1
Operations Decision
Assignment 2: Operations Decision
Marian McGhee
Mr. Japheth Kessio
Economics 550
May 19, 2014
2
Operations Decision
Today, life has become very fast. In today’s fast living world, the value of time has
increased a lot. Most of the people are working and hardly find any time to cook for themselves.
In this busy schedule, the introduction of low calorie microwavable food has lives of people
much more easier. These products are easily consumable and hence have become very popular.
As discussed in assignment 1, the market structure (or selling environment) was perfectly
competitive. In a perfectly competitive market there are a large number of buyers and sellers.
The products sold in this market are perfectly homogeneous. Examples of perfect competition
are vegetable market, market for cereals etc. In a real world situation, there are many sellers of
low calorie microwavable food. If we observe the demand side, we can also find a large number
of buyers in the market. With large number of buyers and sellers, if we examine the nature of the
product, then we can see that the products are almost homogeneous.
The main characteristics of perfect competition are:
i.
Many buyers and sellers
ii.
Free entry and exit
iii.
Information is perfect
iv.
Homogeneous product
Now, firms under perfect competition have no market power and hence cannot affect the
market price. They are bound to sell at the ongoing market price.
But recently, it has been observed that the characteristics of the market are changing. Since the
tastes of people are different, there is a lot of scope for product differentiation in this market. The
sellers are also taking the advantage of this taste differentiation and are differentiating their
3
Operations Decision
product. Thus the sellers of the microwavable food industry are trying to outperform each other.
Due to product differentiation, the products no more remain homogeneous.
Now, in a monopolistic competitive environment, advertisement plays an important role. Here
also, the sellers of the microwavable food incurs advertisement expenditure to promote their
product.
In assignment 1, the market structure was perfectly competitive. Hence the equilibrium price and
quantity were determined by the interaction of the demand and supply curve. But the profit
maximizing condition for a monopolistic competitive firm is different from a perfectly
competitive firm. For a monopolistically competitive firm,
Profit (π) = Total Revenue (TR) – Total Cost (TC)
= P×Q – TC
According to the FOC of profit maximization, we get
𝑑𝜋
𝑑𝑄
=
𝑑(𝑇𝑅)
𝑑𝑄
-
𝑑(𝑇𝐶)
𝑑𝑄
[Here P is not fixed]
= MR – MC = 0
Therefore MR = MC
In assignment 1, the demand function is estimated as:
Option 1: QD = - 5200 - 42P + 20PX + 5.2I + .20A + .25M.
Option 2: QD = - 20,000 - 100P + 15A + 25PX + 10 I
4
Operations Decision
Now, we will find the equilibrium price and quantity for both the cases.
Option 1:
Putting the values of the independent variables, we get,
Qd = 38,650 - 42P
Therefore, inverse demand function is:
P = 38650/42 – Qd/42
Therefore, Total Revenue (TR) = P×Q = 38650Q/42 – Qd2/42
Marginal revenue (MR) = 38650/42 – Qd/21
= 920.2380952 - 0.047619048Qd
The cost functions are given as:
TC = 160,000,000 + 100Q + 0.0063212Q2
VC = 100Q + 0.0063212Q2
MC= 100 + 0.0126424Q
Now, a monopolistically competitive firm equates its MR with MC, i.e. at profit maximizing
output, MR = MC holds.
Therefore,
920.2380952 - 0.047619048Q = 100 + 0.0126424Q
Or, 0.174043Q = 820.2381
Therefore, Q* = 4712.846 ≈ 4713
5
Operations Decision
And P* = 808.0274742 ≈ 808
Option 2:
Putting the values of the independent variables, we get,
Qd = 31410 – 10P
Therefore, inverse demand function is:
P = 3141 – 0.1Qd
Therefore, Total Revenue (TR) = P×Q = 3141Q – 0.1Qd2
Marginal revenue (MR) = 3141 – 0.2Qd
The cost functions are given as:
TC = 160,000,000 + 100Q + 0.0063212Q2
VC = 100Q + 0.0063212Q2
MC= 100 + 0.0126424Q
Now, a monopolistically competitive firm equates its MR with MC, i.e. at profit maximizing
output, MR = MC holds.
Therefore,
3141 – 0.2Q = 100 + 0.0126424Q
Or, 0.326424Q = 3041
Therefore, Q* = 9316.104208 ≈ 9316
And P* = 2209.389579 ≈ 2209
6
Operations Decision
Thus, we can see that the equilibrium quantity is much lower than the value found in assignment
while the equilibrium price calculated is much higher. Therefore, if the market structure becomes
monopolistically competitive, then the equilibrium price will increase and the equilibrium output
will fall.
From the cost structure we can see that the industry has a huge fixed cost. This implies that in the
short run, it will be difficult for the firms to earn pure economic profit. If we calculate the profit,
we can see that in both the cases, the firms incur losses in the short run.
Like perfect competition, a monopolistic firm can earn normal profit, super normal profit
or even can incur losses in the short run. But in the long run it only earns normal profit. Suppose
that a monopolistic competitive firm earning a pure economic profit in the short run. This will
attract other firms outside the industry. With the increase in the number of firms in the industry,
the number of products available to a consumer also increases. The proportionate demand curve
for each firm will shift to the left. Similarly, if the firms were initially incurring losses, few firms
will go out of the industry which will shift the proportionate demand curve to the right. This
process of entry and exit will continue till firms are earning zero profit. Thus, in the long run it
earns only zero economic profit.
7
Operations Decision
Short Run Equilibrium
Long Run Equilibrium
Now, the question is, “whether the firm will continue production or not?”. We know that the
firms can continue production in the short run even incurring losses if it can recover some of the
variable costs. Mathematically, if P > AVC, then the firms will continue production. If we check
this condition, we can notice that in both the cases, the firms can recover the variable costs, i.e. P
8
Operations Decision
> AVC holds. Therefore the firms should continue production in the short run even incurring
losses. In the long run, there are no fixed costs. The firms are only left with variable costs.
Therefore, in the long run, these firms can earn economic profits. If we calculate the profits
earned by the firms in the long run, we can see that the firms earn economic profit in both the
cases.

Profit in the long run:
Option 1:
Perfect competition: 3200652.023
Monopolistic competition: 3196424.852
Option 2:
Perfect competition: 5545261.57
Monopolistic competition: 19102677.47
Therefore, the company should focus on expanding its business by increasing the variable factor.
As the low calorie microwavable food firm belongs to a monopolistically competitive market, it
would focus on advertising of its products to highlight the same to the consumers. From the
previous assignments we can observe that advertisement plays a very important role in
determining demand. If it can attract more customers, then the market share of the firm will
increase. As concentration ration increases, profits will also go up. In a monopolistic competitive
market, a firm charges a price greater than the marginal cost. Therefore the firm has certain
degree of market power. Market power is define in terms of Lerner’s index, where Lerner’s
index is denoted as:
9
Operations Decision
Lerner’s index (L) =
P – MC
P
1
=-e
[Where, e = own price elasticity]
Therefore, Lerner’s index is inversely related to the price elasticity of demand.
Now, in order to make their products as inelastic as possible, the firm will try to
differentiate its product from other firms’ products. If their product is different from others then
the consumers will not find a substitute for that product easily. That will make the demand for
the corresponding product inelastic in nature. We all know that the greater the degree of product
differentiation, the greater the market power. Therefore, it is advisable for the organization to
perform active product differentiation to maximize its profits.
10
Operations Decision
References
Chan, F. (2014). Cross elasticity of demand. Fullerton College. Retrieved 4 May 2014, from
http://staffwww.fullcoll.edu/fchan/Micro/2cross_elasticity_of_demand.htm
McGuigan, J. R., Moyer, R. C., & Harris, F. H. deB. (2014). Managerial economics:
applications, strategies and tactics (13th ed.). Stamford, CT: Cengage Learning.
Menezes, C. (2014). Advertising-Sales Curve. University of Missouri. Retrieved from
http://web.missouri.edu/~menezesc/4351/6.Monop/Elas_Ad.pdf
Minnesota State University. (2008). Study Guide for Test II. Web.mnstate.edu. Retrieved 4 May
2014, from http://web.mnstate.edu/stutes/econ202/Fall08/study2.htm
Nicholson, W. & Snyder, C. (2012). Microeconomic Theory: Basic Principles and Extensions
(11th ed.). USA: Cengage Learning.
Varian, H. R. (2011). Intermediate Microeconomics: A Modern Approach (8th ed.). NY: Norton
Enke, S. (n.d.). Profit Maximization under Monopolistic Competition. The American Economic
Review, Vol. 31, No. 2, 317-326. Retrieved from
http://www.jstor.org/discover/10.2307/362?uid=3738256&uid=2129&uid=2&uid=70&ui
d=4&sid=21102582087203.
U.S. DEPARTMENT OF JUSTICE.(n.d.).COMPETITION AND MONOPOLY. U.S.
DEPARTMENT OF JUSTICE . Retrieved from:
http://www.justice.gov/atr/public/reports/236681.pdf