Factors that leads to Profit maximization

Michael Angelo M. Surla

Hand-out Material In Economics

Factors Leads to Profit Maximization

• Market Concentration- refers to numbers of sellers and buyers in the market. The more
concentrated the market means the lesser producers are there in the industry.

• These few suppliers command huge market power in determining the price in the industry.
Thus, a monopolistic market is considered the most concentrated with a single seller
determining the price that would maximize the profit of the business enterprise.

• Conclusion: Market Concentration

• Minimal Profit- Many Sellers

• Medium Profit- Few Sellers

• High Profit- One Seller

• Market Entry

• Is the planned method of delivering goods or services to a new target market and distributing
them there.

• Bringing in of products or associated products into the target market

• Barriers to entry- refers to inherent features of the industry and various means devised in the
market to prevent the entry of potential players and competitors that want to take advantage of
the enormous profit in industry.

• Two Main categories of market barriers

• 1. Scale barriers- refers to requirements for a large production plants for feasible operation in
the industry

• This in turn will require huge amounts of capital and resources to establish a factory in the
industry

• Thus, existing players have market power since since potential entrants without the necessary
resources may be automatically excluded and prevented in entering the industry.

• Legal Barriers- refer to proprietary rights and their corresponding legal production and
distribution of a product or services
• Example; patents, copyrights and other intellectual property rights.

• Conclusion: Market Entry

• Minimal Profit- No barriers to Entry

• Medium Profit- Some Scale Barriers / Contestable Market

• High Profit- Scale and Legal Barriers ; Gov’t Barriers.

• Product Differentiation

• This factors refers to the ability of a business firm to create a market niche through several
means of varrying its product and services.

• The ability of the business enterprise to convince the buyers that the product or services it is
selling is different from similar products and services can give market power to the firm.

• Conclusion in the Product Differentiation

• Minimal Profit-Homogenous Goods

• Medium profit- Some Degree of Product Differentiation

• High Profit- Highly Differentiated Products.

• Limited Information

• This elements refers to the unevenness in the distribution of information among the actors in
the market. When market actors are not evenly informed those with more information can have
market power and extract surplus from the other actors.

• Conclusion:

– Minimal Profit- perfect information to all participants

– Medium Profit- Limited Information

– High profit- Very limited information

• Examples of Information which are vital on the part of other sellers

1. New technologies

2. Sources of raw materials

3. Innovative Products

4. And processes that are not available to other potential sellers.

 • Market Power

• It refers to the ability of the firm to increase the prices of its products and services

• In order words it refers to the power of the business to control or manipulate the prices of
goods and services

• It is the ability of any actor or group of actors in the market to significantly influence the price in
the market and the quantity to be produced or sold.

• Conclusion:

• Minimal Profit – No Market Power

• Medium Profit- Limited Market Power

• High Profit- High Market Power

• Market Structure

• Market- refers to the place where buyers and sellers meet or transact its business.

• Structure- generally refers to models, it refers to a form it refers to the organization.

• Market structure- refers to the characteristics of a market, wherein it consist of the

organization, the process on how sellers compete with their products and services with one
another and the manner how the sellers differ when it comes to the ability to set and influence
the prices of goods and services.

• Two types of Market Structure

1. Perfect Type

2. Imperfect Type

Perfect type

a. Perfect or pure competition

b. Pure Monopoly

Imperfect type

a. Monopolistic competition

b. oligopoly.

• Perfect Competition
 • Is a market situation where there is a large number of independent sellers offering identical
products

• Products are identical or homogenous

• Examples are Farm products, rice , corn, vegetable sellers

• No single seller and no single buyer can influence change in market price of a product.

• It is easy for new firms and sellers to enter the market and for existing firms or sellers to leave
the market.

• There is no non – price competition.

• Perfect competition – is described as a market structure where no single seller or single buyer
has power to determine the price and the level of output in the market.

• Pure Monopoly

• Refers to a market structure where there is only one seller or producer supplying unique goods
and services .

• Monopsony- a one –buyer market situation

Example the government as a buyer of fighter jets and armoured weapons

Products in pure monopoly are unique in the sense that there are no good or close substitute available.

• Examples of Monopoly MERALCO, PLDT, MWSS

• Monopolist makes the price

• In monopoly it is extremely difficult for new firms to enter the market.

• Monopolistic Competition

• Pertains to a market situation where there is relatively large number of small producers or
suppliers selling similar but not identical products.

• Products are differentiated

• Examples banks, drugs tailoring shop, gasoline station

• Limited control of the price of goods and services

• Oligopoly

• Is associated with a market situation where there are few firms offering standardized or
differentiated goods and services
 • Oligopsony- a few buyer market situation

• Products are identical or differentiated

• Example of businesses car industry, airplanes, sewing machines, cement industry,

• There is a need of enormous amount of money to establish such business.

• Conclusion

• MINIMAL PROFIT- Perfect competition

• MEDIUM PROFIT- Oligopoly and Monopolistic Competition

• HIGH PROFIT- Monopoly.

• Porter’s Five Forces of Competitive Position

• This framework was developed by Michael Porters in 1979 as alternative Perspective on the
profitability analysis and on the attractiveness of an industry for business ventures

• The five Forces are

1. Competition among rival firms within the industry

2. The bargaining power of consumers

• 3. the bargaining power of Suppliers

• 4. threats of entry of rival firms

• 5. threat of substitute products and services

According to Porter, the stronger the forces of competition have bearing on the industry the lower its
profitability and less attractive the industry for business enterprise.

• Competition Among Existing firms in the Industry

• Comes from the competitive behavior of existing players in the industry.

• Industry compete with one another to improve their market control and profitability

• The forces of competitive behavior will depend on the structure of the market

• In a Monopoly market- there is only one seller in the industry which enjoy market power. As a
consequence, THE COMPETITIVE PRESSURE COMING FROM RIVAL FIRMS IS ALMOST ABSENT
BECAUSE THE FIRM IS A SINGLE PRODUCER OF A HIGHLY DIFFERENTIATED PRODUCTS.
• ON THE OTHER HAND, in a competitive market, the aggressive forces coming from rival
companies are intense that a business enterprise is weak in mitigating these strong forces
because there are too many players in the market selling similar products.

• In an oligopolistic market, the forces of competition will depend on the behavior and the
interactions of the few firms in the industry.

• Bargaining Power of the Customers

• Although buyers are supposed to be served by sellers the interests of these market players are
conflicting. Buyers prefer lower price to enhance their level of satisfaction while sellers want
higher price to maximize their profits.

• That forces comes from the bargaining or market power of the buyers

• Example in a monopsony the sole buyer can have a huge bargaining power on the sellers in the
industry if this sole consumer does not buy from the company it does not only threaten the
profitability of the business enterprise but also its survival.

• To mitigate the bargaining power of the buyers of the products and enhance profitability

• These are the options

• 1. Diversification- diversify the buyers of the product meaning it frees the dependence of a
business enterprise and the industry on a single or relatively few buyers.

• 2. to sell differentiated products in the market the industry is able to segment or divide its
product lines.

• Bargaining Power of Suppliers

• The process of production involves the conversion of raw materials or intermediate inputs
performed by factors or processing inputs to produce an output. Thus, a business enterprise as
well as the industry will need raw materials as intermediate inputs to be further transformed. If
the industry sources its raw materials from a single or few suppliers; these suppliers can have
strong forces on the industry that may lower industry profitability.

• Threats of Potential Entrants

• Potential entrants to the industry are realistic threats especially if the industry is very profitable.

• Scale and legal barriers within the industry can reduce the competitive force that these potential
competitors may pose on existing players

• In case of san Miguel Corporation, to arrest the competitive edge of its potential rivals in the
beer market, they introduced various products lines from the original San Miguel beer to cater
to various markets
• Threat of Substitute Goods

• This legitimate factor was considered by the OPEC member countries when they impose
production cuts in the 1970s

• Usually, industry that exhibit high rate of profitability are the ones challenged by the emergence
of substitute goods

• The cross elasticity of demand is the responsiveness of the demand for a substitute good due to
a change in the price of the product produced in the industry.

• The strategy of existing players in mitigating the threats of substitute goods is to lower their
cross elasticity of demand with the product of the industry.

• Environmental Scanning

• The profitability is influenced by various factors that directly affect the competitiveness of the
industry as articulated in Porter’s five forces of competitive positions. However , the indirect
impact of factors and forces were not considered in these analyses, we will identify these factors
and forces through the use of ENVIRONMENTAL SCANNING OF AN INDUSTRY