This is it – The Big ONE ! Chapter 22 + Chapter 23 Chapter 24 + Chapter 25

Theory of the Firm n Pure n Pure Monopoly n Natural n Natural Monopoly n Duopoly n Oligopoly n Monopolistic n Monopolistic Competitive n Perfect n Perfect Competition What is a producer’s ability and willingness to offer a product for sale? Comparing revenue to costs! How does demand relate to revenue, how does that relate to a firm’s profit maximizing decisions – Which should lead to Economic efficiency!! Our big goal!

MonopolyMonopoly Illegal in the United States Near total control of an industry.

Total control of a market??

Natural Monopoly Allowed to exist because of cost benefits, licenses, copyrights, patents, and/or trademarks!!!

DuopolyDuopoly Where two firms control over 80% of the market and other companies are merely fringe players.

OligopolyOligopoly Five to seven firms dominate an industry.

Monopolistic Competitive 100’s of small franchises or businesses offer unique but similar products or services.

Perfect Competition 1000’s of small firms with no power to influence price or quantity in their market – NO MARKET POWER!

Pure Competition Market Structure Continuum Four Market Models

Pure Monopoly Market Structure Continuum PureCompetition Four Market Models

Imperfect Competition Market Structure Continuum PureCompetition PureMonopoly Four Market Models

Monopolistic Competition Market Structure Continuum PureCompetition PureMonopoly Four Market Models

Oligopoly Market Structure Continuum PureCompetition PureMonopoly MonopolisticCompetition Four Market Models

Market Structure Continuum PureCompetition PureMonopoly MonopolisticCompetition Oligopoly Four Market Models Natural Monopoly

Market Structure Continuum PureCompetition PureMonopoly MonopolisticCompetition DuopolyOligopoly Five Market Models NaturalMonopoly Again what is a producer’s ability and willingness to offer a product for sale?

The Costs of Production CHAPTER TWENTY-TWO

GHS Track Coaches Kriegel

Overview!!!Overview!!! TR > TC, TR = TC, TR TC, TR = TC, TR < TC, TR < TVC Revenues: Total, Average, Marginal Revenues: Total, Average, Marginal Costs: Opportunity, Fixed, Sunk, Variable, Total, Average Fixed, Average Variable, Average Total, and Marginal Costs: Opportunity, Fixed, Sunk, Variable, Total, Average Fixed, Average Variable, Average Total, and Marginal Profits: Total, Average, Marginal, Normal, Economic, and Accounting Profits: Total, Average, Marginal, Normal, Economic, and Accounting

Marginal Cost = MC Total Fixed Costs = TFC Total Variable Costs = TVC Average Variable Costs = AVC Total Costs = TC Average Total Costs = ATC Average Fixed Costs = AFC Summary of Definitions...

Quantity Costs (dollars) TC TotalCost Fixed Cost Long v Short run Costs Graphically Presented... TVC Variable Cost TFC

Quantity Short-run average costs (dollars) AFC Long v Short run AVC ATC MC Costs Graphically Presented...

Total Product, TP Quantity of Labor Average Product, AP, and marginal product, MP Quantity of Labor Total Output MarginalProduct AverageProduct NegativeMarginalReturns Law of Diminishing Returns Copyright McGraw-Hill, Inc. 1999

Economic Costs

Economic Costs or Opportunity Costs

Economic Costs Economic Costs or Opportunity Costs Forgoing the opportunity to produce alternative goods and services

Economic Costs Economic Costs or Opportunity Costs Forgoing the opportunity to produce alternative goods and services Explicit Costs -“out of pocket” costs to those you pay for their services. Example - Labor

Economic Costs Economic Costs or Opportunity Costs Forgoing the opportunity to produce alternative goods and services Explicit Costs Implicit Costs -self-owned, self-employed resources that could have went to alternative uses.

Normal Profits

Treated as a cost Treated as a cost Normal Profits

Treated as a cost Treated as a cost Required to attract & retain resources Required to attract & retain resources The money the entrepreneur is makingThe money the entrepreneur is making to keep them in the business. to keep them in the business. Normal Profits

Treated as a cost Treated as a cost Required to attract & retain resources Required to attract & retain resources Economic or Pure Profits Normal Profits

Treated as a cost Treated as a cost Required to attract & retain resources Required to attract & retain resources Economic or Pure Profits EconomicprofitTotalrevenue Opportunity cost of all inputs Normal Profits

TotalRevenue Profits to an Economist Accountant Copyright McGraw-Hill, Inc. 1999

ExplicitCosts Accounting costs (explicit costs only) TotalRevenue Profits to an Economist Accountant Copyright McGraw-Hill, Inc. 1999

ExplicitCosts Accounting costs (explicit costs only) AccountingProfits TotalRevenue Profits to an Economist Accountant Copyright McGraw-Hill, Inc. 1999

Implicit costs (including a normal profit) ExplicitCosts Accounting costs (explicit costs only) AccountingProfits Economic (opportunity) Costs TotalRevenue Profits to an Economist Accountant Copyright McGraw-Hill, Inc. 1999

EconomicProfits Implicit costs (including a normal profit) ExplicitCosts Accounting costs (explicit costs only) AccountingProfits Economic (opportunity) Costs TotalRevenue Profits to an Economist Accountant When a firm makes significant economic profit it may lure other Entrepreneurs away from their current businesses.

A Significant Difference... Accounting: Short and long run is based upon annual chronology

A Significant Difference... Accounting: Short and long run is based upon annual chronology Economics: Short run has fixed plant capacity size Period of time where the firms capital cannot change as a response to increase in demand (fixed resources). You can hire more workers(variable resources) but not expand the factory.

A Significant Difference... Accounting: Short and long run is based upon annual chronology Economics: Short run has fixed plant capacity size Long run has variable plant Long run has variable plant capacity size All resources are variable in the long run.

Types of Economic Analysis Total – Big Picture Average – Per Unit Marginal – Future

Short-run Production Costs

Marginal Concept - Successive Units Short-run Production Costs Costs are not only determined by price but the amount of a resource needed to produce that output. First we will look at costs from the perspective of how much of a resource is needed to get a certain output or product.

Marginal Concept - Successive Units Total Product Short-run Production Costs - the total output of a product that is produced.

Marginal Concept - Successive Units Average Product Total Product Short-run Production Costs Out put per unit of resources used. How many pizzas made with how many workers. 10/5 or TP/Q of resource.

Marginal Concept - Successive Units Average Product Marginal Product Total Product Short-run Production Costs The extra output associated with adding an additional unit of a variable resource. Change in TP/ Change in resource. The major question is how much will output rise when additional workers are hired and when will this max out and why?

Law of Diminishing Returns Marginal Concept - Successive Units Average Product Marginal Product Graphically... Total Product Short-run Production Costs As additional units of a variable resource are added to a fixed plant, beyond some point the extra amount of output will decline. See table on board.

Total Product, TP Quantity of Labor Average Product, AP, and marginal product, MP Quantity of Labor Law of Diminishing Returns Plotting Total Output on this Graph Plotting Average and marginal product on this Graph

Total Product, TP Quantity of Labor Average Product, AP, and marginal product, MP Quantity of Labor Law of Diminishing Returns MarginalProduct AverageProduct Total Output IncreasingMarginalReturns

Total Product, TP Quantity of Labor Average Product, AP, and marginal product, MP Quantity of Labor Law of Diminishing Returns DiminishingMarginalReturns MarginalProduct AverageProduct Total Output

Total Product, TP Quantity of Labor Average Product, AP, and marginal product, MP Quantity of Labor Total Output MarginalProduct AverageProduct NegativeMarginalReturns Law of Diminishing Returns

Other Cost Definitions... Now that we understand that producing “costs” us in terms of resources used, production information must be joined by the actual monetary costs.

Fixed Costs Other Cost Definitions... -those costs that do not change with changes in output. Rent or interest on loans.

Fixed Costs Total Fixed Costs Other Cost Definitions...

Fixed Costs Total Fixed Costs Average Fixed Costs = Total Fixed Costs Quantity Other Cost Definitions... Also AFC * Q = TFC

Fixed Costs Total Fixed Costs Average Fixed Costs = Total Fixed Costs Quantity Variable Costs Other Cost Definitions... -those costs that vary with the level of output. Materials, some labor, fuel, etc…

Fixed Costs Total Fixed Costs Average Fixed Costs = Total Fixed Costs Quantity Variable Costs Total Variable Costs Other Cost Definitions...

Fixed Costs Total Fixed Costs Average Fixed Costs = Total Fixed Costs Quantity Variable Costs Total Variable Costs Average Variable Costs = Total Variable Costs Quantity Other Cost Definitions... Also AVC * Q = TVC Average looks at costs on a per unit basis.

Total Costs Other Cost Definitions...

Total Costs Total Fixed & Variable Costs Other Cost Definitions...

Total Costs Total Fixed & Variable Costs Average Total Costs = Total Costs Quantity Other Cost Definitions... Or ATC = AFC + AVC Also ATC * Q = TC

Total Costs Total Fixed & Variable Costs Average Total Costs = Total Costs Quantity Marginal Costs Other Cost Definitions...

Total Costs Total Fixed & Variable Costs Average Total Costs = Total Costs Quantity Marginal Costs Marginal Cost = Change in Total Costs Change in Quantity Other Cost Definitions... Marginal is the cost incurred because we produced an additional unit of output.

Marginal Cost = MC Total Fixed Costs = TFC Total Variable Costs = TVC Average Variable Costs = AVC Total Costs = TC Average Total Costs = ATC Average Fixed Costs = AFC Summary of Definitions...

Quantity Costs (dollars) Costs Graphically Presented...

Quantity Costs (dollars) TVC Variable Cost Costs Graphically Presented... As we begin production variable costs increase at a decreasing rate.

Quantity Costs (dollars) TFC Costs Graphically Presented...

Quantity Costs (dollars) TFC Combining with variable cost... Costs Graphically Presented...

Quantity Costs (dollars) Costs Graphically Presented... TVC Variable Cost

Quantity Costs (dollars) Add vertically to get Total Cost Costs Graphically Presented... TFC TVC Variable Cost

Quantity Costs (dollars) TC TotalCost Fixed Cost Costs Graphically Presented... TVC Variable Cost TFC

Quantity Short-run average costs (dollars) Plotting Average Costs Costs Graphically Presented...

Quantity Short-run average costs (dollars) AFC Costs Graphically Presented...

Quantity Short-run average costs (dollars) AFC AVC Costs Graphically Presented...

Quantity Short-run average costs (dollars) AFC AVC Add vertically to get... Costs Graphically Presented...

Quantity Short-run average costs (dollars) AFC AVC ATC Costs Graphically Presented...

Quantity Short-run average costs (dollars) AFC AVC ATC Plotting the changes in total cost yields... Costs Graphically Presented...

Quantity Short-run average costs (dollars) AFC AVC ATC MC Costs Graphically Presented...

Quantity of labor Costs (dollars) Average product and marginal product Quantity of output Productivity & Cost Curve Relationship

Quantity of labor Costs (dollars) Average product and marginal product Quantity of output MP MC Productivity & Cost Curve Relationship

Quantity of labor Costs (dollars) Average product and marginal product Quantity of output MP AP MC AVC Copyright McGraw-Hill, Inc Productivity & Cost Curve Relationship

Shifting the costs curves When fixed costs change they shift The FC, AFC and ATC curves. When variable costs change they shift The VC, TC, AVC, ATC and MC curves

Long-run Production Costs For every plant capacity size... there is a short-run ATC curve

All such plant capacities can be plotted... Long-run Production Costs For every plant capacity size... there is a short-run ATC curve

Unit Costs Output For every plant capacity size... there is a short-run ATC curve there is a short-run ATC curve and every ATC has a minimum cost and every ATC has a minimum cost Copyright McGraw-Hill, Inc Long-run Production Costs

Unit Costs Output An infinite number of such cost curves can be constructed... Copyright McGraw-Hill, Inc Long-run Production Costs

The Long-run ATC just “envelopes” all of the short-run ATC curves Unit Costs Output Copyright McGraw-Hill, Inc Long-run Production Costs

Long-run ATC Unit Costs Output Copyright McGraw-Hill, Inc Long-run Production Costs The shape of the LR Curve is similar to the SR Curve but the same explanation does not hold. In the short run costs increased because the plant size was fixed. In the long run that isn’t so. In the long run the shape is explained through economies of scale.

Economies of Scale in Production As plant size increases a number of factors will for a time lead to lower average costs.

Economies of Scale in Production Labor Specialization Labor Specialization The more specialized labor is the more productive up to a point.

Economies of Scale in Production Labor Specialization Labor Specialization Managerial Specialization Managerial Specialization Same explanation as labor up to a point.

Economies of Scale in Production Labor Specialization Labor Specialization Managerial Specialization Managerial Specialization Efficient Capital Efficient Capital The largest capital equipment is very expensive, only if you are producing in large quantities can you afford this.

Economies of Scale in Production Labor Specialization Labor Specialization Managerial Specialization Managerial Specialization Efficient Capital Efficient Capital Other Factors Other Factors Design costs, advertising costs decline per unit as output is increased.

Economies of Scale in Production Labor Specialization Labor Specialization Managerial Specialization Managerial Specialization Efficient Capital Efficient Capital By-products By-products Other Factors Other Factors Diseconomies of Scale When a firm gets too big to be able to efficiently do business. Less communication, worker alienation.

Economies of Scale in Production Labor Specialization Labor Specialization Managerial Specialization Managerial Specialization Efficient Capital Efficient Capital By-products By-products Other Factors Other Factors Diseconomies of Scale Constant Returns to Scale graphically presented...

Unit Costs Output Long-run ATC Curves Copyright McGraw-Hill, Inc Long-run ATC

Unit Costs Output Copyright McGraw-Hill, Inc Long-run ATC Economies of scale Long-run ATC Curves

Unit Costs Output Copyright McGraw-Hill, Inc Long-run ATC Economies of scale Constant returns to scale Long-run ATC Curves

Unit Costs Output Long-run ATC Economies of scale Diseconomies Constant returns to scale Copyright McGraw-Hill, Inc Long-run ATC Curves

Unit Costs Output Where extensive economies of scale exist Copyright McGraw-Hill, Inc Long-run ATC Curves Long-run ATC

Unit Costs Output Where economies of scale are quickly exhausted Copyright McGraw-Hill, Inc Long-run ATC Curves Long-run ATC

n economic (opportunity) cost n explicit costs n implicit costs n normal profit n economic profit n short run n long run n total product n marginal product n average product n law of diminishing returns n fixed costs n variable costs n total cost n average fixed cost n average variable cost n average total cost n marginal cost n economies of scale n diseconomies of scale n constant returns to scale n minimum efficient scale n natural monopoly

NEXT: Pure Competition Chapter 23