Economics notes - Kahviani PDF

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Economics Chapter 8 The Competitive Firm Example : Farming, if you compare two farmers wheat you won’t be able to tell the difference. Profit = Sales revenue – total costs Profit encourages firms to produce products customers desire at prices they’re willing to pay and causes markets to adapt to ch...

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Economics Chapter 8 The Competitive Firm  Example : Farming, if you compare two farmers wheat you won’t be able to tell the difference. Profit = Sales revenue – total costs Profit encourages firms to produce products customers desire at prices they’re willing to pay and causes markets to adapt to changing economic conditions and customer preferences. Explicit Cost – payment made for the use of a resource Implicit Cost – Value of resources used, which no direct payment is made Ex : owner of a business doesn’t get payed for doing work Economic profit = Total Revenue – Total Economic Cost Or = Accounting Profit – Implicit Cost Accounting Cost = Implicit Costs + Explicit Costs Economic Profit is smaller than accounting profit, because there are more costs involved. Normal Profit – the opportunity cost or capital Normal cost is equivalent to an implicit cost and is earned if economic profit is zero. Normal profit is technically a cost (implicit) EQ : Why is economic profit always zero in the long run of competitive market. Because more and more competition arises

Perfectly Elastic

A firms demand curve will be horizontal, Market demand curve will be downward sloping. This is because firms cannot change the price, markets can.

Price Dropped here

But it is dictated here

Firms demand curve -Firm is price taker, will only charge market price. -If it raises price, no one will buy it -If it lowers price, they will sell out There are no pricing decisions all firms take the market price. There are no quality decisions, all products are identical. Only decision left for firms is production. Production decision -Goal is to maximize profit, no revenues. Profit = Total Revenue – Total Costs A firm in the competitive marker maximizes product by producing the optimum level Marginal Revenue = Change in revenue Change in output

Marginal = Extra Revenue =sales Marginal revenue = extra money when you sell one more unit

EQ: You are a firm in a competitive firm, how much money will you make when you produce one extra unit? None, because you sell it at the same price no matter how many you sell.

Never produce a unit of output that yields less revenue than it costs. As output increases marginal cost (MC) increase squeezing the profit from the added units. Compare profit to marginal cost If P > MC, we add profit by selling that one If P < MC, we make a loss by selling that one If P = MC, we make no profit or loss on this one Firm in perfect competition Profit maximizing level of output is where marginal revenue = marginal cost.

@ 9 -> you miss that triangle of profit @10 -> its perfect @11 -> your cost is higher than revenue

Profit Maximization Rule If P > MC, increase outputs, profits will grow.

MR = P = MC

If P < MC, decrease output, losses will go away If P = MC, produce this output because it is the quantity at which profits are maximized.

Economic Loss

Economic Profit

-1 x 10 = $-10

.5 x 10 = $5

Firms in competitive market have zero economic profit in the long run (Easy entry, East exit) Normal profit is good. Profit Maximization Break-Even point Neither loss nor profit

EQ : What does the break-even point represent? -

Long run solution

The Shutdown decision -Shutting down a firm does not eliminate all costs - fixed costs must be paid still - if a firm makes losses, it cannot pay all its fixed costs and its variable costs - the firm will lose less by shutting down (output = 0) if losses from continuing production exceeds fixed costs. Always set P =MR = MC to maximize profit or minimize losses. If price falls below ATC, a loss is made. Firm should not shut down until price falls below ATC.

Investment decision - the decision to build, buy, or lease plants and equipment or to enter or exit an industry. Shutdown decision = short run decision Investment decision = long run decision Fixed costs = owners investment in business, must make enough revenue to recoup money Short run increase output if profits increasing. Decrease outputs if profits decreasing. Raise price, produce more -> lower price, produce less. *The marginal cost curve is the firm’s short tun supply curve, above the shutdown point. *

Chapter 9 Competitive markets Easy entry, easy exit More firms enter, market supply shifts right and prices fall Price falls, economic profits decrease, entry will cease as they get closer to zero. More firms reduce output / exit, market supply curve shifts left, price rises. Economic profit = new firms -> economic losses = drive out firms

Market entry pushes prices down

Firms in a competitive market compete by improving product quality and lowering costs.

If economic profits are high, consumers are willing to pay more than the opportunity cost of resources to acquire a product. -

Signals they want more of that industry. Producers respond by producing more to satisfy consumer demand.

Allocative Efficiency – the industry will end up producing the right output mix Relentless profit squeeze -

High price and profits signal consumers demand for more input

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Economic profit attracts new suppliers. -> market supply curve shifts right, price falls.

Market stabilizes at higher output, lower price, minimum ATC and economic profit at zero Producers must improve their product and innovate technologically to remain competitive.

Chapter 10 Monopoly -> EX : Gasoline Industry in which there is only one producer Competitive market

Monopoly

A monopoly firm has total market power and confronts the downward sloping market demand curve for its own outputs. Marginal Revenue = change in Total revenue / change in demand Market Power – the ability to alter the market price of a good or service. Profit maximization, only one price -

If MR > MR, increase output and profits will rise

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If MR < MC, decrease output, profits rise

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If MR = MC, Produce this amount.

Total barrier to entry Cannot be close substitute No competitive pressure, higher price, smaller quantity. Does not need to increase quantity even if consumers demand more.

Chapter 12 Monopolistic Competition EX: Starbucks A market in which many firms produce similar goods or services, but each maintains some independent control of its own prices. Concentration ratio: the portion of total industry output produced by the largest firms (4) Low concentration ratios are common in monopolistic competition Market power – the ability to alter the marker price of a good or service A monopolistic competitive firm confronts a downward sloping demand curve for its outputs Modest changes in the output or price will have no perceptible influence on the scale of any other firm. Low entry barriers -> easy in, easy out. Production Differentiation : features that make one product appear different from competing products in the same market Brand image- monopolistic competition, each firm has a distinct identity. Brand loyalty -

Each frim has a monopoly only on its brand image

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Brand loyalty make the demand curve facing the firm less price elastic

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Brand loyalty implies low cross price elasticity of demand

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Each monopolistically competitive firm ball establish some consumer loyalty

Cross price elasticity = percent and change of demand product X / percent change of the price of product Y Production decision- the selection of the short run rate of output with existing plant equipment

Economic profit – the difference between revenues in total economic profit MC = MR  Produce this When firms enter a monopolistically competitive industry -

Industry cost curve shifts right decreasing prices

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Demand curve facing individual firm shifts left

Entry induced leftward shifts of the demand curve facing the firm will ultimately eliminate economic profits In the long run there are no economic profits in monopolistic and competition Monopolistic competition tends to be less efficient in the long run been in perfectly competitive industries Marginal cost pricing- the offer (supply) of good that price is equal to their marginal cost Monopolistic competition results in both production and efficiency (above minimum average cost) and allocated inefficiency (wrong mix of outputs) Reduced market share

Short Run

Chapter 13

Long Run

Entry on monopolistic competitive firm

Natural Monopolies EX: Utility Government intervention -

Unregulated markets may produce the wrong mix of outputs

Market failure and Government intervention -

Market does not operate in this ideal way

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Market failure prevents optimal outcomes

Natural monopoly – an industry in which on efirm can achieve economies of scale over the entire range of market supply -

One firm can provide the good/serice at a lower cost than several competing firms

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It operates on a downward sloping ATC curve

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High fixed costs, large capital input, and low marginal cost

Antitrust – government intervention to alter the behavior of firms Ex: pricing, intervention, or advertising Regulations – government intervention to alters the behavior of firms Ex: Pricing, intervention, or advertising Unregulated natural monopoly produce output related to MR = MC Efficiency calls for marginal cost pricing, P = MC Zero economic profits occur when P = ATC Price cannot be Pb Pa = unregulated monopolistic price (too high) Pb = Marginal cost pricing (economic loss) Pc= Average total cost P=ATC

P = ATC, zero economic profit No subsidy is needed Allows a normal profit

Price efficiency ( P= MC ), efficient but generates a loss to the firm (P < ATC) Production efficiency (P=min ATC) ATC curve slopes downward, by decreasing output we get a loss. Rate increase requests must be approved by a competent board. Output regulations -

Government requires minimum level of service. o Ex : if company doesn’t want to go way out into the country to only service 10 houses, they have to if they want the government to keep out competitors.

Government failure – government intervention that fails to improve economic conditions -

Government failure may be worse than market failure

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Marker outcomes after regulation may be worse than before the industry was regulated....