Market failure and socially undesirable outcomes 3 : Market power (HL only)

revenues definition

payments that firms receive when they sell the goods and services that they produce.

total revenue vs average revenue

• total revenue = PxQ → amount of money a firm gets when they sell a g/s

• average revenue = TR/Q = P → revenue per unit output sold

marginal revenue

• formula = change in TR/ change in quantity

• additional revenue from producing one more unit of output

average + marginal revenue for price taker firms

• AR=MR=P

• straight horizontal line → price is constant

price taker vs price maker

• price taker → cannot control the price → exists with perfect competition (price does not change with output)

• price maker → can set their own price → monopoly, oligopoly, monopolistic competition (price changes with output)

total revenue for price taker firms

• increases by the same amount

examples of firms that are price takers

• agricultural farmers

• commodity producers

• individual stock investors

Average revenue + marginal revenue for price taker firms

• MR is twice as steep as AR

• MR is negative → firm is loosing revenue with each extra unit of output

• when MR = 0 TR is at maximum

Total revenue for price taker firms

• revenue is maximized at the local maximum (where MR=0)

PED and TR

• PED is rel. elastic → price increases → TR increases

• PED is rel. inelastic → price increases → TR decreases

costs of production definition

payments by firms to obtain and use factors of production in their production process

fixed vs variable costs definition

• fixed - costs that don’t change with output (short run)

• variable - costs that change with output

Total costs

• total amount of money spent on producing a certain quantity

• = fixed + variable costs

Average costs

• costs per unit output produced

• average fixed costs + average variable costs

Marginal cost 

• additional costs to produce an extra unit of output

• = change in total costs / change in quantity 

the relationship between average costs + marginal costs in the short run

• MC<AC → average cost is falling

• MC>AC → average cost is rising

• MC intersect AC at AC’s minimum

what is meant by short run vs long run

• short run - at least one factor of production is fixed

• long run - all factors of production are variable

total product vs marginal product 

• total - the total quantity of output produced by a firm

• marginal - the additional output that results from one additional variable input

relationship between marginal and total product

• when MP=0, TP is maximized 

• when MP is rising TP rises faster

• when MP is falling TP falls slower

relationship between marginal and average product

• MP>AP → AP increases

• MP<AP → AP decrease

law of diminishing marginal returns

states that as more and more units of a variable input are added to one or more fixed inputs the marginal product of the variable input at first increases, but then it reaches a point after which the marginal product of the variable input starts to decrease

relation of marginal costs to diminishing marginal returns

• marginal product increases → marginal cost decreases

• when marginal product is at maximum → marginal costs is at minimum

• when marginal product falls → marginal costs increase

marginal costs and the firms supply curve

• upward sloping part of MC curve = supply curve

• the firm can only produce more output if the price of the good increases to cover the extra cost of each extra unit produced

explicit vs implicit costs

• explicit -  direct, out-of-pocket payments that businesses actually make, e.g wages, rent, materials, and utility bills.

• implicit - opportunity costs - value of resources the firm already owns but could have used elsewhere (not used when calculating accounting profit)

profit formulas

• revenue - costs of production

• economic profit = total revenues - economic costs

• total revenue - sum of explicit costs - implicit costs

• (economic costs = implicit + explicit costs)

profit maximization

• producing a level of output where the difference between total revenue and total costs is the largest

• largest amount of profit

rewards for f.o.p

• land - rent

• labour - wages

• capital - interest

• enterprise - profit

• → the costs of a business

normal profit

• the minimum amount of revenue that the firm must receive in order to keep the business running

• TR=TC

• normal profit also = the opportunity cost of running the business instead of doing something else. 

abnormal/supernormal profit

• TR>TC

• more than normal profit is made

losses

• TR<TC

• less than normal profit is made

profit maximization - price takers

• AR>AC → abnormal profit

• AR=AC → normal profit

• MC=MR → profit maximization

minimizing loss - price takers

• when AR<AC

• MC=MR → minimize loss

profit maximization - price makers

• MR=MC

• as long as MR>MC the profit can be increased by producing more units until the last unit of output brings not more profit (MC=MR)