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accounting total cost
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explicit costs only
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economic total cost
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accounting total cost + implicit costs
economic total cost is opportunity cost
economic total cost is opportunity cost
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accounting profit =
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total revenue - accounting total costs
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economic profit =
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total revenue - economic total costs
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when economic profit = 0
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normal economic profit; means that the firm is doing as well as it could in it's next best alternative
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economic profit > 0
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firm's owner is doing better than she/he could in her/his next best alternative
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economic profit < 0
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firm's owner is doing worse than she/he could in his/her next best alternative
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short run
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period of time so short that capital is fixed.
firms can change output ONLY by changing the number of workers hired, NOT by changing factory size
firms can change output ONLY by changing the number of workers hired, NOT by changing factory size
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L represents
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labor
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N represents
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natural resources
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K represents
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capital
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in the short run...
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Q=f(L) because capital is fixed
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marginal product of labor =
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change in quantity / change in labor
tells us how output changes as the firm hires an additional worker
tells us how output changes as the firm hires an additional worker
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fixed costs (FC)
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costs that do not change as output changes (rent)... only exist in the short run
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variable costs (VC)
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costs that vary as output changes (labor costs). VC goes up as Q goes up. VC goes down as Q goes down.
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Total cost =
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Fixed costs + variable costs
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marginal cost (MC) =
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change in total cost / change in quantity
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average fixed cost
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fixed cost per unit = FC / Q
continuously declines as output rises
continuously declines as output rises
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Average variable cost (AVC)
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VC/Q, graphed as a U-shaped curve
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Average total cost (ATC)
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TC/Q or AFC + AVC
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ATC =
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AFC + AVC
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MC intersects ATC & AVC at their __________ points
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minimum
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P=R only for a ___________ firm
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competitive
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profit =
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(P-ATC) x Q*
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when profit > 0 for a firm in the short run
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profit = (P-ATC) x Q* and is a rectangular shape
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when profit = 0 for a firm in the short run (normal or zero profit)
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when profit = 0, P=ATC=MC (minimum at ATC)
the firm is doing just as well in its next best alternative
profit = 0 ---> long run equilibrium
the firm is doing just as well in its next best alternative
profit = 0 ---> long run equilibrium
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when profit < 0 for a firm in the short run (negative economic profit AKA loss)
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should the firm operate in the short run or shut it down?
-if the firm closes, loss = fixed costs (firm must still pay rent)
-if the firm operates, the firm will also have variable costs, but will earn TR to offset costs
-if TR >= VC, the firm operates
-operate if P>=AVC at Q*
-if the firm closes, loss = fixed costs (firm must still pay rent)
-if the firm operates, the firm will also have variable costs, but will earn TR to offset costs
-if TR >= VC, the firm operates
-operate if P>=AVC at Q*
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"shut down" price
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when P=AVC=MC (min of AVC)
-the lowest price at which the firm will still operate in the short run
-the lowest price at which the firm will still operate in the short run
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FC =
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(ATC-AVC) x Q*
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Long run equilibrium price =
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where MC = ATC
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in the long run all perfectly competitive firms earn a profit of ________
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zero
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What happens between the short run and the long run when profit > 0 ?
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-other firms will enter the industry & therefore supply will increase. As supply increases, price will decrease until P=ATC=MC, profit = 0 and the industry is in LR eq'm again
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productive efficiency
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produce at the minimum of ATC in the long run
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What happens between the short run and the long run when profit < 0 in the SR ?
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firms begin to exit the industry; the industry supply will decrease and price will increase until the profit = 0
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monopolistic competition
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-numerous buyers & sellers
-no barriers to entry
-each seller produces a slightly differentiated product (products are not perfect substitutes)
--these differences can be real or perceived (marketing can provide info about real differences OR can generate perceived differences)
-no barriers to entry
-each seller produces a slightly differentiated product (products are not perfect substitutes)
--these differences can be real or perceived (marketing can provide info about real differences OR can generate perceived differences)
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market power
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when a firm has some ability to set price; firms face downward-sloping demand curves (i.e. they are not price takers)
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firms in monopolistic competition will maximize profit by producing all units where
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MR >= MC
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Unlike a perfectly competitive firm, in monopolistic competition,
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P is not equal to MR
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in the long run, monopolistically competitive firms have a profit of ______
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zero
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monopolistically competitive firms must _______ their prices to sell more units because their goods are not perfect substitutes
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lower
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Profit maximization for monopolistic competition
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-produce Q where MR=MC
-charge price associated with quantity given by demand curve
-if ATC > P at Q*, they will lose money
-charge price associated with quantity given by demand curve
-if ATC > P at Q*, they will lose money
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Monopoly
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-1 seller, many buyers
-seller produces a unique product
-substantial barriers to entry (patents, licensing, etc.)
-monopolists are price searchers: they face a downward sloping demand curve & must choose p & q to maximize profits
-seller produces a unique product
-substantial barriers to entry (patents, licensing, etc.)
-monopolists are price searchers: they face a downward sloping demand curve & must choose p & q to maximize profits
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price discrimination
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charging different customers different prices for the same good or service
-need to differentiate consumers' willingness-to-pay
-need to prevent resale
-need to differentiate consumers' willingness-to-pay
-need to prevent resale
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Perfect (1st degree) price discrimination
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-when a seller charges each consumer the maximum price he/she is willing to pay; does not charge a single price
-in this case, monopolist captures all of the consumer surplus so CS=0
-in this case, monopolist captures all of the consumer surplus so CS=0
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2nd or 3rd degree price discrimination
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-groups of consumers are charged different prices
ex: pricing on an aircraft, couponing, rebates, volume discounting
ex: pricing on an aircraft, couponing, rebates, volume discounting
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other kinds of price discrimination
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-block pricing
-commodity bundling
-2 part pricing
-commodity bundling
-2 part pricing
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commodity bundling
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-bundle products together and sell as a package price
-useful when consumers have different values for products sold by the same company (cable/internet/phone)
-useful when consumers have different values for products sold by the same company (cable/internet/phone)
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2 part pricing
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-best for products with high fixed costs
-charge annual one time access fee = CS
-charge per unit price = MC
-charge annual one time access fee = CS
-charge per unit price = MC
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In a monopolized industry, prices will be ___________ & eq'm quantity will be _________ than if the industry was competitive
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higher, lower
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monopoly is ____________ ____________
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allocatively inefficient (has DWL) because at Qm, P>MC
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monopoly also doesn't produce at the minimum of ____
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ATC
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consumers are _______ _____ under monopoly
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worse off
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antitrust policy
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-states that it is not illegal to be a monopoly, but it is illegal to monopolize
-Federal Trade Commission (FTC) & Dept. of Justice (DOJ) enforce this policy through the courts
-Federal Trade Commission (FTC) & Dept. of Justice (DOJ) enforce this policy through the courts
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how do the FTC & DOJ enforce the antitrust policy?
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-can charge a firm with being anticompetitive
-can sue to prevent mergers (if mergers reduce competition "too much")
-can sue to prevent mergers (if mergers reduce competition "too much")
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horizontal merger
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a merger between 2+ firms providing essentially the same product or service (ex: office max & staples or U.S. Air & american airlines)
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Herfindahl-Hirschman Index (HHI)
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-a way to measure how competitive a market is
-the square of the percentage market share of each firm (top 50) summed = (firm 1 market)^2 + (firm 2)^2 + [....] (firm 50)^2
-the square of the percentage market share of each firm (top 50) summed = (firm 1 market)^2 + (firm 2)^2 + [....] (firm 50)^2
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vertical merger
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merger between 2 firms operating at different stages in a production process
(Ex: gasoline company merging with an oil refinery)
(Ex: gasoline company merging with an oil refinery)
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oligopoly
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-a few firms
-produce similar products
-firms are interdependent: one firm's actions affect the profit of the other firm(s)
-in an oligopoly, firms could cooperate to achieve monopoly outcomes & split profits, OR they can compete, driving prices & profits down
-outcome will tend to be closer to monopoly as the number of firms shrinks
-produce similar products
-firms are interdependent: one firm's actions affect the profit of the other firm(s)
-in an oligopoly, firms could cooperate to achieve monopoly outcomes & split profits, OR they can compete, driving prices & profits down
-outcome will tend to be closer to monopoly as the number of firms shrinks
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game theory
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technique used to understand strategic interactions between firms
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payoffs
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row player gets first number in ordered pair
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to solve these games,
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first identify each players BEST RESPONSE to another player's actions
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best response
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the strategy that maximizes the player's well-being, conditional on that action being taken
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dominant strategy
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the action that gives the player the best outcome regardless of what the other player does
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nash equilibrium
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the eq'm where each player is playing a best response to the other player(s) actions
* a game can have 0, 1, 2, or more nash equilibria
* a game can have 0, 1, 2, or more nash equilibria
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one-shot game
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more likely to hit nash eq'm
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repeated game
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firms may deviate from best responses (and nash equilibrium) to signal willingness to achieve a cooperative outcome
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trigger strategy
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one firm will cooperate as long as the other one does. if the other one "cheats", the firm never cooperates again
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tit-for-tat
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one player does whatever the other player did in the last period
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extensive form games
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one player moves first
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