Thursday, June 18, 2009

Market Share and Profitability

Yesterday the New York Times reported that Best Buy's market share increased - in part due to the exit of electronics retailer Circuit City and simultaneously Best Buy had a decrease in profitability. Now in an economic downturn lower profits are expected, but this is a good example why a focus on market share does not always equate to greater profitability.

One way to see this is to use the basic monopolistically competitive firm model. As the firm initially increases their share of the market, their operating profit increases and keeps increasing up to the point where marginal revenue equals marginal cost. So we see that the monopolistically competitive firm can increase their output (market share) and simultaneously increase their profits, but this is not always going to be the case.

As the firm increases their market share beyond the point where marginal revenue and marginal cost equalize, an increase in market share results in a decrease in profits.

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