Download Cost Curves of the Individual Firm

Micro
Cost Curves of the Individual Firm
Total Fixed, Total Variable,
and Total Costs
Average Total Cost, Average Variable,
and Marginal Costs
Long-Run Avg. Costs
Total Cost (TC) – the amount a firm pays to buy the inputs
for production (TC=FC+VC)
Fixed Cost (FC) – costs that do NOT vary with the
quantity of output produced
Variable Cost (VC) – costs that DO vary with the quantity
of output
Average Total Costs (ATC) – total costs divided by the quantity of output (TC/Q)
Average Fixed Costs (AFC) – fixed costs divided by the quantity of output (FC/Q)
Average Variable Costs (AVC) – variable costs divided by the quantity of output (VC/Q)
Marginal Costs – the increase in total cost that arises from an extra unit of production (TC/Q)
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Average and Marginal Costs:
Average Variable and Average Total Costs decrease as long as Marginal Costs are less than Average.
When MC=ATC or MC=AVC, the average costs are at their minimum. When marginal costs are greater
than average costs, average costs are rising.
The Sum of the MC curve greater than AVC is the “supply” curve for the firm. Therefore, the sum of
MC’s for the firms makes up the Supply curve for the entire market.
Law of Diminishing Marginal Return: As additional resources
are added to increase output, the marginal output (MP) will
decrease after a point. Total output will be a maximum where
MP=0. Marginal Costs (MC) are inverse to Marginal
Product(MP)
Total Output (TP)
Average & Marginal Product
Micro
Production Possibilities Curve:
 Shows possible outputs for alternative uses of inputs
 Shows Opportunity Cost of various production levels
 Optimal point on PPC is where MB=MC
 Incremental increases in producing one alternative causes
increasing costs of the other given up (Law of Increasing
Opportunity Costs
 Production inside the PPC is inefficient/wasteful
 Production outside the PPC is essentially impossible in
long-run
Economic Growth: Outward movement of PPC. Caused by:
 More resources
 Technology
 Investment in Human Capital
 Specialization
Productive Resources:
Natural (Land)
Human (Labor)
Capital
Entrepreneurial
Supply and Demand
Supply
Price
$60
40
20
Demand
0
50 100 150 200
Quantity
Demand
 Income Effect
 Substitution Effect
 Law of Diminishing Marginal Utility
Causes of Shifting Demand:
-Income
-# Consumers
-Tastes
-Prices of Substitutes, Complements
-Situation
-Expectation of future price
Supply
 Law of Diminishing Marginal
Return
 Direct Price/Quantity relationship
 The sum of market firm’s Marginal
Costs
Causes of Shifting Supply:
-Change in variable costs
-# of producers in market (Long-run)
-Expectation of future price
Micro
Shortage
Surplus
Producer/Consumer Surplus
Price Elasticity:
Ep 
(Q 2  Q1) /
( P 2  P1) /
2
( P1  P 2)
(Average)
2
%Q (Q 2  Q1) /(Q1)

(Point)
%P ( P 2  P1) /( P1)
Ep=1 Unitary
Ep>1 Elastic
Ep<1 Inelastic
Demand Elasticity Determinants:
 Necessity of product
 Expense of product (as % of budget)
 Number of Substitutes for product
 Amt. of time to adjust to price changes
Supply Elasticity Determinants:
 Complexity of production process
 # of different resources used
 Amt. of time to adjust production when prices change
Ec 
%Qx
%Py
Cross Elasticity:
X and Y are related products
Ey 
%Q
%Y
Income Elasticity:
Normal and Inferior Products
(Y=income)
Demand Elasticity and Total Revenue
Ep 
(Q1  Q 2)
Micro
Perfect Competition:
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Very many firms
Homogenous product
Perfect information
Easy entry, exit
Long-run Normal profits
P=MR=AR=d
MR=MC= Profit Maximization or Loss
Minimization output
Cost changes for one firm will NOT
impact Market Supply
Short-Run:
Some cost(s) is/are Fixed. A change in
variable costs will shift market supply.
Changes in Fixed Costs (S-R) will NOT
change firm or market output or pricing
Allocative Efficiency (P=MC)
Productive Efficiency (P=MC=ATC)
Long-Run:
All costs are variable. Market Supply shifts
with firm entry/exit.
Monopolistic Competition
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Several Firms
Differentiated, but similar products
Easy Entry, Exit
P>MR
MR=MC=Profit Max. or Loss Min.
Inefficient in Long-Run (Cost of Variety)
Normal Profits in Long-Run
Firm demand shifts with MR as firms enter
or exit the market
Shutdown: (Short-Run)
AVC<P when MR=MC
Operate: (Short-Run)
AVC>P when MR=MC
w/Short-Run
Losses
Cost changes for one firm will NOT impact
Market Supply,
Firms tend to have extensive Constant
Returns to Scale in Long-Run Costs
Remember !!:
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Short-Run changes to variable costs (AVC) ONLY will shift Market Supply
Costs do NOT change in the Long-Run. All firms are Constant Cost Industries (CB promise)
Micro
Game Theory
Oligopolies
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Few firms dominate market
Products are very similar
Barriers to Entry
Long-Run profits possible
Theories:
 Game Theory
 Kinked Demand (Non-collusive, interdependent)
 Cost Plus pricing
Collusive Oligopoly (Shared Profit Cartel)
Non-Collusive Kinked Demand
Oligopoly Notes:
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Oligopolies are tough to analyze. Note the assumptions.
Cartels are fragile. There is high incentive to cheat.
In Game Theory, find the Nash Equilibria and the dominant strategy. There won’t
always be one!
Oligopolists rely on advertising to try to differentiate. Very little price competition, if
any.
Price Leadership is very common. Firms will very often follow the pricing strategies of
competitors.
Pricing and output tend to be relatively stable.
There is extremely little opportunity for new firms to enter these markets. Positive
profits are very common in the Long-Run.
Micro
Pure Monopoly in Long-Run Equilibrium
Monopolies:
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One dominant firm
No entry. Substantial barriers (Monopoly
Rent Seeking
Allocatively and Productively Inefficient
P>MR
MR=MC is optimal output
Monopolies are illegal under Sherman AntiTrust Act. (Remember ATT, Microsoft)
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Types:
Pure
Natural
Geographic (Local)
Natural Monopoly (graph left)
Definition: Costs decline through the range of
Demand due to extensive Economies of Scale.
They are desirable due to these low cost production
capabilities.
Regulation:
F.R.=Fair Return. Firm is allowed to earn Normal
profits
S.O.=Socially Optimal. Firm is controlled to
permit Allocative Efficiency. Typically they must
be subsidized to continue Long-Run operations.
P
Monopoly Price Discrimination:
MC
ATC
D=P=AR=MR
Total
Revenue
Q1
Q
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Condition:
Control of the market
Ability to segregate buyers
Ability to prevent resales
Product is sold to each buyer at the highest price that the
buyer will pay. No consumer surplus exists.
Monopolist will sell Q1 units, and total revenue will equal
the sum of the selling prices. (MR=P)
Monopolists can also price discriminate based on elasticity
of different consumer groups.
Micro
Factor Markets
The market demand for resources is DERIVED from
the market for products.
Some Important Formulas:
TR
TP
Dresource   MRP
MR 
TP
QLabor
TFC
MFC 
QLabor
TFC  QLabor * Wage
TC
MRC 
QLabor
MP 
MRP  MP * MR 
Optimal Resource Utilization occurs where:
MRP=MFC
TR TP
*
TP QLabor
Notes:

Changes in productivity will affect both MRP
and MC (opposite directions)

Changes in product demand in one market MAY
NOT shift demand for a resource, but will shift
MR and MRP for the firm

Resource prices in the market are a function of
Supply and Demand for that resource

Slope of MRP curve for firm will be greater the
LESS competition in the product market
Least-Cost Resource Combination:
MPL MPK MPN


PL
PK
PN
Profit Maximizing Resource Combination:
MRPL
MRPK
MRPN
1
1
1
MFCL
MFCK
MFCN
Micro
Factor Markets (Cont’d)
Monopsony
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Single resource buyer
Optimizes resource use where MRP=MFC
MFC>Wage
Pays lower wage and employs fewer than competitive
resource market
Market Failures and Government Intervention
Negative Externalities (Spillover Costs):
MSC>MPC
Some market costs are paid by parties outside the
market (Ex: pollution)
Overallocation
Positive Externalities (Spillover Benefits):
MSB>MPB
Benefits are received by parties outside the market
for the product (Ex: lighthouses)
Underallocation
Government can correct externalities with:
Taxes
Regulations
Fines
Subsidies
Public Goods
Tax Policies:
Negative Externality
Correction
MSC
MPC
Progressive vs. Regressive taxes
Positive Externality
Corrections
MPC
MSC
MSB
Benefits-Received vs. Ability-to-Pay taxes
MSB
MSC
Tax Incidence
MPB
MSB
Micro
Income Distribution
Inequities caused by:
 Abilities
 Discrimination
 Preferences
 Education
 Wealth
 Chance
Income Disparity has increased because of:
 increased demand for skilled workers
 increased international trade (lower world wages)
 decreased influence of labor unions
 shift to service oriented economy (lower income
jobs)
Argument FOR Inequality:
Income inequality provides incentives for individuals to innovate and grow the economy as a means of
increasing personal income
Argument AGAINST Inequality:
Redistribution of income will result in increased Total Utility in society.
Economics of Public Policy
Inefficient Voting
Public programs may be implemented (or not implemented) because of the distribution of benefits vs.
costs within the society.
Inefficient “Yes” Voting – policies pass when policy costs to society are greater than society’s benefit.
Inefficient “No” Voting – policies are rejected by voters even though total costs to society are lower than
total benefit to society.
Logrolling
Inefficient programs are implemented because policy-makers garner support for their program by
promising support to fellow policy-makers in their inefficient programs.
Benefits vs. Costs
Public policies that involve immediate benefits but delayed costs are favored over policies that involve
immediate costs with delayed benefits. Total Benefits vs. Costs are not a factor of decision making.