Decision treatment
Sunk cost	Already incurred and unrecoverable	Ignore
Opportunity cost	Return from the next-best alternative	Include
Accounting cost	Recorded monetary expense	Include
Economic cost	Accounting cost plus opportunity cost	Use for project decisions

Market Structures

Market	Firm behavior	Key condition
Perfect competition	Price taker	P = MC
Monopoly	Chooses quantity and obtains price from demand	MR = MC
Cournot oligopoly	Chooses quantity strategically	Mutual quantity best responses
Bertrand oligopoly	Chooses price strategically	Mutual price best responses