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Costs of Production & Theory of the Firm
- 1. REVIEW COSTS OF PRODUCTION, THEORY OF THE FIRM
- 2. ECONOMIC COSTS Profits to an Profits to an Economist Accountant T Economic (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. SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product, TP Total Product Increasing Marginal Average Product, AP, and Quantity of Labor Marginal Product, MP Returns Average Product Marginal Quantity of Labor Product
- 4. SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product, TP Total Product Diminishing Marginal Average Product, AP, and Quantity of Labor Returns Marginal Product, MP Average Product Marginal Quantity of Labor Product
- 5. SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product, TP Total Product Negative Marginal Average Product, AP, and Quantity of Labor Marginal Product, MP Returns Average Product Marginal Quantity of Labor Product
- 6. PRODUCTIVITY AND COST CURVES Average product and marginal product AP MP Quantity of labor MC Costs (dollars) AVC Quantity of output
- 7. LONG-RUN PRODUCTION COSTS Unit Costs Output
- 8. LONG-RUN PRODUCTION COSTS Unit Costs Output
- 9. LONG-RUN PRODUCTION COSTS The long-run ATC just “envelopes” all of the short-run ATC curves. Unit Costs Output
- 10. LONG-RUN PRODUCTION COSTS Unit Costs long-run ATC Output
- 11. ECONOMIES AND DISECONOMIES OF SCALE •Labor Specialization •Managerial Specialization •Efficient Capital • Other Factors Diseconomies of Scale Constant Returns to Scale graphically presented...
- 12. ECONOMIES AND DISECONOMIES OF SCALE Economies of scale Unit Costs long-run ATC Output
- 13. ATC decreases as ATC is constant as Output increases Output increases Economies Constant returns of scale to scale Unit Costs long-run ATC Output
- 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 scale Unit Costs long-run ATC Output
- 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. MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position $200 Economic Profit MC 150 Cost and Revenue $131.00 MR MR = MC ATC 100 AVC Optimum $97.78 Solution 50 0 1 2 3 4 5 6 7 8 9 10
- 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. 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. 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. PROFIT MAXIMIZATION IN THE LONG RUN Temporary profits and the reestablishment of 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. PROFIT MAXIMIZATION IN THE LONG RUN An 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. PROFIT MAXIMIZATION IN THE LONG RUN New competitors increase supply, and lower prices 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. PROFIT MAXIMIZATION IN THE LONG RUN Decreases in demand, losses, and the reestablishment 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. PROFIT MAXIMIZATION IN THE LONG RUN A 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. PROFIT MAXIMIZATION IN THE LONG RUN Competitors with losses decrease supply, and prices 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. 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. 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. MONOPOLY REVENUES & COSTS Elastic Inelastic $200 150 Inelastic Dollars Portion 200 MR is Negative A Monopolist will 50 MR D always operate on Q the Elastic Portion 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 of the Demand $750 Curve 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. OUTPUT AND PRICE DETERMINATION Profit Maximization Under Monopoly Remember the MR=MC Rule? 200 175 Profit Per Unit Price, 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. OUTPUT AND PRICE DETERMINATION Profit Maximization Under Monopoly 200 175 Profit Per Unit Price, 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. OUTPUT AND PRICE DETERMINATION Loss Minimization Under Monopoly 200 Loss Since Pm exceeds AVC, Per Unit 175 the firm will produce Price, 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. OUTPUT AND PRICE DETERMINATION Loss Minimization Under Monopoly 200 Loss Per Unit What are the 175 Price, 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. 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 a Pm higher price than in Pc competition D MR Q Qm Qc
- 34. INEFFICIENCY OF PURE MONOPOLY P S = MC At MR=MC A monopolist will sell less units at a Pm higher price than in Pc competition Monopoly pricing effectively creates an income transfer from buyers to the seller! D MR Q Qm Qc
- 35. REGULATED MONOPOLY P Dilemma of Regulation MR = MC Which Price? Fair-Return Price Price and Costs Pm Socially-Optimum Price Pf ATC Pr MC D MR Qm Qf Qr Q
- 36. MONOPOLISTIC COMPETITION AND EFFICIENCY Long-Run Equilibrium MC Price is Not = Minimum ATC ATC P3 = A3 Price and Costs Price MC D MR Q3 Quantity
- 37. MONOPOLISTIC COMPETITION AND EFFICIENCY • Not Productively Efficient Minimum ATC • Not Allocatively Efficient Price MC • Excess Capacity Graphically…
- 38. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low A $12 B $15 High Uptown’s Price Strategy $12 $6 C $6 D $8 Low $15 $8
- 39. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low A $12 B $15 Greatest Combined High Profit Uptown’s Price Strategy $12 $6 C $6 D $8 Low $15 $8
- 40. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low A $12 B $15 Independent Actions High Stimulate Uptown’s Price Strategy $12 $6 Response C $6 D $8 Low $15 $8
- 41. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low A $12 B $15 Independent Actions High Stimulate Uptown’s Price Strategy $12 $6 Response Gravitating C $6 D $8 to the Low Worst Case $15 $8
- 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. 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. 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