Simple Example
In a simple case, suppose industry demand for good X at market price P is given by:
Suppose there are two potential producers of good X, Firm A, and Firm B. Firm A has no fixed costs and constant marginal cost equal to . Firm B also has no fixed costs, and has constant marginal cost equal to, where (so that Firm B's marginal cost is greater than Firm A's).
Suppose Firm A acts as a monopolist. The profit-maximizing monopoly price charged by Firm A is then:
Since Firm B will never sell below its marginal cost, as long as, Firm B will not enter the market when Firm A charges . That is, the market for good X is an effective monopoly if:
Suppose, on the contrary, that:
In this case, if Firm A charges, Firm B has an incentive to enter the market, since it can sell a positive quantity of good X at a price above its marginal cost, and therefore make positive profits. In order to prevent Firm B from having an incentive to enter the market, Firm A must set its price no greater than . To maximize its profits subject to this constraint, Firm A sets price (the limit price).
Read more about this topic: Limit Price
Famous quotes containing the word simple:
“Although military, economic and political strength certainly favors the more powerful side, the matter of simple justice is a counterbalancing factor.”
—Jimmy Carter (James Earl Carter, Jr.)
“You are all alike, you respectable people. You can’t tell me the bursting strain of a ten-inch gun, which is a very simple matter; but you all think you can tell me the bursting strain of a man under temptation. You daren’t handle high explosives; but you’re all ready to handle honesty and truth and justice and the whole duty of man, and kill one another at that game. What a country! What a world!”
—George Bernard Shaw (1856–1950)