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ECO404 Managerial Economics GDB 1 Solution Spring 2013

The Case:

In 1976, Steven jobs, then 20 years old, dropped out of college and, with a friend, developed a prototype desktop computer. With financing from an independent investor, the Apple Computer Company was born, revolutionizing the computer industry. Sales of Apple computers jumped from $3 million in 1977 to more than $1.9 billion in 1986, with profits of more than $150 million. The immense success of Apple was not lost on potential competitors, and by 1984, more than 75 companies had jumped into the market. Even IBM, which had originally chosen not to enter the market, soon put all its weight and muscle behind the development of its own version of the personal computer, the IBM PC. Similarly, Michael Dell first built and sold personal computers from his dorm room at the University of Texas in 1984 at the age of 19. Dell Computer Company was initially started from $1000. 4 years later, shares of Dell stock were sold for $8.50 and the IPO raised $30 million. Dell’s name rings from the desktop to the data center. It is the world’s #3rd supplier of PCs that provides a broad range of technology products for the consumer, education, enterprise, and government sectors. Dell was ranked #33 in Business Week’s Top 100 Brands, #34 on the 2008 Fortune 500 list, and was received 400 product awards in 2007. Another name in the computer industry is of Microsoft Corporation, an American multinational software corporation, founded by Bill Gates and Paul Allen, on April 4, 1975. It deals with the development, manufacturing, licensing and supporting of a wide range of computer related products and services. It is the world’s largest software maker company in terms of revenues and also included among the world’s most valuable companies. Microsoft announced in June 2012, that it would be entering the PC vendor market for the first time with the launch of the Microsoft Surface tablet computer. As of year 2013, it is the market dominant company in both the PC operating system and Microsoft Office. The company also produces a wide range of other Softwares for desktops and servers. Standard and Poor’s and Moody’s have both given AAA rating to Microsoft.

Requirement:

Carefully read the cases of world’s three major computer industries, Apple, Dell and Microsoft and point out which theory of profit perfectly fits on this case and why? What are the factors that cause these companies to earn above normal profits? Highlight those factors in the light of all theories of profit that you have studied in your managerial economics course.

Solution:

THEORIES OF PROFIT:

• Risk-Bearing Theories of Profit

• Frictional Theory of Profit

• Monopoly Theory of Profit

• Innovation Theory of Profit

• Managerial Efficiency Theory of Profit

In economics, a firm is a monopoly when, because of the lack of any viable competition, it is able to become the sole producer of the industry’s product.In a normal competitive situation, the price the firm gets for its product is exactly the same as the Marginal cost of producing the product.Because the monopoly firm does not have to worry about losing customers to competitors, it can set a price that is significantly higher than Marginal (Economic) cost of producing (the last unit of) the product.Therefore, a monopoly Situation usually allows the firm to set a monopoly price which is higher than the price that would be found in a more competitive industry.and to generate an economic profit over and above the normal profit that is typically found in a perfectly competitive industry.The economic profit obtained by a monopoly firm is referred to as monopoly profit. The existence of a monopoly, and therefore the existence of a monopoly price and monopoly profit, depend on the existence of barriers to entry: these stop other firms from entering into the industry and sapping away profits.

 

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