AP Micro Review - Theory of the Firm

2,561 views

Published on

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
2,561
On SlideShare
0
From Embeds
0
Number of Embeds
7
Actions
Shares
0
Downloads
49
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

AP Micro Review - Theory of the Firm

  1. 1. AP MICROECONOMICS REVIEW: THEORY OF THE FIRM
  2. 2. Market Structure Continuum FOUR MARKET MODELS Pure Competition
  3. 3. Market Structure Continuum Pure Competition FOUR MARKET MODELS Imperfect Competition All Markets that are Not Purely Competitive
  4. 4. Market Structure Continuum Pure Competition FOUR MARKET MODELS Pure Monopoly
  5. 5. Market Structure Continuum Pure Competition Pure Monopoly FOUR MARKET MODELS Monopolistic Competition
  6. 6. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition FOUR MARKET MODELS Oligopoly
  7. 7. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly FOUR MARKET MODELS Pure Competition: • Very Large Numbers • Standardized Product • “Price Takers” • Free Entry and Exit
  8. 8. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly FOUR MARKET MODELS Pure Monopoly: • Single Seller • No Close Substitutes • Price Maker • Blocked Entry
  9. 9. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly FOUR MARKET MODELS Monopolistic Competition: •Relatively Large Number of Sellers •Differentiated Products •Easy Entry and Exit
  10. 10. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly FOUR MARKET MODELS Oligopoly: •A Few Large Producers •Homogeneous or Differentiated Products •Control Over Price, But Mutual Interdependence •Strategic Behavior •Entry Barriers
  11. 11. Economic Profit Implicit costs (including a normal profit) Explicit Costs Accounting costs (explicit costs only) Accounting Profit Economic(opportunity)Costs T O T A L R E V E N U E Profits to an Economist Profits to an Accountant ECONOMIC COSTS
  12. 12. SHORT-RUN COSTS GRAPHICALLY Quantity Costs(dollars) TC Total Cost Fixed Cost TVC Variable Cost TFC Combining TVC With TFC to get Total Cost
  13. 13. SHORT-RUN COSTS GRAPHICALLY Quantity Costs(dollars) AFC AVC ATC MC Plotting Average and Marginal Costs
  14. 14. PRODUCTIVITY AND COST CURVES Costs(dollars) Averageproductand marginalproduct Quantity of labor Quantity of output MP AP MC AVC
  15. 15. ECONOMIES AND DISECONOMIES OF SCALE UnitCosts Output long-run ATC Economies of scale
  16. 16. ECONOMIES AND DISECONOMIES OF SCALE UnitCosts Output long-run ATC Economies of scale Constant returns to scale
  17. 17. ECONOMIES AND DISECONOMIES OF SCALEUnitCosts Output long-run ATC Economies of scale Diseconomies of scale Constant returns to scale
  18. 18. SHORT-RUN PROFIT MAXIMIZATION Two Approaches... First: Total-Revenue -Total Cost Approach Three Characteristics of MR=MC Rule: • The rule applies only if producing is preferred to shutting down • Rule applies to all markets • Rule can be restated P=MC Second: Marginal-Revenue -Marginal Cost Approach MR = MC Rule
  19. 19. $200 150 100 50 0 CostandRevenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Profit $131.00 $97.78 MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position
  20. 20. $200 150 100 50 0 CostandRevenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Profit $131.00 $97.78 MARGINAL REVENUE-MARGINAL COST APPROACH MR = MC Optimum Solution Profit Maximization Position
  21. 21. $200 150 100 50 0 CostandRevenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Loss $81.00 $91.67 MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position
  22. 22. $200 150 100 50 0 CostandRevenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Loss $81.00 $91.67 MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position
  23. 23. $200 150 100 50 0 CostandRevenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC $71.00 MARGINAL REVENUE-MARGINAL COST APPROACH Short-Run Shut Down Point Minimum AVC is the Shut-Down Point
  24. 24. $200 150 100 50 0 CostandRevenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Loss $81.00 $91.67 MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position
  25. 25. CostandRevenue,(dollars) MC MR1 MARGINAL REVENUE-MARGINAL COST APPROACH Quantity Supplied MR2 MR3 MR4 MR5 P1 P2 P3 P4 P5 Q2 Q3 Q4 Q5 Marginal Cost & Short-Run Supply Yields the Short-Run Supply Curve Supply No Production Below AVC
  26. 26. MARGINAL REVENUE-MARGINAL COST APPROACH Marginal Cost & Short-Run Supply AVC2 MC2 Higher Costs Move the Supply Curve to the Left CostandRevenue,(dollars) MC1 AVC1 Quantity Supplied S1 S2
  27. 27. MARGINAL REVENUE-MARGINAL COST APPROACH Marginal Cost & Short-Run Supply AVC2 MC2 Lower Costs Move the Supply Curve to the Right CostandRevenue,(dollars) MC1 AVC1 Quantity Supplied S1 S2
  28. 28. P Q S=MC AVC ATC 8 D P Q8000 D S= MCs IndustryFirm (price taker) Economic Profit $111$111 SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm “Takes” its Price from the Industry Equilibrium
  29. 29. P Q S=MC AVC ATC 8 D P Q8000 D S= MCs IndustryFirm (price taker) Economic Profit $111$111 SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm “Takes” its Price from the Industry Equilibrium How about the long-run?
  30. 30. Temporary profits and the reestablishment of long-run equilibrium S1 MC ATC P Q100 P Q100,000 IndustryFirm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG RUN MR D1
  31. 31. An increase in demand increases profits… MR D1 MC ATC P Q100 P Q100,000 IndustryFirm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG RUN D2 Economic Profits S1
  32. 32. New competitors increase supply, and lower prices decrease economic profits. MR D1 MC ATC P Q100 P Q100,000 IndustryFirm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG RUN D2 Zero Economic Profits S1 S2
  33. 33. Decreases in demand, losses, and the reestablishment of long-run equilibrium S1 MC ATC P Q100 P Q100,000 IndustryFirm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG RUN D1 MR
  34. 34. A decrease in demand creates losses… MR D1 MC ATC P Q100 P Q100,000 IndustryFirm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG RUN D2 Economic Losses S1
  35. 35. MR D1 MC ATC P Q100 P Q100,000 IndustryFirm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG RUN D2 Return to Zero Economic Profits S1 S3 Competitors with losses decrease supply prices return to zero economic profits.
  36. 36. P MR Q MC ATC Quantity Price Price = MC = Minimum ATC (normal profit) LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRM
  37. 37. PURE COMPETITION AND EFFICIENCY Productive Efficiency Price = Minimum ATC Allocative Efficiency Price = MC Underallocation Price > MC Overallocation Price < MC
  38. 38. T MONOPOLY REVENUES & COSTS DollarsDollars $200 150 200 50 $750 500 250 MR Elastic 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 TR Q
  39. 39. MONOPOLY REVENUES & COSTS Q DollarsDollars $200 150 200 50 $750 500 250 TR MR D InelasticElastic 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 A Monopolist will always operate on the Elastic Portion of the Demand Curve Inelastic Portion MR is Negative
  40. 40. Profit Maximization Under Monopoly D MC ATC MR $94 $122 Profit MR = MC Profit Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price,costs,andrevenueRemember the MR=MC Rule?
  41. 41. Profit Maximization Under Monopoly D MC ATC MR $94 $122 Profit MR = MC Profit Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price,costs,andrevenue
  42. 42. Loss Minimization Under Monopoly D MC ATC MR A Pm Loss MR = MC Loss Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price,costs,andrevenue AVC Qm V Since Pm exceeds AVC, the firm will produce
  43. 43. Loss Minimization Under Monopoly D MC ATC MR A Pm Loss MR = MC Loss Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price,costs,andrevenue AVC Qm V What are the Economic Effects of Monopoly?
  44. 44. Q INEFFICIENCY OF PURE MONOPOLY P D MR S = MC Pc Pm QcQm At MR=MC A monopolist will sell less units at a higher price than in competition An industry in pure competition sells where supply and demand are equal
  45. 45. Q INEFFICIENCY OF PURE MONOPOLY P D MR S = MC Pc Pm QcQm At MR=MC A monopolist will sell less units at a higher price than in competition Monopoly pricing effectively creates an income transfer from buyers to the seller!
  46. 46. Q D MC ATC P Q1 PriceandCosts PRICE DISCRIMINATION Q2 A perfectly discriminating monopolist has MR=D, producing more product and more profit! MR=D
  47. 47. Q D MC ATC P Q1 PriceandCosts Economic profits with price discrimination PRICE DISCRIMINATION Q2 MR=D
  48. 48. Natural Monopolies Socially Optimum Price P = MC Fair-Return Price P = ATC Dilemma of Regulation REGULATED MONOPOLY Graphically…
  49. 49. REGULATED MONOPOLY Q D MR MC ATC P PriceandCosts Monopoly Price MR = MC Qm Pm
  50. 50. REGULATED MONOPOLY Q D MR MC ATC P PriceandCosts Fair-Return Price Normal Profit Only Qf Pf
  51. 51. REGULATED MONOPOLY Q D MR MC ATC P PriceandCosts Socially-Optimum Price P = MC Qr Pr
  52. 52. REGULATED MONOPOLY Q D MR MC ATC PPriceandCosts MR = MC Fair-Return Price Socially-Optimum Price Qm Qf Qr Dilemma of Regulation Which Price? Pm Pf Pr
  53. 53. D MR P1 ATC PriceandCosts Q1 Short-Run Economic Profits Expect New Competitors PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A1 MC
  54. 54. D MR P1 ATC PriceandCosts Q1 Expect New Competitors PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A1 New competition drives down the price level – leading to economic losses in the short run. MC Short-Run Economic Profits
  55. 55. D MR MC P2 ATC PriceandCosts Q2 Short-Run Economic Losses PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A2
  56. 56. Short-Run Economic Losses D MR MC P2 ATC PriceandCosts Q2 PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A2 With economic losses, firms will exit the market – stability occurs when economic profits are zero.
  57. 57. D MR MC P3 = A3 ATC PriceandCosts Q3 PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity Long-Run Equilibrium Normal Profit Only
  58. 58. MONOPOLISTIC COMPETITION AND EFFICIENCY • Not Productively Efficient  Minimum ATC • Not Allocatively Efficient Price  MC • Excess Capacity Graphically…
  59. 59. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low Uptown’sPriceStrategy RareAir’s Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15
  60. 60. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low Uptown’sPriceStrategy RareAir’s Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15 Greatest Combined Profit
  61. 61. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low Uptown’sPriceStrategy RareAir’s Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15 Independent Actions Stimulate Response
  62. 62. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low Uptown’sPriceStrategy RareAir’s Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15 Independent Actions Stimulate Response Gravitating to the Worst Case
  63. 63. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low Uptown’sPriceStrategy RareAir’s Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15 Collusion Invites a Different Solution.
  64. 64. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low Uptown’sPriceStrategy RareAir’s Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15 Collusion Invites a Different Solution.
  65. 65. OLIGOPOLY BEHAVIOR A Game-Theory Overview High Low High Low Uptown’sPriceStrategy RareAir’s Price Strategy BA DC $12 $15 $12 $6 $6 $8 $8$15 But, the incentive to cheat is very real. Collusion Invites a Different Solution.
  66. 66. D1 MR1 Quantity The firm’s demand and marginal revenue curves KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price
  67. 67. MR2 D1 D2 MR1 Quantity KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price Rivals tend to follow a price cut
  68. 68. MR2 D1 D2 MR1 Quantity KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price Rivals tend to follow a price cut or ignore a price increase
  69. 69. MR2 D1 D2 MR1 Quantity Effectively creating a kinked demand curve KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price
  70. 70. D Quantity Effectively creating a kinked demand curve KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price
  71. 71. D MR1 Quantity Effectively creating a kinked demand curve KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price MC2 MC1 MR2
  72. 72. D Quantity Profit maximization MR = MC occurs at the kink. KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price MC2 MC1 MR2 MR1
  73. 73. D Quantity This behavior can set off a price war. KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price MC2 MC1 MR2 MR1
  74. 74. Colluding Oligopolists Will Split the Monopoly Profits. D MC ATC MR Economic Profit MR = MC Priceandcosts Q0 P0 A0 CARTELS AND OTHER COLLUSION

×