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Market Structure and the Behavior of Firms. Market Structures Benchmark models Perfect Competition Monopoly.

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Presentation on theme: "Market Structure and the Behavior of Firms. Market Structures Benchmark models Perfect Competition Monopoly."— Presentation transcript:

1 Market Structure and the Behavior of Firms

2 Market Structures Benchmark models Perfect Competition Monopoly

3 Its registration time…how about economics? Major Econ 211 (Micro I) Econ 211 (Micro I) Econ 212 (Macro I) Econ 212 (Macro I) Econ 349 (Micro II) Econ 349 (Micro II) Econ 375 (Macro II) Econ 375 (Macro II) Math 123 (Stats) Math 123 (Stats) Econ 420 (Regression) Econ 420 (Regression) Econ 421 (Empirical Research) Econ 421 (Empirical Research) 12 additional hours in Econ 12 additional hours in Econ hours hoursMajor Econ 211 (Micro I) Econ 211 (Micro I) Econ 212 (Macro I) Econ 212 (Macro I) Econ 349 (Micro II) Econ 349 (Micro II) Econ 375 (Macro II) Econ 375 (Macro II) Math 123 (Stats) Math 123 (Stats) Econ 420 (Regression) Econ 420 (Regression) Econ 421 (Empirical Research) Econ 421 (Empirical Research) 12 additional hours in Econ 12 additional hours in Econ hours hoursMinor Econ 211 Econ 212 Math additional hours in Econ 18 hoursMinor Econ 211 Econ 212 Math additional hours in Econ 18 hours Fall 2008 Econ 325 (Gender Econ) Econ 350 (Environmental Econ) Econ 360 (Law & Econ) Econ 420 (Regression) Spring 2009 Econ 301 (Money & Banking) Econ 340 (Sports Econ) Econ 349 (Micro II) Econ 414 (Intl Econ)

4 Behavior of Firms What is the objective of a business? Assume firms maximize profit = TR – TC TR = Total Revenue = Pq TC = Total Economic Costs TR = Total Revenue = Pq TC = Total Economic Costs Economic Cost = Explicit Cost + Implicit Cost

5 1. $107, $113, $149, $185, $107, $113, $149, $185,300 Suppose that a young chef opened his own restaurant. To do so, he quit his job, which was paying $36,000 per year; cashed in a $6,000 certificate of deposit that was yielding 5% (to purchase equipment); and took over a building owned by his wife which had been rented out for $3,000 per month. His expenses for the first year amounted to $60,000 for food, $40,000 for extra help, and $7,000 for utilities. The chef is trying to figure out whether he would have been better off not being in business last year. He knows how to calculate his revenues, but he needs help with the cost side of the picture. What were the chef's total economic costs? Explicit CostsImplicit Costs $60,000 (food) $40,000 (extra help) $7,000 (utilities) $6,000 (equipment) $113,000$72,300 Total Economic Cost = $185,300 $36,000 (foregone job) $300 (foregone interest) $36,000 (foregone rent) 12345

6 Technological Constraints Production Function q = F(L, K) q = output L = labor K = capital F(·) represents technology Lab Experiment 3: Widget Production _ Variable inputFixed input

7 Other measures of productivity Total Product q = F(L, K) Average Product AP = q/L Marginal Product MP = Δq/ ΔL Note: Diminishing Marginal Returns (DMR) When there is at least one fixed input, eventually a point is reached at which the marginal product of an additional worker begins to fall.

8 q L Productivity Graphs labor output labor q/L TP MP AP L1L1 L1L1 DMR L2L2 L2L2 Slope = MP L = q/ L

9 Measuring Marginal Product Batting Averages GPAs GPA FallSpringCumulative First Year Second Year Third Year Fourth Year When MP > AP then AP will rise When MP < AP then AP will fall

10 a) The fourth b) The fifth c) The sixth d) The seventh a) The fourth b) The fifth c) The sixth d) The seventh Which worker at Decent Donuts has the highest marginal product? Number of Workers Total Donuts Produced Daily

11 Short Run Costs TC = FC + VC Does not vary with output: Rent Utilities Salaries Property taxes Insurance premiums Varies with output: Labor Raw materials

12 Short Run Cost Curve Family output $ $ FC VC TC AFC MC AVC ATC TC = FC + VCATC = AFC + AVC

13 a) interest payments to a local bank for a loan. b) the local property tax on the building owned by the Texaco operator. c) the premiums paid for liability insurance, which are fixed at about $30,000 per year. d) the federal excise tax paid on each gallon of Texaco gasoline sold. a) interest payments to a local bank for a loan. b) the local property tax on the building owned by the Texaco operator. c) the premiums paid for liability insurance, which are fixed at about $30,000 per year. d) the federal excise tax paid on each gallon of Texaco gasoline sold. Which of the following would be classified as a variable cost for the local Texaco gasoline station? 12345

14 Properties of the Cost Curves Ross Perot Equation Short Run Cost Curve Shifters Change in price of labor Change in price of capital Change in amount of capital Change in technology output $ MC labor q/L MP output $ AFC MC AVC ATC

15 a) $0.20 b) $5 c) $240 d) $720 a) $0.20 b) $5 c) $240 d) $720 Austyn's fixed cost is $3,600. Austyns employs 20 workers and pays each worker $60. The average product of labor is 30, the marginal product of the 20th worker is 12. What is the marginal cost of the last unit produced by the last worker Austyns hired? 12345

16 Long Run Costs What is the optimal size for a factory? output $ ATC 1 ATC 2 ATC 3 ATC 4 q2q2 LRAC

17 Long Run Average Cost Curve output $ ATC 3 LRAC q MES EOS: double the inputs, output more than doubles DOS: double the inputs, output less than doubles LRAC falls LRAC rises Specialization Coordination/Communication Problems

18 a) Diminishing returns b) Economies of scale c) Diseconomies of scale d) Constant returns to scale a) Diminishing returns b) Economies of scale c) Diseconomies of scale d) Constant returns to scale When all inputs increase by 40% and output rises by 30%, the firm is experiencing: 12345

19 Perfect Competition: Price Taker Model Characteristics of the Industry Large number of small buyers/sellers Homogeneous product Free entry/exit Perfect information firms are price takers Characteristics of the Industry Large number of small buyers/sellers Homogeneous product Free entry/exit Perfect information firms are price takers S D PP1P1 Q1Q1 Quantityquantity $ IndustryFirm = MR MR = ΔTR / Δq $

20 Maximizing Profit = TR – TC = P q - [FC + VC] What output should firm produce? produce until MR = MC If MR > MC produce more If MR < MC produce less What output should firm produce? produce until MR = MC If MR > MC produce more If MR < MC produce less MR MC quantity $ q 1 = 300 $60 = P 1 I want you to maximize profit What is TR = ? What is TC = ? What is TR = ? What is TC = ?

21 a) expand output b) reduce output c) leave output unchanged d) decrease its price a) expand output b) reduce output c) leave output unchanged d) decrease its price In a perfectly competitive industry, the market price of the product is $12. Firm A is producing the output at which average total cost equals marginal cost, both of which are $10. To maximize its profits, Firm A should: 12345

22 Profit and Loss Diagrams MC quantity $ q 1 = 300 $60 = P 1 ATC MR 1 $50 = ATC Positive Profit: > 0 = Pq – (ATC)q = (P-ATC)q = (60-50)300 = $3000 Negative Profit = (35-50)250 = -$3750 Zero Profit? MR 2 $35 = P 2 q 2 = 250

23 a) $5,000 b) $25,000 c) $45,000 d) It is impossible to determine with the information given. a) $5,000 b) $25,000 c) $45,000 d) It is impossible to determine with the information given. Juans Software Company is a perfect competitor. Juan has total fixed costs of $25,000, average variable costs for 1,000 units of the product of $45, and marginal revenue of $75. What is his total economic profit? 12345

24 Sometimes its better to stay open and lose a little bit… Temporary Shut Down: q = 0 = Pq – (FC +VC) = 0 – (FC + 0) = - FC Stay open if TR > VC Shut down if TR < VC MC quantity $ q 1 = 2000 $25 = P 1 ATC MR 1 $35 = ATC 1 AVC $20 = AVC 1 Stay open: = -$20,000 Shut down: = -$30,000 Fixed Cost = $30,000

25 A competitive firm is maximizing profits by producing 600 units of output at the current market price of $800 per unit. The firm has AFC of $150 and total costs of $600,000 at this output level. TR = TC = = FC = VC = ATC = AFC = AVC = MR = MC = SD = $480,000 $850 $510,000 $ 90,000 -$120,000 $800 $150 $600,000 $1,000 $800 -$90,000 Firm should shut down since TR < VC

26 Shutdown recap Shut down if TR < VC Pq < (AVC)(q) P < AVC MC quantity $ q SD ATC AVC P SD = Min AVC Note: The portion of the MC curve above the shutdown point is the firms supply curve

27 How should a business react if… Price rises? Marginal costs rise? Fixed costs rise? I have to remember to think at the margin! MC quantity $ q1q1 P1P1 ATC MR 1 AVC

28 Long Run Equilibrium A = TR – Explicit Costs E = A - Implicit Costs LRE: E = 0 A = 6% A = 9% E = 3% if E > 0 entry occurs if E < 0 exit occurs Economy E = 0% 7% 0% Firm =

29 Long Run Adjustment Process MC quantity $ q1q1 P1P1 ATC MR 1 MR 2 D1D1 S1S1 Q1Q1 At P 1 : each firm produces q 1 and earns E = 0 Demand rises to D 2 : D2D2 S2S2 P2P2 At P 2 : each firm produces q 2 and earns E > 0 Since E > 0, new firms will enter: supply shifts to S 2 Price will fall back to P 1 and E = 0 q2q2 Q3Q3 Industry Firm Quantity $ LRS Long run supply curve for a constant cost industry is horizontal causes price to rise to P 2

30 a) lower price, economic losses by rutabaga farmers, and entry into the market. b) lower price, economic losses by rutabaga farmers, and exit from the market. c) higher price, economic profits for rutabaga farmers, and entry into the market. d) higher price, economic losses by rutabaga farmers, and exit from the market. a) lower price, economic losses by rutabaga farmers, and entry into the market. b) lower price, economic losses by rutabaga farmers, and exit from the market. c) higher price, economic profits for rutabaga farmers, and entry into the market. d) higher price, economic losses by rutabaga farmers, and exit from the market. The rutabaga market is perfectly competitive. Research is published claiming that eating rutabagas leads to gaining weight and so the demand for rutabagas permanently decreases. The permanent decrease in demand results in a 12345

31 a) The firms costs will rise, resulting in positive economic profit in the short run and, hence, the industry supply curve will shift rightward in the long run b) The firms costs will rise, resulting in economic losses in the short run and, hence, the industry supply curve will shift rightward in the long run. c) The firms costs will rise, resulting in economic losses in the short run and, hence, the industry supply curve will shift leftward in the long run. d) The industry supply curve will shift leftward in the short run, causing permanent long-run economic losses a) The firms costs will rise, resulting in positive economic profit in the short run and, hence, the industry supply curve will shift rightward in the long run b) The firms costs will rise, resulting in economic losses in the short run and, hence, the industry supply curve will shift rightward in the long run. c) The firms costs will rise, resulting in economic losses in the short run and, hence, the industry supply curve will shift leftward in the long run. d) The industry supply curve will shift leftward in the short run, causing permanent long-run economic losses Suppose that newspaper companies are now required to use recycled paper, which is more expensive than new paper. Which of the following is most likely to result if the newspaper industry is highly competitive? 12345

32 a) $25 b) $50 c) $60 d) $300 a) $25 b) $50 c) $60 d) $300 Ians fixed cost of mowing lawns is $250 and his marginal cost is constant at $10 per lawn. If Ian mows 5 lawns in one day, what is his average total cost? 12345

33 a) average fixed cost is equal to $1.50. b) profit per bushel is equal to $2.75. c) average variable cost is equal to $1.25. d) economic profit is equal to $250. a) average fixed cost is equal to $1.50. b) profit per bushel is equal to $2.75. c) average variable cost is equal to $1.25. d) economic profit is equal to $250. A wheat farmer operating in the short run produces 100 bushels of wheat. Her average total cost per bushel is $1.75, total revenue is $450, and (total) fixed costs are equal to $100. Then 12345

34 Business people often speak about price elasticity without actually using the term. Which of the following quotations describes an elastic demand for a product? a) "A price cut won't help me. It won't increase my sales; I'll just get less money for each unit that I was selling before." b) "I don't think a price cut will help my bottom line any. Sure, I'll sell a bit more, but what I may gain by selling more, I'll more than lose because the price will be lower." c) "My customers are real shoppers. Since I cut my prices just a few cents below those my competitors charge, customers have been flocking to my store and sales are booming." d) "The economic expansion has done wonders for my sales. With more people back at work, my sales are taking off, and I don't even have to reduce my prices." a) "A price cut won't help me. It won't increase my sales; I'll just get less money for each unit that I was selling before." b) "I don't think a price cut will help my bottom line any. Sure, I'll sell a bit more, but what I may gain by selling more, I'll more than lose because the price will be lower." c) "My customers are real shoppers. Since I cut my prices just a few cents below those my competitors charge, customers have been flocking to my store and sales are booming." d) "The economic expansion has done wonders for my sales. With more people back at work, my sales are taking off, and I don't even have to reduce my prices." 12345

35 A group of dairy farmers are trying to raise milk prices by 20%. If the price elasticity of demand for is 0.75, and the price elasticity of supply for milk is 0, then by how much should farmers reduce their milk production to obtain the 20% increase? a) 2.7% b) 7.5% c) 15% d) 20% a) 2.7% b) 7.5% c) 15% d) 20% 12345

36 a) french fries and onion rings b) DVDs and milk c) hockey pucks and hockey sticks d) All of the above are correct, because the cross-price elasticity is always a positive number. a) french fries and onion rings b) DVDs and milk c) hockey pucks and hockey sticks d) All of the above are correct, because the cross-price elasticity is always a positive number. For which of the following is the cross-price elasticity of demand most likely a large positive number? 12345


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