Download In any business, the market value of all the inputs used for

LONG-RUN
Another way to look at firms is in the big picture, the long run. Long run is the period of
time in which quantities of all inputs can be varied. Associated with this concept is
economies of scale. Economies of scale refer to the decrease in cost per unit of a product
(aka average total cost) due to increased production (Diseconomies of scale vice versa).
For example, suppose that the Nestea company found a more efficient way to produce
their bottled tea due to technological advances. This would bring about increased
production, which would then decrease the price of each product. The opposite would
have to occur to have diseconomies of scale. The graph below helps to illustrate this
concept.
Avg cost
LRAC
EoS 
CRoS 
DoS 
Output
In this graph, economies of scale (EoS) is shown by the decreasing avg cost curve while
the diseconomies of scale (DoS) is shown with an increasing part of the avg cost curve.
The CRoS, the abbreviation for constant returns of scale, is shown in the middle of the
graph where it is a line because CRoS is where avg total cost stays the same as output
changes.
Speaking of cost curves, there are several of them. Among them are long-run average
total cost and long run average variable cost; however, in the long run, these two cost
curves are the same, since there is no long-run average fixed cost curve. Their graphs
are very similar to those in the short run.
Prices
LRATC=LRAVC
Quantity
REVENUES
What do producers care about the most? The answer would be profit, which is the
difference of how much they sell and how much they paid to produce the product. In
technical terms, these two concepts are called total revenue and total costs. Total revenue
is defined as the amount a firm, such as Nike or McDonalds, receives for sale of its
products while total cost is the value of inputs a firm uses in production.
Another economic concept similar to this one is called marginal revenue. Marginal
revenue is the revenue with one additional unit of production. Let’s say that American
Eagle Outfitters decide to increase their supply of girls’ pink blouses from 400 to 401.
The additional revenue that comes from this increase is the marginal revenue. However,
doesn’t this sound like price? It does sound like price because it is price of a product.
The numerical increase of total revenue that American Eagle would get from increasing
their supply with one more blouse represents price. Therefore, MR=price.
Yet another idea that ties in well with the other two is that of average revenue.
The formula that is its definition is total revenue/quantity sold (TR/Q). However, does
this not sound like price? It does because once total revenue (PxQ) divided by quantity
(Q) should become P, price. Therefore, Price=AR.
PROFIT
Already mentioned, what producers want is profit. However, there are two kinds of
profits: normal profit and supernormal profit. Normal profit is also 0 economic profit.
What is economic profit? It is profit (TR-TC), including explicit and implicit costs.
While explicit costs are those that involve directly paying money (eg wages), implicit
costs are otherwise known as opportunity costs (eg time and not being able to make
another product). Going back to normal profit, NP would be where TR and TC “cancel
each other out” to equal 0, meaning they would be the same number. On the other hand,
supernormal profit is a profit that exceeds the amount that a firm must make to be able to
continue trading (aka economic profit= ((P-ATC)Q)
As already stated, profit = total revenue –total cost (Profit=TR-TC). However, there is
another way of defining profit: Profit=MC=MR. Called the Golden Rule, This idea is
demonstrated in the graph below, where X marks the spot (MC=MR).
$
MC
.
P
X
MR
Q
Still, don’t think that firms are just consumer-using monsters only out to get
profit. While profit maximization is the main goal of a firm, there are others, such as
environmental concerns, customer satisfaction, technological advances, working
conditions, and the investment market.
PERFECT COMPETITON
High
price
PC
MC
Output
efficiency




O
M
Low
Characteristics of Perfect Competition
Many buyers and sellers
Goods offered for sale are largely/exactly the same
Firms can freely enter or exit market (aka No barriers).
Because of first 2, each buyer and seller is “price taker”.
Above are the assumptions of this economic model. Why do we call them
assumptions? We call them so because perfect competition does not really exist in the
real world, for the closest example would be the agriculture market (farms). As so, the
demand curve for PC is perfectly elastic.
In the short run, perfectly competitive markets are productively inefficient, since
output will not occur where MC = AC, but it is allocatively efficient, since quantity of a
good sold under PC will always happen where AR=MC=MR (Golden rule), since this is
where profit is maximized. In the long run, profit is maximized at a lower level, for
market supply increases due to increased number of firms, which decreases price, which
will then decrease profits. This will later lead to each firm making 0 economic profit
(aka normal profits), stopping more firms from coming into the market. However, in the
long run, such markets are both allocatively and productively efficient.
What do these terms mean? Allocative efficiency refers to an efficient
distribution of resource where some consumers are not better off than other
consumers; productive efficiency refers to production of a good by a firm
with minimum inputs. AE is where P=MC whereas PE is where MC=ATC.
Going along with the concept of markets coming in and coming out, firms would
shut down if price is below average variable cost (AVC) in the short run, for if a firm
shuts down temporarily, it still has to pay its fixed costs, since it is a sunk cost, one that
cannot be recovered. So, if AVC> Price, the firm shut down for the day. On the other
hand, Price =ATC is where the market price has to be for the firm to stay open with
normal profit (break even). This information is summarized in the following table and
graph:
P< AVC
P< ATC
AVC<P< ATC
P=ATC
shut down
stay open with econ profit
stay open with temporary loss
stay open with normal profit
SHUTDOWN (P<AVC)
ATC
Price
MC
AVC
P
MR
Quantity
MONOPOLY
A monopoly is defined as a firm that has sole power of product without close
substitutes. Some assumptions of the monopoly model are the following:




1 firm taking control of others
Products sold are unique/without close substitutes
High barriers to entry (3 sources: single firm owns key resource,
patents/copyrights, natural monopoly)
A price maker-absolute market power (ability to influence market price)
Some examples of a monopoly are gas stations in a rural area, small town newspaper, and
utility companies. Since they are either goods that are absolutely needed or a good that is
the only one sold in the area, the company can become a monopoly and maximize profits
at points where they want to, for they know their customers will buy from them. This
implies that they will have always economic profits. Although a monopoly does not have
a supply curve, the demand curve facing the monopolist will be downward-sloping, since
it is the same as the industry’s, since they control the industry’s pricing. Here is a graph
to illustrate this point:
Price
MC
X
P
ATC
Economic Profit
Demand
Q
MR
The profit maximizing level of output (Q) is found by hitting MC=MR, then
going higher until the monopolist hits the demand curve. The corresponding price (P) is
the profit-maximizing price, which is where the monopoly will make the price so that
they can maximize profit. As one can sense, monopolies are neither allocatively nor
productively efficient, for they do not care about the society (AE) nor do they care about
the environment/resource market (PE). They only care about maximizing profits. Also,
seen on the graph is the fact that a monopoly will have deadweight loss, for a monopoly
will never be economically efficient with the “Must-maximize-profit” attitude, especially
when the quantity sold is too low. The area that is striped on the graph is DWL.
While the above was based on the idea of a pure monopoly, there is another kind
of monopoly: a natural monopoly. Natural monopolies exist because the cost of
producing a good or service is lower if there is just a single producer than if there are
several competing producers. An example would be if a water company decided to
monopolize its service within Metro-atlanta, due to increased convenience for the
company and the consumers, decreasing confusion.
When it’s better to have no competition, economies of scale help to regulate prices. The
graph for a natural monopoly is as follows:
Natural Monopoly
Price
ATC
Monopoly
Fair Return
Socially optimal
MC
Demand
Quantity
MR
EXPLAIN GRAPH, NICK!
Below is a table with the advantages and disadvantages of a monopoly compared to
perfect competition.
Monopoly
Adv: Natural monopoliesmost cost-effective way of
providing services
Adv: surplus funds to fund
research & development
Dis: Higher prices DWL
Perfect Competition
Adv: Lower prices
Dis: Non-existent in real
world
Dis: just normal profits
In any business, the market value of all the inputs used for production is called the
total cost. Total cost will include wages, capital, raw materials, and opportunity costs. In
general, all costs are explicit (requiring money to be paid by the firm) except opportunity
costs, which do not require an outlay of money, and is thus an implicit cost.
Explicit Costs can be further divided into two groups: fixed and variable (added
up to total.) Fixed costs are any cost that does not change regardless of changes in
output. For example, a business operating in a rented building must still pay the same
price for rent whether they produce five thousand units of their good or none at all. On
the other hand, variable costs vary with the quantity of produced output. For example, a
producer of shirts would have to buy enough material to make the shirts for every shirt
they make. So if they produce five shirts, they buy enough material for five shirts, but if
they make five thousand shirts, they have to buy enough material for five thousand shirts,
a much larger cost.
Other than total cost, two other measures of cost are extremely useful in
determining how much a producer should produce. First is average cost, which is simply
the total cost divided by the output. The other is marginal cost, which is the total cost
increase added by one extra unit of production. In general, the graph of these four
important curves (MC, ATC, AVC, and AFC) are below. Marginal Cost usually initially
decreases, because an increase in costs will allow someone to more fully use the
equipment (such as getting one employee to fill one task while another does a separate
task, as opposed to making one employee do both tasks) but Marginal Cost will then rise
after a certain amount is produced (because the facility will be used efficiently, and
increasing workers will crowd it.) Average Total cost is U-shaped because of two
reasons. 1) Average fixed cost always decreases with more output because it is spread
out more. And 2) Average variable cost usually increases more as more output is
produced because of diminishing marginal return. So early on, when Average fixed cost
is still high and average variable costs are still low, Average total cost is low. When AFC
begins to decline, and AVC begins to rise, it falls to the bottom of the U. Then, when
AVC begins to increase at larger amounts per increase in unit (on the margin) ATC rises
more and more.
Price
MC
ATC
AVC
AFC
Quantity
There is a difference between Accounting Cost and Economic Costs. Accounting costs
are the equivalent of explicit costs. Any revenue made after Explicit costs is called
accounting profit. But economic cost is accounting cost plus implicit costs (opportunity
costs). In order to have economic profit, a producer must have more revenue than both
explicit and implicit costs.
The law of Diminishing Return states that states that the marginal product of an input will
decline as the input increases. The production function is the comparison of quantity
inputs and the quantity of outputs produced. Total Product would be the total amount of
goods produced, Marginal would be the amount of output made with each individual
increase of input. Average product is the total output over the total inputs.
Short Run ATC in
Small Factory
Short Run ATC in
Large Factory
Short Run ATC
in Medium
Factory
ATC in Long Run
OLIGOPOLY
The model of an oligopoly assumes that:
1) There are only a few sellers in the market
2) Because of this assumption, the sellers have a large impact on the market
3) The sellers offer similar or identical products
One of the ways to measure the type of market is with a “concentration ratio,” which is
essentially the total percentage of output produced by the top four producers.
Collusion and non-collusion are driven by the producers ability to charge the monopolist
price by working together, and thus maximizing their profits, and their desire to “get
ahead” of the other producers and make more. By producing more, they drop the price,
thus beginning competition and ruining the collusion. For this reason, oligopolies will
often (at least want) to form cartels, or official and explicit unison of firms. Though the
producers would prefer this outcome because it allows them to act as a monopoly instead
of competitive markets, this is usually prohibited by anti-trust laws. Collusion produces
at a Nash Equilibrium, which is choosing a strategy in response to another producers
strategy. For this reason, once they reach the optimum point for collusion, there will be
no incentive to alter their plans. An example of a cartel is OPEC. As long as they work
together to keep output lower, prices stay high and revenue increases. When they stop
working together and some produce more than they had planned, the prices drop and
revenue decreases, thus there is no incentive to produce more than the Nash Equilibrium.
MONOPOLISTIC COMPETITION
Monopolistic competition assumes that:
1) There are many sellers
2) Each seller has product differentiation. This means that the products sold are
slightly different from other firms, which allows them to differentiate their
products and use advertising and brand-names. This means that the producers
aren’t price takers, but have a downward sloping demand curve.
3) Free entry (no barriers so firms can enter or leave and drive economic profit to
zero in the long run)
4)
In the short-run, there are two options, either the firm is making a profit (the demand at
MC = MR is higher than ATC) or it’s taking losses (the price for the demand at MC =
MR is less than ATC) The figure on the left displays the first option.
MC
MC
ATC
Price
ATC
Profit
Demand
Loss
Price
ATC
ATC
MR
Profit Maximizing Quantity
Demand
MR
Loss Minimizing Quantity
In the long-run, there is no economic loss or profit (or else firms would exit or enter the
market respectfully) so Price will equal ATC, as below.
Price =
ATC
Profit Maximizing quantity
The efficient scale in perfect competition is the place where ATC is lowest and that is the
price they produce at. In a monopolistic competition, they can produce more (excess
capacity) and still lower the ATC. The place where MC = MR is the efficient production
area for monopolistic competition because it is maximizes profits.
Price
Price
e
D2
e
D2
MC1
MR2
D1
g
MR2
D1
g
MC2
MR1
Q
MR1
Quantity
Q
Quantity
The reason for the kinked demand curve is the fact that other firms will adjust their prices
for a decrease in price (Demand 1 and MR1 apply) but when a firm chooses to increase
their price, other producers will not adjust the prices (no reason to) but if they choose to
lower their prices, the other firms will have to lower their as well, and thus a price war
will lower demand. The point of equilibrium is in the center.
Price discrimination is the practice of selling the same good or service for multiple prices
when the price differences are not justified by the differences in cost.
In order for Price Discrimination to occur, the firm must have:
1) Monopoly power (not necessarily a monopolist, but has to have market power)
2) Market Segregation (must be able to separate buyers into distinct classes)
3) No resale
Firms practice price discrimination because: it allows for more profit to be made, and
allows for more production.
The producers get the advantage of more profit and more production, on the other hand,
consumers get better services if they pay for them. One example of price discrimination
is airline tickets. First class costs more for the same airplane. For this reason, consumers
can buy a first class ticket, and receive better seats for a higher price. The airlines get
more profit from this example, so both sides benefit.
Contestable Markets:
Contestable Markets are characterized by one or few firms producing most of the
products, but they have to charge the competitive price. The reason is there are no
barriers to entry or exit, so if the company should begin to produce and sell at prices
higher than the competitive price (and thus earn economic profits) other firms will jump
into the market, make profits until the price drops, and then leave when they aren’t
making economic profits.
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a2FdKFCTvBkI
Written by Robert Fenner, this article about the betting-shop monopoly of
Tabcorp Holdings Ltd., Autralia’s biggest gambling company, discusses its move to sell
stock of about $300 million to boost its balance sheet. The reason that decided to do this
was that Tabcorp suffered a 3.7% decrease in first-half profit. Considering that Tabcorp
is a monopoly, this significant reduction in profit would be an alarm to the Melbournebased company. In order to increase their profit, its main goal, Tabcorp underwent some
changes, such as decreased dividends and decreased prices of stock.
In the end, the impositions of this changes did their job: increasing the profit of
the betting monopoly that Tabcorp has in Victoria. With the decreased dividends, money
that is paid to the investor, Tabcorp wanted to discourage more investment in their shares,
which would allow them to keep the revenue to themselves, increasing their falling profit.
This hoped=for effect was boosted with the decreased prices at which an investor could
buy a share: to increase investment. Tabcorp wanted to increase the supply of shares so
that even more of the profit would be kept, since the dividend percentage was cut.
Already mentioned, these two changes in policy were able to increase slot-machine profit
by 11%. Also, to attract more customers to Star City, the only casino in Sydney, the
Chief Executive Officer Kupper is initiating an expansion of this area, which includes
new restaurants and a hotel. Although Tabcorp is working hard now to gain as much
profit as it can, they may not be so in 2012, for it is in this year that Tabcorp’s bettingshop monopoly ends, momentarily opening up the market which was previously blocked
by barriers to entry.