Econ2a-f

Labour-

  • anyone that gets paid to work

Capital-

  • physical asset

Entrepreneurship-

  • the process of starting and launching a business and includes the willingness and ability to take on that business risk

Factor payments

  • Land

  • Wages

  • Returns

  • Profits

  • Price x output is total revenue

Explicit costs: 

  • things you get a receipt for

Implicit costs

  • Input costs that do not require an outlay of money by the firm

  • Opportunity cost of the money that has been invested in

Total costs

  • Explicit costs + Implicit costs

Normal profits-

  • min amount of money it takes for you to be employed in the company

Economic profit-

  • above the normal profit

  • Total revenue-total cost

Accounting profit

  • Total revenue minus explicit cost

Economic loss-

  • below the normal profit

Total revenue-

  • total cost=pi

Total product

  • Q(product)

Avg. product

  • Q/I(product/labor)

Production function

  • Relationship between the quantity of inputs used to make a

good and the quantity of output of that good

  • shows the highest output that a firm can produce for a specified combination of inputs

  • It shows what is technically feasible when the firm operates efficiently

  • Q = f (land, labor, capital and entrepreneurship)

Marginal product

  • ^q/^L(change of total product/change of labor)

Fixed costs

  • rent,loans

*law of diminishing marginal product

  • marginal cost is below the avg cost the avg cost goes down

  •  marginal cost is above the avg cost the avg cost goes up

  • Avg costs are u shaped

  • Marginal cost are always valley shaped

  • Marginal product is hill shaped

Example of law of diminishing marginal product

  • as more workers are hired, each additional worker produces less output, illustrating diminishing marginal product

The relationship between short-run and long run run average total cost 

  • Many decisions are 

    • fixed in the short run

    • Variable in the long run

  • Firms have greater flexibility in the long-run

  • Long-run cost curves differ from short-run cost curves

    • Much flatter than short-run cost curves

  • Short-run cost curves

    •  Lie on or above the long-run cost curves


Shapes of long-run average cost curves

  • Short run firms are limited to operating on a single average cost curve

(corresponding to the level of fixed costs they have chosen)

  • In the long run when all costs are variable, they can choose to operate on any average cost curve

  • The long-run average cost (LRAC) curve is actually based on a group

of short-run average cost (SRAC) curves, each of which represents one

  • specific level of fixed costs

  • More precisely, the long-run average cost curve will be the least expensive average cost curve for any level of output

Economies of Scale

  • refers to the situation where, as the quantity of output goes up, the cost per unit goes down

Constant returns to scale

  •  Long-run average total cost stays the same as the

quantity of output changes

Diseconomies of scale

  • the long-run average cost of producing output increases as total output increases


Isoquants characteristics 

  • Curves don't cross

  • Uniformed

  • Slope-marginal rate of technical substitution=MRTS

  • Downward sloping


Cost minimization

  • Highest isoquant we can get for the lowest price

  • Isoquants is tangent to the isocost curve

  • MRTS-price ratio and all budget spent

Market Structures

  • Pure competition

    • No market power(Farmer’s Market)

  • Monopolistic Competition

    • Product differentiation(toothpaste or aspirin

  • Oligopoly

    • Few major supplies(Meat packers)

  • Monopoly

    • One major Supplier(Rare Earths)

Pure competition

  • The industry has many firms and many customers 

  • All firms produce identical products

  • Sellers and buyers have all relevant information to make rational decisions about the product being bought or sold

  • Firms can enter and leave the market without any restrictions

  • Price taker-the pressure of competing firms forces them to accept the prevailing equilibrium price in the market

Revenue of a competitive firm

  • Total Revenue = price*quantity 

  • Average revenue=total revenue/quantity

  • Marginal revenue=change in total revenue/change in quantity


Profit Maximization

  • If marginal cost> price- cut down production

  • If marginal cost<price-Increase production

*Profit Maximizing level of output-

  • Marginal Revenue=Marginal cost

Important Prices

  • Total cost=total fixed cost+total variable cost

  • Average total cost=average fixed cost+average variable cost

  • P=Average revenue(Break even point)

  • P=Average variable cost(shut down point)

  • P<Average variable cost(firm needs to shut down)

  • If price is between atc and avc operate in the short run exit in the long run

Long run

  • Horizontal if 

    • All firms have identical cost

    • And costs do not change as other firms enter or exit the market

  • Slope upward if

    • Firms have different costs

    • Or costs rise as firms enter the market

4 criteria for competitive market

  1. No individual has influence on the price

  2. Uniformed product

  3. Relevant information is known

  4. Freedom of entry and exit

Efficiency in perfectly competitive markets

  • Marginal utility=Price=Marginal revenue=Marginal cost=Average total cost 

    • normal profits being made,market is stable- means it efficient 

  • Marginal utility=P(consumer optimal)

  • MR=MC(Profit max)

  • ATC(society benefits)

  • Productive Efficiency-producing the at the lowest cost possible

    • Goods are being produced and sold at the lowest possible average cost

  • Allocative efficiency-that when the max of goods being produced represents the mix that society most desires 

    • Businesses supply what is being demanded

Monopolistic Competition

  • A market structure in which many firms sell products that are similar but different

  • Attributes

    • Many sellers 

    • Product differentiation

    • Free entry and exit

Monopolistically competitive firm in the short run

  • Profit maximization

    • Produce the quantity where MR=MC

  • Uses demand curve to find price

  • If price>average total cost:economic profit

  • If price<average total cost:loss

  • If price=average total cost:normal profit

  • Total revenue=price quantity

  • atc=total cost/quantity

  • Atc X Q=total cost

  • Total cost/q*q=total cost

The Long-Run Equilibrium

  • When firms are making profits, new firms have incentive to enter the market

    • Demand curve shifts left

    • Firms experience declining profits

  • When firms are making losses, firms have incentive to exit

    • Demand curve shifts right

    • Firms experience greater profits

  • Process of entry and exit continues until the firms in the market make zero economic profit

Amount of advertising

  • When firms sell different products and charge prices above the marginal cost,each firm has an incentive to advertise to attract more buyers

  • Advertising spending

    • Differentiated consumer goods:10-20% of revenue

    • Industrial products:Little advertising 

    • Homogenous products:No advertising 

The debate over advertising

  • The critique of advertising 

  • Firms advertise to manipulate people's tastes

    • Psychological rather than informational 

    • Creates a desire that otherwise might not exist

  • Impedes competition 

    • Makes buyers less concerned with price differences 

    • Makes demand less elastic 

    • Firms can increase profits by charging a larger markup

The defense of advertising

  • Provide information to customers

    • Customers-make better choices

    • Enhances the ability of markets to allocate resources efficiently 

  • Fosters competition 

    • Customers-take advantage of price differences 

    • Allows new firms to enter more easily 

Advertising as a signal of quality

  • Larger amount of money on advertising can itself be a signal to consumers about quality 

    • Little apparent information

    • Content of advertising is irrelevant 

Brand names

  • Spend more on advertising and charge higher prices than generic substitutes

  • Critics of brand names

    • Products are not differentiated

  • Defenders of brand names 

    • Consumers-information about quality

    • Firms-incentive to maintain high quality

Monopolistic vs Perfect Competition

  • The perfectly competitive firm produces at the efficient scale, where average total cost is minimized. 

  • The monopolistically competitive firm produces at less than the efficient scale. 

  • Price equals marginal cost under perfect competition,

  • but price is above marginal cost under monopolistic competition.

Monopolistic Competition and the welfare of society

  • Inefficiency of markup of price over marginal cost

    • Deadweight loss of monopoly pricing

  • Inefficiency of number of firms

    • Product-variety externality(positive externality of consumers)

    • Business stealing externality(negative externality of consumers)

The Benefits of Variety and Product Differentiation

  • Product differentiation is based on variety and innovation

  • If it wasn’t for product differentiation, everyone would wear the same clothes, eat the same foods, and drive the same car

  • Economists have struggled to address the question of whether a market-oriented economy produces the optimal amount of variety

    • Critics think that too much product differentiation along with advertising and marketing is socially wasteful

    • On the other hand no one forces consumers to buy highly advertised brand names or differentiated products

    • This controversy may never resolve due to the two sides placing different values on what variety means for consumers

Oligopoly

  • A market structure in which only a few sellers offer similar or identical products 

  • When deciding how much to produce and what price to charge,each firm in an oligopoly is concerned with

    • What its competitors are doing

    • How its competitors will react to what they might do

Game Theory

  • The study of how people behave in strategic situations

Characters of Oligopolies

  • Few large firms

    • There are a few large firms that dominate the industry 

    • They can influence the price or quantity 

  • Firms can interact with each other

    • Firms in oligopoly do not act independently of each other.

    • They take into account the likely reactions of their competitors.

  • Product differentiation

    • Firms sell similar products.

    • They engage in competitive advertising.

    • They engage in brand marketing.

    • They try to convince consumers that their product is better.

Barriers to entry

  • Firms might not be able to enter the industry because of 

    • Financial 

    • Branding

    • Control over vital assets(the channels of distribution)

    • Governmental

  • Financial

  • Large firms produce on a large scale and benefit from decreased cost per unit .

  • If a new firm tries to enter the market the existing firm that is well established can afford to lower the price to deter them.

  • New firms will be unable to compete due to the huge set up costs involved

Brand Proliferation

  • The same firms produces several brands of the same type of product

  • This will leave very little room for new firms to competitor 

Demand curve of Oligopoly 

  • Elastic demand curve 

    • Increase in price,lose many customers and revenue 

  • Inelastic

    • Decrease in price,gain few customers but will lose revenue

Relationship between the demand curve and the marginal revenue curve

  • Because the D/C is kinked the firms MR curve consists of two distinct parts.

  • It is constant between D and E.

  • Between these points if MC changes, price will not

  • change.


No price Competition 

  • When competitive firms try to increase sales/market share by methods other than changing prices

Examples 

  • Branding

    • To create loyalty and recognition

  • Packaging

    • Distinctive to competitors

  • Competitive advertising

    • creates difference in the minds of consumers

  • Ex:

    • Opening hours: 24/7

    • Quality of service: Layout,staff,services

    • Sponsorship:Of local or national events

    • Special offers:Gifts,coupons,loyalty cards 

Benefits of non-price competition to consumers

  • Consumer loyalty reward

    • Consumers can receive loyalty points which can be used as they wish

  • Stability in prices

    • Consumers will better be able to budget as prices will not always be changing