1. Market Structure and the Behavior of Firms

2. Market Structures
Benchmark models
Perfect Competition
Monopoly

3. Behavior of Firms What is the objective of a business? Maximize profit
 = TR – TC
TR = Total Revenue = Pq
TC = Total Economic Costs
Economic Cost = Explicit Cost + Implicit Cost

4. Suppose that a young chef opened his own restaurant
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?
$107,000
$113,000
$149,000
$185,300
Explicit Costs
Implicit Costs
$60,000 (food)
$36,000 (foregone job)
$40,000 (extra help)
$300 (foregone interest)
$7,000 (utilities)
$36,000 (foregone rent)
$6,000 (equipment)
$113,000
$72,300
Total Economic Cost = $185,300

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

6. Other measures of productivity
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.

7. Productivity Graphs DMR TP AP L1 L2 L1 L2 MP output
Slope = MPL = ∆q/ ∆L
q/L ∆q TP ∆L AP
labor L1 L2 L1
labor L2 MP

8. Measuring Marginal Product
Batting Averages
GPAs
GPA
Fall
Spring
Cumulative
First Year
Second Year
Third Year
Fourth Year
4.0
2.0
3.0
3.0
3.5
3.125
When MP > AP then AP will rise
When MP < AP then AP will fall

9. Which worker at Decent Donuts has the highest marginal product?
Number of Workers 1 2 3 4 5 6 7 8 9 10
Total Donuts Produced Daily 12 26 44 64 86
110
122
125
127
128
Which worker at Decent Donuts has the highest marginal product?
The fourth
The fifth
The sixth
The seventh

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

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

12. Which of the following would be classified as a variable cost for the local Texaco gasoline station?
interest payments to a local bank for a loan.
the local property tax on the building owned by the Texaco operator.
the premiums paid for liability insurance, which are fixed at about $30,000 per year.
the federal excise tax paid on each gallon of Texaco gasoline sold. 1 2 3 4 5

13. $9 per hour multiplied by total hours of work plus $700.
Oscar has negotiated a lease for his sporting goods store where he is required to pay $2,500 per month in rent. Oscar pays his staff $9 per hour to sell sporting goods and his monthly electricity bill averages $700, depending on his total hours of operation. Oscar's fixed costs of production equal:
$2,500 per month.
$3,200 per month.
$9 per hour multiplied by total hours of work plus $700.
$9 per hour multiplied by total hours of work plus $3,200. 1 2 3 4 5

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 $ MC $ MC
ATC
output
AVC
q/L
AFC
output MP
labor

15. Austyn's total fixed cost is $3,600
Austyn's total fixed cost is $3,600. Austyn’s 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 Austyn’s hired?
$0.20 $5
$240
$720 1 2 3 4 5

16. Ian’s 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?
$25
$50
$60
$300 1 2 3 4 5

17. Long Run Costs What is the optimal size for a factory? $ LRAC output
ATC1
ATC2
ATC4
LRAC
ATC3 q2
output

18. Coordination/Communication Problems
LRAC Curve $
LRAC
ATC3
Diseconomies of Scale
Economies of Scale
Specialization
Coordination/Communication Problems
qMES
output
EOS: double the inputs, output more than doubles
 LRAC falls
DOS: double the inputs, output less than doubles
 LRAC rises

19. When all inputs increase by 40% and output rises by 30%, the firm is experiencing:
Diminishing returns
Economies of scale
Diseconomies of scale
Constant returns to scale 1 2 3 4 5

20. 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
MR = ΔTR / Δq $ $ S P1 P
= MR D Q1
Quantity
quantity
Industry
Firm

21. Maximizing Profit  = TR – TC  = P  q - [FC + VC]$ MC MR
$20 = P1
q1 = 600
quantity
What output should firm produce?
 produce until MR = MC
If MR > MC  produce more
If MR < MC  produce less
I want you
to maximize profit
What is TR = ?
What is TC = ?

22. leave output unchanged 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:
expand output
reduce output
leave output unchanged
decrease its price 1 2 3 4 5

23. Profit and Loss Diagrams
Positive Profit
 = Pq – (ATC)q
 = (P-ATC)q
 = (60-50)300
 = $3000
Negative Profit
 = (35-50)250
 = -$3750
Zero Profit? $ MC
ATC
$60 = P1
MR1
$50 = ATC1
$35 = P2
MR2
q2 = 250
q1 = 300
quantity

24. It is impossible to determine with the information given.
Juan’s 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?
$5,000
$25,000
$45,000
It is impossible to determine with the information given. 1 2 3 4 5

25. average fixed cost is equal to $1.50.
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
average fixed cost is equal to $1.50.
profit per bushel is equal to $2.75.
average variable cost is equal to $1.25.
economic profit is equal to $250. 1 2 3 4 5

26. Sometimes it’s better to stay open and lose a little bit…
 = TR – (FC +VC)
Temporary Shut Down: q = 0
 = Pq – (FC +VC)
 = 0 – (FC + 0)
 = - FC
Stay open if TR > VC
Shut down if TR < VC $ MC
ATC
AVC
$35 = ATC1
$25 = P1
MR1
$20 = AVC1
q1 = 2000
quantity
Stay open:  = -$20,000
Shut down:  = -$30,000

27. 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 $300 and total costs of $600,000 at this output level.
TR =
TC =
 =
FC =
VC =
ATC =
AFC =
AVC =
MR =
MC =
SD =
$480,000
$600,000
-$120,000
$180,000
$420,000
$1,000
$300
$700
$800
Firm should stay open since TR > VC
$800
-$180,000

28. How should a business react if…
I have to remember to think at the margin!
Price rises?
Marginal costs rise?
Fixed costs rise? $ MC
ATC
AVC P1
MR1
quantity q1

29. Long Run Equilibrium A = TR – Explicit Costs E = A - Implicit Costs
LRE: E = 0
Economy
A= 6%
E= 0%
A= 9%
E= 0%
E= 3%
A= 6%
E= 0%
A= 6%
E= 0%
if E > 0  entry occurs
if E < 0  exit occurs

30. Long Run Adjustment Process$ $ MC S1
ATC S2 P2
MR2
LRS P1
MR1 D2 D1 Q1 Q3
Quantity q1 q2
quantity
Industry
Firm
At P1: each firm produces q1 and earns E = 0
Demand rises to D2:
price rises to P2
Long run supply curve
for a constant cost
industry is horizontal
At P2: each firm produces q2 and earns E > 0
Since E > 0 , new firms will enter: supply shifts to S2
Price will fall back to P1 and E = 0

31. Market Demand Firm’s Cost 1000 firms in the industry
Price (dollars per cassette)
Quantity Demanded (thousands per week)
3.65
500
5.20
450
6.80
400
8.40
350
10.00
300
11.60
250
13.20
200
14.80
150
Output (cassettes per week) MC
AVC
ATC
150
6.00
8.80
15.47
200
6.40
7.80
12.80
250
7.00
11.00
300
7.65
7.10
10.43
350
8.40
7.20
10.06
400
10.00
7.50
450
12.40
8.00
10.22
500
12.70
9.00
1000 firms in the industry