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Economics- Theory of the Firm

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Isinsu Kutlu

on 15 March 2012

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Transcript of Economics- Theory of the Firm

Costs of Production Short Run
Period of time in which at least one factor of production is fixed. Production takes places in this period. Long Run
Period of time in which all factors of production are variable (except technology). Planing takes place in this period. Economic Costs Explicit Costs
Costs of factors of production (wages, rent, interest, etc.) Implicit Costs
Opputunity Cost. Economic or Opputunity Costs:
Forgoing the opputunity to produce alternative goods and services. Normal and Economic Profits Normal Profits Normal Profits are required to attract and retain factors.
Normal Profits are treated as a cost! Economic Profits Economic Profit= Total Revenue - Opputunity Cost of all inputs Economic Profit Implicit Costs (Including normal profit) Profits to an Economist Explicit Costs Short-run Costs of Production Total Product Output that a firm produces using its fixed and variable factors in a given period of time. Average Product Output that is produced, on average, by each unit of the variable factor.
AP= TP/V
V- number of units of the variable factor. Marginal Product Extra output that is produced by using an extra unit of the variable factor.
MP= Change in TP/Change in V Total Costs: complete costs of producing an output. Total Fixed Cost: Total cost of fixed assets that a firm uses in a given time. (constant) Total Variable Cost: Total cost of the variable assets that a firm uses in a given time.
TVC= # of variable factors x cost of each variable factor Total Cost: Total cost of all the fixed and variable factors used to produce a certain output.
Average Costs: Costs per unit of output. Average Fixed Cost: Fixed cost per unit of output. (falls as output increases)
AFC= TFC/Q Average Variable Cost: Variable cost per unit of output. (falls as output increases, then starts to rise again as output continues to increase- diminishing average returns)
AVC= TVC/Q Average Total Cost: Total cost per unit of output. (falls and then rises again)
ATC= AFC+AVC/Q Marginal Cost: Increase in total cost of producing an extra unit of output. (tends to fall as output increases, then starts to rise again as the output continues to increase- diminishing marginal return)
MC= change in TC/change in Q Diminishing Marginal Returns As extra units of the variable factor are added to a fixed factor, the output from each additional unit of the variable factor will eventually diminish. Diminishing Average Returns As more of the variable factors are applied to the fixed factors, the output per unit of the variable factor eventually falls, so the cost per unit of output eventually rises. Long-run Average Costs of Production All costs become variable in the long-run. LRAC curve is an envelope to all the SRAC decisions theoretically. Increasing Returns to Scale When long-run unit costs are falling as output increases. A given percentage increase in all factors of production will lead to a greater percentage increase in output, and reduce long-run average costs. Constant Returns to Scale When long-run average costs are constant as output increases. A given percentage increase in all factors of production will lead to the same percentage increase in output and leave long-run average costs the same. Decreasing Returns to Scale When long-run average cost is rising as output increases. A given percentage increase in all factors of production will lead to a smaller percentage increase in output and increase long-run average costs. Economies of Scale Any decreases in the long-run average costs that come about when a firm alters all of its factors of production in order to increase its scale of output. Leads to the firm experiencing increasing returns to scale. Diseconomies of Scale Any increases in the long-run average costs that come about when a firm alters all of its factors of production in order to increase its scale of output. Leads to decreasing returns to scale. Due to the economies of scale LRAC curves are u-shaped in theory. In practice the curve looks like this: Theory of the Firm Perfect Competition Monopoly Monopolistic Competition Oligopoly Market Structure Continuum Perfect Competition Characteristics Very large numbers of producers in the industry.
Standardized product- homogenius
"Price taker"- the firm can't set the price, the price is determined by the industry's supply and demand curves.
Free entry and exit to the market.
Demand to a competitive seller is perfectly elastic.
To increase total revenue firms have to produce more.
Average revenue and marginal revenue are constant- P=MR=AR Profit Maximization MC=MR
Firms would ratehr produce than shut down.
MC=MR is the profit maximiztion in all markets.
Competitive maximize and produce where P=MC.
Short-run loss minimization.
Firms in a perfectly competitive market can make economic profits in the short-run, but in the long-run these profits will get competed away with the new firms entering the market. Monopoly Characteristics Single seller.
No close substitutes in the market.
"Price maker"- many prices
Barriers to entry in the market. Barriers to entry Economies of scale
Legal Barriers: Patents + Liscences
Ownership of essential resources Monopolies are relatively rare but there are times when a monopoly is desired in the industry- electric companies. Natural Monopoly If ATC declines over extended output, least cost of production is realized only if there is one producer. ATC- slopes down with only one producer in the market, with competition it will eventually rise. A monopoly has a downward sloping demand curve. Industry's demand curve is the firm's demand curve, since there is only one firm in the industry. Monopoly vs. Perfect Competition A monopolist is able to reach economies of scale (price low- more consumers in the market) where a perfect competitor isn't able to do this.
Perfect competitors are productively and allocatively efficient- they must produce at the lowest cost and meet the demand. A monopolist isn't productively or allocatively efficient.
Perfect competitor need to be allocatively and productively efficient to stay in the market. A monopolist needs economies of scale to stay in the market.
Monopolistic Competition Characteristics Relatively large numbers of producers:
- small market share
- no collusion
Firms act independently
Product differentiation:
- product attributes
- services
- location
- brand names and packaging
- non-price competition
- advertising
Some control over price. *demand curve is downward sloping When there is economic profit Firms are expected to come into the market and take away the economic profit. *ATC curve is u-shaped because for each variable cost added, the ouput per unit i more so the cost goes down but then Diminishing Marginal Returns come in and raise it up again. When there is economic loss Firms will leave the market. The industry's demand curve will be shared by less firms so the demand will shift to destroy the loss. The firms that stay in the market are also the firms that are the most efficient- they will bring costs down. Efficiency Not productively efficient.
Not allocatively efficient.
Excess Capacity. Oligopoly Characteristics Homogeneous or differentiated product.
Control over price.
Mutual interdependence.
Entry Barriers:
- economies of scale
- high investment capital
Mergers *Market that consists of relatively few sellers, where the actions of each firm usually affect the other firms in the industry. Their products are the same but differentiated. We measure the market concentration by concentration ratios:
Localized markets: different locally than nationally
Interindustry competition
World trade: import competition
Herfindahl Index
Performance Concentration Ratio Levels No Concentration: 0%- P.C or at the very least M.C
Total Concentration: 100%- means an extremely concentrated oligopoly
Low Concentration: 0%-50%, P.C-M.C
Medium Concentration: 50%-80%, oligopoly
High Concentration: 80%-100%, oligopoly-monopoly Oligopoly Models There are 3 models due to diversity in the market:
Kinked Demand Curve: single price- can lead to price wars
Collusive Pricing
Price Leadership
Perfect Competition Model Monopoly Model
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