Page 4 - Microeconomics

• IF ECONOMIES OF SCALE OCCUR FIRM DECISION MAKING & SHORT a. Economic profits are forced to zero by firms
INDEFINITELY, a firm can expand at even lower RUN SUPPLY entering the industry.
unit costs to serve the entire market. This is a • IF P > ATC, PROFITS EXIST AND THE FIRM b. Losses are eliminated by firms leaving the
characteristic of a “natural” monopoly which is WILL PRODUCE Q*. industry to obtain at least normal profits
usually owned or regulated by the government. elsewhere.
• IF DISECONOMIES OF SCALE SET IN AS $ 2. Resources are reallocated from industries
SOON AS ECONOMIES OF SCALE END (U- Profit MC ATC experiencing losses to industries making economic
SHAPED LRAC), there is a unique plant size that profits.
minimizes the unit cost of production for the firm. P*
• IF THE AVERAGE COST CURVE TURNS $
FLAT, at least for a portion of production, there is ATC* P = MR = AR = D MC
no unique plant size. This is the most frequent case ATC
in the business world.
• MINIMUM EFFICIENCY SCALE (MES): LRAC
Minimum output level of constant returns to scale. Q* Production
ECONOMIC PROFIT • IF P < ATC, THERE WILL BE LOSSES. P=MR=AR=D
• Accounting Costs = Explicit cost (actual expenses) 1. The firm will produce at a loss if the price is Normal Profit
• Implicit Costs = Net benefit that could have been higher than the average variable cost (P > AVC),
derived from the next best alternative because it can still cover variable costs. Also, Q* Q
• Economic Costs (or opportunity costs) = Explicit TFC (losses at shutdown) exceeds losses at Q*. COMPETITION & EFFICIENCY
cost + implicit cost 2. The firm will shut down if the price is lower • A PERFECTLY COMPETITIVE MARKET
• Accounting Profit = Total revenue – explicit cost than the average variable cost (P < AVC) because BRINGS ABOUT:
• Economic Profit = Total revenue – (explicit cost + it cannot cover even variable costs. Also, TFC 1. Allocative Efficiency (Q* where MC = P): The
implicit cost) (losses at shutdown) is less than losses at Q*.
• Normal Profit = The profit earned from investing • THE SHORT RUN INDIVIDUAL SUPPLY cost of resources used to produce the marginal unit is
in the average industry in the economy. Normal CURVE OF THE FIRM: That portion of the equal to the amount of money a consumer is willing
profit is achieved when economic profit is zero. marginal cost curve above its intersection with the to pay for the marginal unit at Q*. The opportunity
average variable cost curve. The quantity produced cost in producing the marginal unit is equal to the
PERFECT COMPETITION at the intersection between marginal cost and the amount sovereign consumers are willing to pay for
the unit. This occurs in both the short and long run
demand curve is equilibrium quantity. Since the
CHARACTERISTICS firm will shut down if the demand curve is below periods for a perfectly competitive firm.
• LARGE NUMBER OF BUYERS AND SELLERS: the average variable cost curve, this portion of the 2. Productive Efficiency (Q* at minimum ATC):
Large enough to prevent individual buyers or sellers, marginal cost curve is not part of the supply curve Production occurs at the lowest average cost per
or small groups of buyers or sellers, from exclusively of the firm. unit. This always occurs in the long run period for
influencing the market price. $ MC a perfectly competitive firm.
• HOMOGENOUS PRODUCT: Firms are selling Loss ATC
standardized or identical goods. AVC
• PERFECT INFORMATION ABOUT PRICES ATC* MONOPOLY
AND SUPPLIES: Producers and consumers neither P* CHARACTERISTICS
need nor are fooled by advertising. P = MR = AR = D
• FIRMS AND CONSUMERS ARE PRICE • SINGLE SELLER (THE FIRM IS THE ENTIRE
TAKERS: Firm faces a perfectly elastic demand Shutdown Point INDUSTRY)
curve for its product at the market price (P*). If a • GOODS PRODUCED HAVE NO CLOSE
firm charges a price higher than P*, the firm will Q* Production SUBSTITUTES
have zero revenue. If a firm charges a price lower P* • IMPERFECT INFORMATION
than P*, the firm will have a lower revenue than the MC • PRICE MAKER OR PRICE SEARCHER:
revenue it can achieve at P* which is irrational. The downward-sloping demand curve facing the
• NEGLIGIBLE BARRIERS TO ENTRY: Firms Supply Curve for Firm monopolist is also the market demand curve.
easily enter and exit the industry. 1. Price must decline if the monopolist seeks to
PROFIT MAXIMIZATION Q sell more. If the monopolist raises the price, the
• FIRM OBJECTIVE – TO MAXIMIZE PROFIT: LONG RUN amount sold declines.
Profit is revenue minus costs, where costs include • IN THE LONG RUN, all costs are now 2. The monopolist can choose the price or the
implicit costs. variable: amount sold, but not both.
• Firms choose to produce up to the point where 1. Firms can: • BECAUSE PRICE DECLINES AS OUTPUT IS
MR = MC: The revenue from the last marginal unit a. Expand or contract their fixed factors (EX: EXPANDED, marginal revenue is less than price.
(marginal revenue [MR]) is equal to the cost of Plant size). • AT Q WHERE MR = 0,
producing the marginal unit (marginal cost [MC]). b. Freely enter or leave the industry.
1. Marginal revenue is the change in total revenue 2. The supply response to an increase in demand 1. Total revenue is maximized.
 ∆TR  2. Elasticity of demand curve is unitary elastic.
for every additional quantity sold:   ∆Q  . is greater in the long run than in the short run. $

2. If marginal revenue exceeds marginal cost, the Whether price rises or falls depends on whether the
industry has diseconomies or economies of scale.
firm should increase production. |Elasticity| = 1
3. If marginal revenue is less than marginal cost, 3. Supply curve based on time period:
production should be reduced. P S I P S S P
• IN PERFECT COMPETITION: Marginal revenue S L
(MR) = price (P), since the firm is a price taker. D=AR=P
The perfectly competitive firm, therefore, expands
production to the point where marginal cost equals
price. Likewise, marginal revenue is equal to average Q Q Q MR
revenue, which is the same as the demand curve. Immediate Run Short Run Long Run Production
Therefore, AVERAGE REVENUE (AR) = TR . 4. Time period affects the elasticity of the supply
Q curve. It is based on producers’ capacity to respond • BARRIERS TO ENTRY:
P Market S M P Firm to price change given the TIME AVAILABLE. 1. Strong legal barriers, patents and licenses.
AR F = • ECONOMIC PROFIT IN THE LONG RUN: 2. Economies of scale keep out competition because
MR F = 1. In a dynamic economy with changing technology the unit costs of a new entrant to the industry are
P* D F and consumer tastes, there will always be some much higher than the established monopolist who
competitive industries with economic profits and can charge lower prices.
others with economic losses as adjustments are 3. Control of an essential resource can prevent
D M
Q* Q M Q F undertaken. competitors from entering the market.
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