REVIEW  COSTS OF PRODUCTION,THEORY OF THE    FIRM
ECONOMIC COSTS                               Profits to an          Profits to an                                Economist...
SHORT-RUN PRODUCTION       RELATIONSHIPSLaw of Diminishing Returns           Total Product, TP                            ...
SHORT-RUN PRODUCTION       RELATIONSHIPSLaw of Diminishing Returns           Total Product, TP                            ...
SHORT-RUN PRODUCTION       RELATIONSHIPSLaw of Diminishing Returns           Total Product, TP                            ...
PRODUCTIVITY AND COST CURVES   Average product and    marginal product                                                AP  ...
LONG-RUN PRODUCTION COSTSUnit Costs                        Output
LONG-RUN PRODUCTION COSTSUnit Costs                        Output
LONG-RUN PRODUCTION COSTS             The long-run ATC just “envelopes”               all of the short-run ATC curves.Unit...
LONG-RUN PRODUCTION COSTSUnit Costs                             long-run ATC                        Output
ECONOMIES AND  DISECONOMIES OF SCALE•Labor Specialization•Managerial Specialization•Efficient Capital• Other FactorsDiseco...
ECONOMIES AND             DISECONOMIES OF SCALE             Economies              of scaleUnit Costs                     ...
ATC decreases as    ATC is constant as     Output increases    Output increases             Economies   Constant returns  ...
ATC decreases as    ATC is constant as   ATC increases as             Output increases    Output increases     Output incr...
MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position                      $200                            ...
MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position                      $200                            ...
MARGINAL REVENUE-MARGINAL COST APPROACH Short-Run Shut Down Point                     $200                                ...
SHORT-RUN COMPETITIVE EQUILIBRIUM       The Competitive Firm “Takes” its       Price from the Industry Equilibrium        ...
SHORT-RUN COMPETITIVE EQUILIBRIUM       The Competitive Firm “Takes” its       Price from the Industry Equilibrium        ...
PROFIT MAXIMIZATION IN THE LONG RUNTemporary profits and the reestablishmentof long-run equilibrium                       ...
PROFIT MAXIMIZATION IN THE LONG RUNAn increase in demand increases profits…        Economic                               ...
PROFIT MAXIMIZATION IN THE LONG RUNNew competitors increase supply, and lowerprices decrease economic profits.    Zero Eco...
PROFIT MAXIMIZATION IN THE LONG RUNDecreases in demand, losses, and thereestablishment of long-run equilibrium            ...
PROFIT MAXIMIZATION IN THE LONG RUNA decrease in demand creates losses…        Economic                                   ...
PROFIT MAXIMIZATION IN THE LONG RUNCompetitors with losses decrease supply, andprices return to zero economic profits.S3  ...
MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position                     $200                               ...
MONOPOLY REVENUES & COSTS                         Elastic            $200             150  Dollars             200        ...
MONOPOLY REVENUES & COSTS                                    Elastic              Inelastic                        $200   ...
OUTPUT AND PRICE DETERMINATIONProfit Maximization Under Monopoly           Remember the MR=MC Rule?              200      ...
OUTPUT AND PRICE DETERMINATIONProfit Maximization Under Monopoly                                 200                      ...
OUTPUT AND PRICE DETERMINATION     Loss Minimization Under Monopoly                                200                    ...
OUTPUT AND PRICE DETERMINATION     Loss Minimization Under Monopoly                                200                    ...
INEFFICIENCY OF PURE MONOPOLY     P An industry in pure competition S = MC       sells where supply and       demand are e...
INEFFICIENCY OF PURE MONOPOLY     P                        S = MC                           At MR=MC                      ...
REGULATED MONOPOLY                  P   Dilemma of Regulation                       MR = MC Which Price?                  ...
MONOPOLISTIC COMPETITION                         AND EFFICIENCY                            Long-Run Equilibrium       MC  ...
MONOPOLISTIC COMPETITION      AND EFFICIENCY• Not Productively Efficient    Minimum ATC• Not Allocatively Efficient      ...
OLIGOPOLY BEHAVIOR            A Game-Theory Overview                                 RareAir’s Price Strategy             ...
OLIGOPOLY BEHAVIOR            A Game-Theory Overview                                 RareAir’s Price Strategy             ...
OLIGOPOLY BEHAVIOR            A Game-Theory Overview                                 RareAir’s Price Strategy             ...
OLIGOPOLY BEHAVIOR            A Game-Theory Overview                                 RareAir’s Price Strategy             ...
OLIGOPOLY BEHAVIOR            A Game-Theory Overview                                 RareAir’s Price Strategy             ...
OLIGOPOLY BEHAVIOR            A Game-Theory Overview                                 RareAir’s Price Strategy             ...
OLIGOPOLY BEHAVIOR            A Game-Theory Overview                                 RareAir’s Price Strategy             ...
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Review: Costs of Production, Theory of the Firm

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Review: Costs of Production, Theory of the Firm

  1. 1. REVIEW COSTS OF PRODUCTION,THEORY OF THE FIRM
  2. 2. ECONOMIC COSTS Profits to an Profits to an Economist Accountant TEconomic (opportunity) Costs Economic O Profit T A Accounting L Profit Implicit costs (including a R normal profit) E V Explicit Accounting E Costs N costs (explicit U costs only) E
  3. 3. SHORT-RUN PRODUCTION RELATIONSHIPSLaw of Diminishing Returns Total Product, TP Total Product Increasing MarginalAverage Product, AP, and Quantity of Labor Marginal Product, MP Returns Average Product Marginal Quantity of Labor Product
  4. 4. SHORT-RUN PRODUCTION RELATIONSHIPSLaw of Diminishing Returns Total Product, TP Total Product Diminishing MarginalAverage Product, AP, and Quantity of Labor Returns Marginal Product, MP Average Product Marginal Quantity of Labor Product
  5. 5. SHORT-RUN PRODUCTION RELATIONSHIPSLaw of Diminishing Returns Total Product, TP Total Product Negative MarginalAverage Product, AP, and Quantity of Labor Marginal Product, MP Returns Average Product Marginal Quantity of Labor Product
  6. 6. PRODUCTIVITY AND COST CURVES Average product and marginal product AP MP Quantity of labor MC Costs (dollars) AVC Quantity of output
  7. 7. LONG-RUN PRODUCTION COSTSUnit Costs Output
  8. 8. LONG-RUN PRODUCTION COSTSUnit Costs Output
  9. 9. LONG-RUN PRODUCTION COSTS The long-run ATC just “envelopes” all of the short-run ATC curves.Unit Costs Output
  10. 10. LONG-RUN PRODUCTION COSTSUnit Costs long-run ATC Output
  11. 11. ECONOMIES AND DISECONOMIES OF SCALE•Labor Specialization•Managerial Specialization•Efficient Capital• Other FactorsDiseconomies of ScaleConstant Returns to Scale graphically presented...
  12. 12. ECONOMIES AND DISECONOMIES OF SCALE Economies of scaleUnit Costs long-run ATC Output
  13. 13. ATC decreases as ATC is constant as Output increases Output increases Economies Constant returns of scale to scaleUnit Costs long-run ATC Output
  14. 14. ATC decreases as ATC is constant as ATC increases as Output increases Output increases Output increases Economies Constant returns Diseconomies of scale to scale of scaleUnit Costs long-run ATC Output
  15. 15. MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position $200 Economic Profit MC 150 Cost and Revenue $131.00 MR ATC 100 AVC $97.78 50 0 1 2 3 4 5 6 7 8 9 10
  16. 16. MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position $200 Economic Profit MC 150 Cost and Revenue $131.00 MRMR = MC ATC 100 AVCOptimum $97.78Solution 50 0 1 2 3 4 5 6 7 8 9 10
  17. 17. MARGINAL REVENUE-MARGINAL COST APPROACH Short-Run Shut Down Point $200 MC 150 Cost and Revenue ATC 100 AVC $71.00 MR 50 Minimum AVC is the Shut-Down Point 0 1 2 3 4 5 6 7 8 9 10
  18. 18. SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm “Takes” its Price from the Industry Equilibrium S= MCs P P Economic ATC Profit S=MC$111 D $111 AVC D 8 Q 8000 Q Firm Industry (price taker)
  19. 19. SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm “Takes” its Price from the Industry Equilibrium S= MCs P P Economic ATC Profit S=MC$111 How about the D $111 long-run? AVC D 8 Q 8000 Q Firm Industry (price taker)
  20. 20. PROFIT MAXIMIZATION IN THE LONG RUNTemporary profits and the reestablishmentof long-run equilibrium S1 P P MC ATC$60 $60 50 50 40 MR 40 D1 100 Q 100,000 Q Firm Industry (price taker)
  21. 21. PROFIT MAXIMIZATION IN THE LONG RUNAn increase in demand increases profits… Economic S1 P Profits P MC ATC$60 $60 50 50 40 MR 40 D2 D1 100 Q 100,000 Q Firm Industry (price taker)
  22. 22. PROFIT MAXIMIZATION IN THE LONG RUNNew competitors increase supply, and lowerprices decrease economic profits. Zero Economic S1 P P S2 Profits MC ATC$60 $60 50 50 40 MR 40 D2 D1 100 Q 100,000 Q Firm Industry (price taker)
  23. 23. PROFIT MAXIMIZATION IN THE LONG RUNDecreases in demand, losses, and thereestablishment of long-run equilibrium S1 P P MC ATC$60 MR $60 50 50 40 40 D1 100 Q 100,000 Q Firm Industry (price taker)
  24. 24. PROFIT MAXIMIZATION IN THE LONG RUNA decrease in demand creates losses… Economic S1 P Losses P MC ATC$60 MR $60 50 50 40 40 D1 D2 100 Q 100,000 Q Firm Industry (price taker)
  25. 25. PROFIT MAXIMIZATION IN THE LONG RUNCompetitors with losses decrease supply, andprices return to zero economic profits.S3 Return to Zero S1 P Economic Profits P MC ATC$60 MR $60 50 50 40 40 D1 D2 100 Q 100,000 Q Firm Industry (price taker)
  26. 26. MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position $200 Economic Loss MC 150 Cost and Revenue ATC 100 AVC $91.67 $81.00 MR 50 0 1 2 3 4 5 6 7 8 9 10
  27. 27. MONOPOLY REVENUES & COSTS Elastic $200 150 Dollars 200 50 MR D Q T 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 Dollars 500 TR 250 Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
  28. 28. MONOPOLY REVENUES & COSTS Elastic Inelastic $200 150 Inelastic Dollars Portion 200 MR is NegativeA Monopolist will 50 MR Dalways operate on Qthe Elastic Portion 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18of the Demand $750Curve Dollars 500 TR 250 Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
  29. 29. OUTPUT AND PRICE DETERMINATIONProfit Maximization Under Monopoly Remember the MR=MC Rule? 200 175 Profit Per UnitPrice, costs, and revenue 150 MC $122 125 $94 100 Profit ATC 75 D 50 25 MR = MC MR Q 0 1 2 3 4 5 6 7 8 9 10
  30. 30. OUTPUT AND PRICE DETERMINATIONProfit Maximization Under Monopoly 200 175 Profit Per UnitPrice, costs, and revenue 150 MC $122 125 $94 100 Profit ATC 75 D 50 25 MR = MC MR Q 0 1 2 3 4 5 6 7 8 9 10
  31. 31. OUTPUT AND PRICE DETERMINATION Loss Minimization Under Monopoly 200 Loss Since Pm exceeds AVC, Per Unit 175 the firm will producePrice, costs, and revenue 150 MC A ATC 125 Loss Pm AVC 100 V 75 D 50 25 MR = MC MR Q 0 1 2 3 4 5 6 7 8 9 10 Qm
  32. 32. OUTPUT AND PRICE DETERMINATION Loss Minimization Under Monopoly 200 Loss Per Unit What are the 175Price, costs, and revenue 150 MC Economic Effects AVC A Pm125 Loss ATC of Monopoly? V 100 75 D 50 25 MR = MC MR Q 0 1 2 3 4 5 6 7 8 9 10 Qm
  33. 33. INEFFICIENCY OF PURE MONOPOLY P An industry in pure competition S = MC sells where supply and demand are equal At MR=MC A monopolist will sell less units at aPm higher price than inPc competition D MR Q Qm Qc
  34. 34. INEFFICIENCY OF PURE MONOPOLY P S = MC At MR=MC A monopolist will sell less units at aPm higher price than inPc competition Monopoly pricing effectivelycreates an income transfer from buyers to the seller! D MR Q Qm Qc
  35. 35. REGULATED MONOPOLY P Dilemma of Regulation MR = MC Which Price? Fair-Return PricePrice and Costs Pm Socially-Optimum Price Pf ATC Pr MC D MR Qm Qf Qr Q
  36. 36. MONOPOLISTIC COMPETITION AND EFFICIENCY Long-Run Equilibrium MC Price is Not = Minimum ATC ATC P3 = A3Price and Costs Price  MC D MR Q3 Quantity
  37. 37. MONOPOLISTIC COMPETITION AND EFFICIENCY• Not Productively Efficient  Minimum ATC• Not Allocatively Efficient Price  MC• Excess Capacity Graphically…
  38. 38. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low A $12 B $15 HighUptown’s Price Strategy $12 $6 C $6 D $8 Low $15 $8
  39. 39. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low A $12 B $15 Greatest Combined High ProfitUptown’s Price Strategy $12 $6 C $6 D $8 Low $15 $8
  40. 40. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low A $12 B $15 Independent Actions High StimulateUptown’s Price Strategy $12 $6 Response C $6 D $8 Low $15 $8
  41. 41. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low A $12 B $15 Independent Actions High StimulateUptown’s Price Strategy $12 $6 Response Gravitating C $6 D $8 to the Low Worst Case $15 $8
  42. 42. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low Collusion A $12 B $15 Invites a Different High Solution.Uptown’s Price Strategy $12 $6 C $6 D $8 Low $15 $8
  43. 43. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low Collusion A $12 B $15 Invites a Different High Solution.Uptown’s Price Strategy $12 $6 C $6 D $8 Low $15 $8
  44. 44. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low Collusion A $12 B $15 Invites a Different High Solution.Uptown’s Price Strategy $12 $6 But, the incentive to cheat C $6 D $8 is very real. Low $15 $8
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