this is it – the big one ! chapter 22 + chapter 23 chapter 24 + chapter 25

This is it – The Big ONE!

Chapter 22 + Chapter 23Chapter 24 + Chapter 25

Theory of the FirmTheory of the FirmTheory of the FirmTheory of the Firm

Pure MonopolyPure Monopoly Natural MonopolyNatural Monopoly DuopolyDuopoly OligopolyOligopoly Monopolistic CompetitiveMonopolistic Competitive Perfect CompetitionPerfect Competition

What is a producer’sability and willingness to offer a product for sale?Comparing revenue to costs!

How does demand relateto revenue, how does thatrelate to a firm’s profitmaximizing decisions – Which should lead to Economic efficiency!!Our big goal!

MonopolyMonopolyMonopolyMonopoly

Illegal in the United StatesIllegal in the United States

Near total control of an industry.Near total control of an industry.

Total control of a market??

Natural MonopolyNatural MonopolyNatural MonopolyNatural Monopoly

Allowed to exist because of cost Allowed to exist because of cost benefits, licenses, copyrights, patents, benefits, licenses, copyrights, patents,

and/or trademarks!!!and/or trademarks!!!

DuopolyDuopolyDuopolyDuopoly

Where two firms control over 80% of Where two firms control over 80% of the market and other companies are the market and other companies are

merely fringe players.merely fringe players.

OligopolyOligopolyOligopolyOligopoly

Five to seven firms dominate an Five to seven firms dominate an industry. industry.

Monopolistic CompetitiveMonopolistic CompetitiveMonopolistic CompetitiveMonopolistic Competitive

100’s of small franchises or 100’s of small franchises or businesses offer unique but similar businesses offer unique but similar

products or services.products or services.

http://www.pizzahut.com/homepage/homepage.htm

Perfect CompetitionPerfect CompetitionPerfect CompetitionPerfect Competition

1000’s of small firms with no power 1000’s of small firms with no power to influence price or quantity in their to influence price or quantity in their market – NO MARKET POWER!market – NO MARKET POWER!

Pure CompetitionPure Competition

Market Structure ContinuumMarket Structure Continuum

Four Market ModelsFour Market Models

Pure MonopolyPure Monopoly


PurePureCompetitionCompetition


Imperfect CompetitionImperfect Competition



PurePureMonopolyMonopoly


Monopolistic CompetitionMonopolistic Competition





OligopolyOligopoly




MonopolisticMonopolisticCompetitionCompetition





MonopolisticMonopolisticCompetitionCompetition OligopolyOligopoly

Four Market ModelsFour Market ModelsNatural MonopolyNatural Monopoly




MonopolisticMonopolisticCompetitionCompetition

DuopolyDuopolyOligopolyOligopoly

Five Market ModelsFive Market Models

Natural Natural MonopolyMonopoly

Again what is a producer’s ability and willingness to offer a product for sale?

The Costs of ProductionThe Costs of Production

CHAPTER TWENTY-TWO

GHS Track Coaches

Kriegel

Overview!!!Overview!!!Overview!!!Overview!!!

TR > TC, TR = TC, TR < TC, TR < TVCTR > TC, TR = TC, TR < TC, TR < TVC Revenues: Total, Average, MarginalRevenues: Total, Average, Marginal Costs: Opportunity, Fixed, Sunk, Variable, Costs: Opportunity, Fixed, Sunk, Variable,

Total, Average Fixed, Average Variable, Total, Average Fixed, Average Variable, Average Total, and MarginalAverage Total, and Marginal

Profits: Total, Average, Marginal, Normal, Profits: Total, Average, Marginal, Normal, Economic, and AccountingEconomic, and Accounting

Marginal Cost = Marginal Cost = MCMC

Total Fixed Costs = Total Fixed Costs = TFCTFCTotal Variable Costs = Total Variable Costs = TVCTVC

Average Variable Costs = Average Variable Costs = AVCAVC

Total Costs = Total Costs = TCTC

Average Total Costs = Average Total Costs = ATCATC

Average Fixed Costs = Average Fixed Costs = AFCAFC

Summary of Definitions... Summary of Definitions...

Quantity

Co

sts

(do

llar

s)TC

TotalTotalCostCost

Fixed CostFixed CostLong v Short

run

Costs Graphically Presented...Costs Graphically Presented...

TVC

Variable CostVariable Cost

TFC

Quantity

Sh

ort

-ru

n a

vera

ge

cost

s (d

oll

ars)

AFCLong v Short

run

AVCATC

MC


To

tal

Pro

du

ct,

TP

Quantity of Labor

Ave

rag

e P

rod

uct

, A

P,

and

mar

gin

al p

rod

uct

, M

P

Quantity of Labor

Total OutputTotal Output

MarginalMarginalProductProduct

AverageAverageProductProduct

NegativeNegativeMarginalMarginalReturnsReturns

Law of Diminishing ReturnsLaw of Diminishing Returns

Copyright McGraw-Hill, Inc. 1999

Economic CostsEconomic Costs

Economic CostsEconomic CostsEconomic Costs or Economic Costs or Opportunity CostsOpportunity Costs


Forgoing the Forgoing the opportunityopportunity

to produce alternativeto produce alternativegoods and servicesgoods and services

Economic CostsEconomic CostsEconomic Costs or Opportunity Costs

Forgoing the opportunity

to produce alternativegoods and servicesExplicit CostsExplicit Costs-“out of pocket” costs

to those you pay for theirservices. Example - Labor


Forgoing the opportunity

to produce alternativegoods and servicesExplicit CostsExplicit Costs

Implicit CostsImplicit Costs-self-owned, self-employedresources that could havewent to alternative uses.

Normal ProfitsNormal Profits

• Treated as a costTreated as a cost


• Treated as a costTreated as a cost• Required to attract & retain resourcesRequired to attract & retain resources•The money the entrepreneur is making The money the entrepreneur is making to keep them in the business.to keep them in the business.


• Treated as a costTreated as a cost• Required to attract & retain resourcesRequired to attract & retain resources

Economic or Pure ProfitsEconomic or Pure Profits


• Treated as a costTreated as a cost• Required to attract & retain resourcesRequired to attract & retain resources

Economic or Pure ProfitsEconomic or Pure Profits

EconomicEconomicprofitprofit

TotalTotalrevenuerevenue

Opportunity costOpportunity costof all inputsof all inputs


TotalTotalRevenueRevenue

Profits to anProfits to anEconomistEconomist

Profits to anProfits to anAccountantAccountant


ExplicitExplicitCostsCosts

AccountingAccountingcosts (explicitcosts (explicit

costs only)costs only)








AccountingAccountingProfitsProfits





Implicit costsImplicit costs(including a(including a

normal profit)normal profit)





Ec

on

om

ic (

op

po

rtu

nit

y) C

os

tsE

co

no

mic

(o

pp

ort

un

ity)

Co

sts





EconomicEconomicProfitsProfits

Implicit costsImplicit costs(including a(including a

normal profit)normal profit)





Ec

on

om

ic (

op

po

rtu

nit

y) C

os

tsE

co

no

mic

(o

pp

ort

un

ity)

Co

sts




When a firm makes significant economic profit it may lure otherEntrepreneurs away from their current businesses.

A Significant Difference...A Significant Difference...

Accounting:Accounting: Short and long run Short and long run is basedis basedupon annual chronologyupon annual chronology



Economics:Economics: Short run Short run has fixed planthas fixed plantcapacity sizecapacity size

Period of time where the firms capital cannot change as a response to increase in demand (fixed resources). You can hire more workers(variable resources) but not expand the factory.



Economics:Economics: Short run Short run has fixed planthas fixed plantcapacity sizecapacity size

Long run Long run has variable planthas variable plantcapacity sizecapacity size

All resources are variable in the long run.

Types of Economic Analysis• Total – Big Picture• Average – Per Unit• Marginal – Future

Short-run Production Costs Short-run Production Costs

Marginal Concept - Successive UnitsMarginal Concept - Successive Units


Costs are not only determined by price but the amount of a resource needed to produce that output. First we will look atcosts from the perspective of how much of a resource is neededto get a certain output or product.


Total ProductTotal Product


- the total output of a product that is produced.


Average ProductAverage ProductTotal ProductTotal Product


Out put per unit of resources used. How many pizzasmade with how many workers. 10/5 or TP/Q of resource.


Average ProductAverage ProductMarginal ProductMarginal Product



The extra output associated with adding an additional unit of avariable resource. Change in TP/ Change in resource.

The major question is how much will output rise when additionalworkers are hired and when will this max out and why?



Average ProductAverage ProductMarginal ProductMarginal Product

Graphically...Graphically...



As additional units of a variable resource are added toa fixed plant, beyond some point the extra amount of output will decline. See table on board.

To

tal

Pro

du

ct,

TP

Quantity of Labor

Ave

rag

e P

rod

uct

, A

P,

and

mar

gin

al p

rod

uct

, M

P

Quantity of Labor


Plotting Total Outputon this Graph

Plotting Average andmarginal product

on this Graph

To

tal

Pro

du

ct,

TP

Quantity of Labor

Ave

rag

e P

rod

uct

, A

P,

and

mar

gin

al p

rod

uct

, M

P

Quantity of Labor





IncreasingIncreasingMarginalMarginalReturnsReturns

To

tal

Pro

du

ct,

TP

Quantity of Labor

Ave

rag

e P

rod

uct

, A

P,

and

mar

gin

al p

rod

uct

, M

P

Quantity of Labor


DiminishingDiminishingMarginalMarginalReturnsReturns




To

tal

Pro

du

ct,

TP

Quantity of Labor

Ave

rag

e P

rod

uct

, A

P,

and

mar

gin

al p

rod

uct

, M

P

Quantity of Labor




NegativeNegativeMarginalMarginalReturnsReturns


Other Cost Definitions... Other Cost Definitions... Now that we understand that producing “costs” us in terms of resources used, production information must be joined by the actual monetary costs.

Fixed CostsFixed Costs

Other Cost Definitions... Other Cost Definitions...

-those costs that do not changewith changes in output. Rent orinterest on loans.

Fixed CostsFixed CostsTotal Fixed CostsTotal Fixed Costs



Average Fixed Costs =Average Fixed Costs =Total Fixed CostsTotal Fixed Costs

QuantityQuantity


Also AFC * Q = TFC



QuantityQuantity

Variable CostsVariable Costs


-those costs that vary with the level of output. Materials, some labor, fuel, etc…



QuantityQuantity

Variable CostsVariable CostsTotal Variable CostsTotal Variable Costs




QuantityQuantity

Variable CostsVariable CostsTotal Variable CostsTotal Variable Costs

Average Variable Costs =Average Variable Costs =Total Variable CostsTotal Variable Costs

QuantityQuantity


Also AVC * Q = TVC Average looks at costs on a per unit basis.

Total CostsTotal Costs


Total CostsTotal CostsTotal Fixed & Variable CostsTotal Fixed & Variable Costs



Average Total Costs =Average Total Costs =Total CostsTotal Costs

QuantityQuantity


Or ATC = AFC + AVC

Also ATC * Q = TC



QuantityQuantity

Marginal CostsMarginal Costs




QuantityQuantity

Marginal CostsMarginal Costs

Marginal Cost =Marginal Cost =Change in Total CostsChange in Total Costs

Change in QuantityChange in Quantity


Marginal is the cost incurred because we produced an additionalunit of output.

Marginal Cost = Marginal Cost = MCMC

Total Fixed Costs = Total Fixed Costs = TFCTFCTotal Variable Costs = Total Variable Costs = TVCTVC

Average Variable Costs = Average Variable Costs = AVCAVC

Total Costs = Total Costs = TCTC

Average Total Costs = Average Total Costs = ATCATC

Average Fixed Costs = Average Fixed Costs = AFCAFC

Summary of Definitions... Summary of Definitions...

Quantity

Co

sts

(do

llar

s)


Quantity

Co

sts

(do

llar

s)

TVC



As we begin production variable costs increase at a decreasing rate.

Quantity

Co

sts

(do

llar

s)

TFC


Quantity

Co

sts

(do

llar

s)

TFC

Combining with variable cost...Combining with variable cost...


Quantity

Co

sts

(do

llar

s)


TVC


Quantity

Co

sts

(do

llar

s) Add vertically toAdd vertically toget get Total CostTotal Cost


TFC

TVC


Quantity

Co

sts

(do

llar

s)TC

TotalTotalCostCost

Fixed CostFixed Cost


TVC


TFC

Quantity

Sh

ort

-ru

n a

vera

ge

cost

s (d

oll

ars)

Plotting Average CostsPlotting Average Costs


Quantity

Sh

ort

-ru

n a

vera

ge

cost

s (d

oll

ars)

AFC


Quantity

Sh

ort

-ru

n a

vera

ge

cost

s (d

oll

ars)

AFC

AVC


Quantity

Sh

ort

-ru

n a

vera

ge

cost

s (d

oll

ars)

AFC

AVC

Add vertically to get...Add vertically to get...


Quantity

Sh

ort

-ru

n a

vera

ge

cost

s (d

oll

ars)

AFC

AVCATC


Quantity

Sh

ort

-ru

n a

vera

ge

cost

s (d

oll

ars)

AFC

AVCATC

Plotting the changesPlotting the changesin total cost yields...in total cost yields...


Quantity

Sh

ort

-ru

n a

vera

ge

cost

s (d

oll

ars)

AFC

AVCATC

MC


Quantity of labor

Co

sts

(d

olla

rs)

Ave

rag

e p

rod

uct

an

dm

arg

inal

pro

du

ct

Quantity of output

Productivity & Cost Curve RelationshipProductivity & Cost Curve Relationship

Quantity of labor

Co

sts

(d

olla

rs)

Ave

rag

e p

rod

uct

an

dm

arg

inal

pro

du

ct

Quantity of output

MPMP

MCMC


Quantity of labor

Co

sts

(d

olla

rs)

Ave

rag

e p

rod

uct

an

dm

arg

inal

pro

du

ct

Quantity of output

MPMPAPAP

MCMCAVCAVC



Shifting the costs curves Shifting the costs curves

When fixed costs change they shift When fixed costs change they shift The FC, AFC and ATC curves.The FC, AFC and ATC curves.

When variable costs change they shift When variable costs change they shift The VC, TC, AVC, ATC and MC curvesThe VC, TC, AVC, ATC and MC curves

Long-run Production Costs Long-run Production Costs

For every plant capacity size...For every plant capacity size...

there is a short-run there is a short-run ATCATC curve curve

All such plant capacitiesAll such plant capacitiescan be plotted...can be plotted...


For every plant capacity size...For every plant capacity size...

there is a short-run there is a short-run ATCATC curve curve

Un

it C

ost

sU

nit

Co

sts

OutputOutput

For every plant capacity size...For every plant capacity size... there is a short-run ATC curve there is a short-run ATC curve

and every and every ATC ATC has a minimum costhas a minimum cost



Un

it C

ost

sU

nit

Co

sts

OutputOutput

An infinite number of such costAn infinite number of such costcurves can be constructed...curves can be constructed...



The The Long-run ATCLong-run ATC just “envelopes” just “envelopes”all of the short-run ATC curvesall of the short-run ATC curves

Un

it C

ost

sU

nit

Co

sts

OutputOutput



Long-run ATCLong-run ATCUn

it C

ost

sU

nit

Co

sts

OutputOutput


Long-run Production Costs Long-run Production Costs The shape of the LR Curve is similar to the SR Curve but the same explanation does not hold. In the short run costsincreased because the plant size was fixed. In the long run that isn’t so.

In the long run the shape is explained through economies of scale.

Economies of Scale in ProductionEconomies of Scale in ProductionAs plant size increases a number of factors will for a time leadto lower average costs.

Economies of Scale in ProductionEconomies of Scale in Production• Labor SpecializationLabor Specialization

The more specialized labor is the more productive up to a point.

Economies of Scale in ProductionEconomies of Scale in Production• Labor SpecializationLabor Specialization• Managerial SpecializationManagerial Specialization

Same explanation as labor up to a point.

Economies of Scale in ProductionEconomies of Scale in Production• Labor SpecializationLabor Specialization• Managerial SpecializationManagerial Specialization• Efficient CapitalEfficient Capital

The largest capital equipment is very expensive, only if you areproducing in large quantities can you afford this.

Economies of Scale in ProductionEconomies of Scale in Production• Labor SpecializationLabor Specialization• Managerial SpecializationManagerial Specialization• Efficient CapitalEfficient Capital• Other FactorsOther Factors

Design costs, advertising costs decline per unit as output is increased.

Economies of Scale in ProductionEconomies of Scale in Production• Labor SpecializationLabor Specialization• Managerial SpecializationManagerial Specialization• Efficient CapitalEfficient Capital• By-productsBy-products• Other FactorsOther FactorsDiseconomies of ScaleDiseconomies of ScaleWhen a firm gets too big to be able to efficiently do business.Less communication, worker alienation.

Economies of Scale in ProductionEconomies of Scale in Production• Labor SpecializationLabor Specialization• Managerial SpecializationManagerial Specialization• Efficient CapitalEfficient Capital• By-productsBy-products• Other FactorsOther FactorsDiseconomies of ScaleDiseconomies of ScaleConstant Returns to ScaleConstant Returns to Scale

graphically presented...graphically presented...

Un

it C

ost

sU

nit

Co

sts

OutputOutput

Long-run ATC Curves Long-run ATC Curves


Long-run ATCLong-run ATC

Un

it C

ost

sU

nit

Co

sts

OutputOutput



EconomiesEconomiesof scaleof scale


Un

it C

ost

sU

nit

Co

sts

OutputOutput




Constant returnsConstant returnsto scaleto scale


Un

it C

ost

sU

nit

Co

sts

OutputOutput



DiseconomiesDiseconomiesof scaleof scale

Constant returnsConstant returnsto scaleto scale



Un

it C

ost

sU

nit

Co

sts

OutputOutput

Where extensiveWhere extensiveeconomies ofeconomies of

scale existscale exist




Un

it C

ost

sU

nit

Co

sts

OutputOutput

Where economiesWhere economiesof scale areof scale are

quickly exhaustedquickly exhausted




economic (opportunity) costeconomic (opportunity) cost explicit costsexplicit costs implicit costsimplicit costs normal profitnormal profit economic profiteconomic profit short runshort run long runlong run total producttotal product marginal productmarginal product average product average product law of diminishing returnslaw of diminishing returns fixed costsfixed costs

variable costsvariable costs total costtotal cost average fixed costaverage fixed cost average variable costaverage variable cost average total costaverage total cost marginal costmarginal cost economies of scaleeconomies of scale diseconomies of scalediseconomies of scale constant returns to scaleconstant returns to scale minimum efficient scaleminimum efficient scale natural monopolynatural monopoly

NEXT:NEXT:

Pure CompetitionPure Competition

Chapter 23Chapter 23

this is it – the big one ! chapter 22 + chapter 23 chapter 24 + chapter 25

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