economics 2.1-2.4

ABIZ 0440 Agricultural Economics and Marketing

2.1 Market Efficiency

• Instructor: Chad Lawley

• Department: Department of Agribusiness and Agricultural Economics

Profit Calculation

• Objective of Profit Producers: Maximize profit

• Profit Formula:

  • Total Revenue = Amount received from sales

  • Total Cost = Amount paid for inputs

  • Profit = Total Revenue – Total Cost

• Revenue Calculation:

  • Revenue = Price x Quantity

  • Measuring costs can be subtle and complex.

Costs of Production

• Understanding Costs: Cost is what is given up to acquire goods.

• Opportunity Cost: All foregone options to acquire an item.

• Types of Costs:

  • Explicit Costs: Direct payments in cash outlays.

  • Implicit Costs: Non-cash costs, representing lost opportunities.

  • Example discussion of both types is important.

Cost of Capital as Opportunity Cost

• Opportunity cost for financial capital (e.g., $500,000 in farm machinery).

• Consideration of what is foregone by owning machinery vs. alternative investments.

• Accountants and economists may measure costs differently (e.g., machinery, buildings).

Economic vs Accounting Profit

• Economic Profit: Total revenue minus all opportunity costs (explicit and implicit).

• Accounting Profit: Total revenue minus explicit costs only.

• Importance of considering economic profit in business decisions.

Production and Costs

• Cost Incurred by Producers: When buying inputs for production.

• Fixed Acreage: Assumes fixed acreage for short run analyses; only variable inputs can change.

• Production Function: Relationship between inputs and outputs, leading to diminishing marginal returns.

Diminishing Marginal Product

• Adding inputs yields progressively less output.

• Excessive fertilizer can decrease yield due to limited other inputs.

Production Function and Total Cost Curve

• Graphs: Exhibit relationship between nitrogen application rates and output.

Examples of Production

• Planting examples related to return on seed investment indicating increasing but diminishing margins.

Various Measures of Cost

• Fixed Costs: Do not vary with output (incurred even with no production).

• Variable Costs: Change with output levels.

• Average Costs: Calculated across fixed and variable costs based on output quantity.

Shapes of Cost Curves

• Changes in average total costs as output increases. Efficient scale defined as the quantity minimizing average total costs.

Economies and Diseconomies of Scale

• Economies of Scale: Lower long-run average costs with increased output.

• Diseconomies of Scale: Higher long-run average costs with increased output.

• Constant Returns to Scale: No change in long-run average costs with increased output.

Long-Run Average Total Cost Curve

• Represents average costs over various outputs using graphical representation.

Competitive Market Characteristics

• Nature of Competition: Many buyers/sellers, undifferentiated goods.

• Price Takers: Producers cannot influence market price; they react to market conditions.

Revenue for Competitive Producers

• Revenue equals price times quantity.

• Average revenue equal to price indication.

Short Run Shutdown Decisions

• Temporary shutdowns do not require variable cost payments but do require fixed cost payments.

• Exit from market means no costs need to be paid.

• Sunk Costs: Costs that cannot be recovered.

Long Run Firm Exit Decisions

• Exit from market when total revenue is less than total cost.

• Entry conditions for new producers relate to average total costs.

Profit Measurement for Competitive Firms

• Short run profits possible with fixed producers.

• Long run adjustments lead to equilibrium in pricing to average total cost.

• Producers function at efficient scale in the long run.

Elasticity in Market

• Adjustments based on market equilibrium principles implying how prices and quantities react to demand changes.

Economic Surplus

Opportunity Cost

• Marginal Opportunity Cost: Additional cost of producing one more unit, typically driven by market conditions.

• Low-cost firms are prioritized in production; high-cost firms participate as demand increases.

Producer Surplus

• Definition: Amount sellers receive minus variable costs.

• Visual representation of producer surplus changes with price fluctuations and new producer entry.

Consumer Surplus

• Defined as value to buyers minus the actual price paid, reflecting consumer welfare.

• Demand curves representation alongside cost shows welfare indicators.

Total Societal Welfare

• Comprising consumer surplus and producer surplus illustrates market efficiency under perfect competition.

Monopoly Overview

Characteristics of Monopolies

• Definition: Single seller dominating the market.

• Pricing Power: Price maker versus price taker in competitive markets.

• Reasons for monopolies: resource ownership, government regulation, and efficiencies in large-scale production.

Monopoly Impact

• Monopolies limit outputs to influence higher prices, resulting in reduced consumer surplus and potential total surplus.

• Pricing strategies and consumer impact are essential discussions.

Price Discrimination

• Charging different consumers different prices based on willingness to pay increases profits.

• Key examples include varying pricing strategies employed by sectors such as airlines and publishers.

Monopsony Characteristics

Definition and Impact

• Single buyer in the market, often influencing prices paid to sellers.

• Examination of monopolistic practices and their economic implications in agriculture.

Oligopoly and Monopolistic Competition

Market Structure Summary

• Oligopolies consist of few sellers; monopolistic competition has many firms with slight product differentiation.

• Each structure affects pricing, entry, and competition dynamics—with unique economic outcomes.

Producers’ Long-Run Outcomes

• Economic profits analyzed over competing firms' entry and exit adjustments.

• Conclusion of market efficiencies and comparisons between various competitive structures outlined.