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AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
AP Micro Review - Theory of the Firm
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AP Micro Review - Theory of the Firm

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  • 1. AP MICROECONOMICS REVIEW: THEORY OF THE FIRM
  • 2. Market Structure Continuum FOUR MARKET MODELS Pure Competition
  • 3. Market Structure Continuum Pure Competition FOUR MARKET MODELS Imperfect Competition All Markets that are Not Purely Competitive
  • 4. Market Structure Continuum Pure Competition FOUR MARKET MODELS Pure Monopoly
  • 5. Market Structure Continuum Pure Competition Pure Monopoly FOUR MARKET MODELS Monopolistic Competition
  • 6. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition FOUR MARKET MODELS Oligopoly
  • 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. 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. 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. 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. 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. 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. SHORT-RUN COSTS GRAPHICALLY Quantity Costs(dollars) AFC AVC ATC MC Plotting Average and Marginal Costs
  • 14. PRODUCTIVITY AND COST CURVES Costs(dollars) Averageproductand marginalproduct Quantity of labor Quantity of output MP AP MC AVC
  • 15. ECONOMIES AND DISECONOMIES OF SCALE UnitCosts Output long-run ATC Economies of scale
  • 16. ECONOMIES AND DISECONOMIES OF SCALE UnitCosts Output long-run ATC Economies of scale Constant returns to scale
  • 17. ECONOMIES AND DISECONOMIES OF SCALEUnitCosts Output long-run ATC Economies of scale Diseconomies of scale Constant returns to scale
  • 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. $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. $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. $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. $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. $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. $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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. P MR Q MC ATC Quantity Price Price = MC = Minimum ATC (normal profit) LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRM
  • 37. PURE COMPETITION AND EFFICIENCY Productive Efficiency Price = Minimum ATC Allocative Efficiency Price = MC Underallocation Price > MC Overallocation Price < MC
  • 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. 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. 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. 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. 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. 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. 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. 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. 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. Q D MC ATC P Q1 PriceandCosts Economic profits with price discrimination PRICE DISCRIMINATION Q2 MR=D
  • 48. Natural Monopolies Socially Optimum Price P = MC Fair-Return Price P = ATC Dilemma of Regulation REGULATED MONOPOLY Graphically…
  • 49. REGULATED MONOPOLY Q D MR MC ATC P PriceandCosts Monopoly Price MR = MC Qm Pm
  • 50. REGULATED MONOPOLY Q D MR MC ATC P PriceandCosts Fair-Return Price Normal Profit Only Qf Pf
  • 51. REGULATED MONOPOLY Q D MR MC ATC P PriceandCosts Socially-Optimum Price P = MC Qr Pr
  • 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. D MR P1 ATC PriceandCosts Q1 Short-Run Economic Profits Expect New Competitors PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A1 MC
  • 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. D MR MC P2 ATC PriceandCosts Q2 Short-Run Economic Losses PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A2
  • 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. D MR MC P3 = A3 ATC PriceandCosts Q3 PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity Long-Run Equilibrium Normal Profit Only
  • 58. MONOPOLISTIC COMPETITION AND EFFICIENCY • Not Productively Efficient  Minimum ATC • Not Allocatively Efficient Price  MC • Excess Capacity Graphically…
  • 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. 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. 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. 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. 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. 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. 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. D1 MR1 Quantity The firm’s demand and marginal revenue curves KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price
  • 67. MR2 D1 D2 MR1 Quantity KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price Rivals tend to follow a price cut
  • 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. MR2 D1 D2 MR1 Quantity Effectively creating a kinked demand curve KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price
  • 70. D Quantity Effectively creating a kinked demand curve KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price
  • 71. D MR1 Quantity Effectively creating a kinked demand curve KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price MC2 MC1 MR2
  • 72. D Quantity Profit maximization MR = MC occurs at the kink. KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price MC2 MC1 MR2 MR1
  • 73. D Quantity This behavior can set off a price war. KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price MC2 MC1 MR2 MR1
  • 74. Colluding Oligopolists Will Split the Monopoly Profits. D MC ATC MR Economic Profit MR = MC Priceandcosts Q0 P0 A0 CARTELS AND OTHER COLLUSION

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