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Industrial organization
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the study of how firms' decisions about prices and quantities depend on the market conditions they face
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What question does the field of industrial organization address?
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How does the number of firms affect the prices in a market and the efficiency of the market outcome?
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A key determinant of pricing and pricing decisions
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Costs of production
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Total revenue
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the total amount of money a firm receives for the sale of their output
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Total cost
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the amount that a firm pays for all of the inputs that go into producing goods and services
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Profit
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total revenue minus total cost
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Explicit costs
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input costs that require an outlay of money by the firm
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Implicit costs
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input costs that do not require an outlay of money by the firm
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Which do economists care more about, explicit or implicit costs?
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Explicit because they only care about where the money goes
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Economic profit
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total revenue minus total cost, including both explicit and implicit (opportunity) costs
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Accounting profit
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total revenue - explicit costs
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Economic loss
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when economic profit is negative
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Production function
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the relationship between quantity of inputs used to make a good and the quantity of output of that good
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Marginal product
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the increase in output that arises from an additional unit of input
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Diminishing marginal product
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the property whereby the marginal product of an input declines as the quantity of the input increases
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Total cost curve
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a graphical representation of the total cost, showing how total cost depends on the quantity of output.
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Total product
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the total amount of output produced with a given amount of input
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average product
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the average amount produced by each unit of a variable factor of production, often labor
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marginal product initially increases...
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specialization
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marginal product later decreases...
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diminishing returns
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why does marginal product initially increase?
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division of labor
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Why does marginal product decrease?
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Always happens in the short room because more and more of variable inputs are being added to a fixed amount of fixed inputs
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In microeconomics, the short run is defined as which of the following?
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A period during which some inputs in a firm's production process cannot be changed?
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As a firm hires additional workers, one would expect the marginal product to...
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rise initially; but eventually fall
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What can be altered in the short run to change production?
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Variable inputs
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Fixed inputs can be altered in the short or long run?
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Long run
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When the MP is increasing...
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TP is increasing at an increasing rate
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When MP is positive but decreasing
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TP is increasing at a decreasing rate
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When MP is 0,
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TP is at its maximum
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When MP is negative
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TP is decreasing
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When MP is above AP,
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AP is rising
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When MP is below AP,
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AP is falling
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When total physical product is at its maximum, marginal physical product must be
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equal to zero
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When marginal product exceeds average product, which of the following might be true
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average product must be increasing
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All firms are...
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profit maximizers
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Marginal total revenue is equal to what
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marginal cost
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Perfectly competitive have what in the long run
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Zero economic profit
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if economic profit is 0, accounting profit has to be
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positive
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Do fixed costs include implicit costs?
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yes
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firm
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An organization that employs factors of production to produce a good or service that it hopes to profitably sell
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total product of labor
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The total quantity, or total output of a good produced at each quantity of labor employed
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marginal product of labor
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the change in output from hiring one additional unit of labor
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average product of labor
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a measure of average labor productivity and is total product divided by the amount of labor employed
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fixed costs
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Costs that do not vary with the quantity of output produced
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When does the total cost curve get steeper?
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Law of diminishing marginal returns?
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A coffee shops fixed v.s. variable costs
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Fixed: Rent of shop and salary of a bookkeeper
Variable: cost of coffee beans, milk, sugar, and paper cups; any additional workers owner needs to hire to make more cups of coffee
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variable costs
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costs that vary with the quantity of output produced
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Average cost tells us what?
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the cost of a typical unit of output if total cost is divided evenly over all the units produced.
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Marginal cost tells us what
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the increase in total cost that arises from producing an additional unit of output.
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shape of marginal cost curve
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nike swoosh
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shape of average total cost curve
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U-shaped
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Three properties of the curves
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Marginal cost eventually rises with the quantity of output.
The average-total-cost curve is U-shaped.
The marginal-cost curve crosses the average-total-cost curve at the minimum of average total cost.
The average-total-cost curve is U-shaped.
The marginal-cost curve crosses the average-total-cost curve at the minimum of average total cost.
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economies of sale
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the property whereby long-run average total cost falls as the quantity of output increases
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diseconomies of sale
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the property whereby long-run average total cost rises as the quantity of output increases
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constant returns to sale
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the property whereby long-run average total cost stays the same as the quantity of output changes
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What might cause economies or diseconomies of sale?
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Economies of scale often arise because higher production levels allow specialization among workers, which permits each worker to become better at a specific task. Diseconomies of scale can arise because of coordination problems that are inherent in any large organization.
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At low levels of production, the firm...
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-benefits from increased size because it can take advantage of greater specialization
-has the potential for economies of scale
-is unlikely to experiences acute problems with coordination
-has the potential for economies of scale
-is unlikely to experiences acute problems with coordination
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The long run ATC is
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falling at low levels of production because of increasing specialization and rising at high levels of production because of growing coordination problems.
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U shaped cruves
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ATC and AVC
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If MC is below ATC
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ATC is falling
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If MC is below AVC
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AVC is falling
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If MC if above ATC
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ATC is rising
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If MC is above AVC
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AVC is rising
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Short Run
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only variable inputs can be altered
some inputs are fixed
plant capacity is fixed
there are both fixed and variable costs
some inputs are fixed
plant capacity is fixed
there are both fixed and variable costs
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Long run
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all inputs can be altered
no inputs are fixed
plant capacity can be altered
all costs are variable
no inputs are fixed
plant capacity can be altered
all costs are variable
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increasing returns to scale
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when output increases more than in proportion to an increase in all inputs
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decreasing returns to scale
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output is increasing at a slower rate than all inputs
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constant returns to scale
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output is increasing at the same rate as all inputs
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minimum efficient scale
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helps determine the number of firms in a market
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True or False: It doesn't matter whether you compute marginal cost using total cost or variable cost.
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True: Marginal cost equals the change in total cost for each additional unit of output. It is also equal to the change in variable cost for each additional unit of output. This occurs because total cost equals the sum of variable cost and fixed cost, and fixed cost does not change as the quantity changes. Thus, as quantity increases, the increase in total cost equals the increase in variable cost. See Section: Average and Marginal Cost.
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perfectly competitive market
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a market that meets the conditions of 1) many buyers and sellers, 2) all firms selling identical products, and 3) firms can freely enter or exit the market
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average revenue
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total revenue divided by the quantity sold
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For all types of firms, average revenue equals
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the price of the good
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marginal revenue
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the additional income from selling one more unit of a good; sometimes equal to price
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the firm maximizes profit at which marginal cost equals what
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marginal revenue
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Three rules of profit maximization
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If marginal revenue is greater than marginal cost, the firm should increase its output.
If marginal cost is greater than marginal revenue, the firm should decrease its output.
At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal.
If marginal cost is greater than marginal revenue, the firm should decrease its output.
At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal.
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shutdown
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a short-run decision not to produce anything because of market conditions
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exit
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a long-run decision to leave the market
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sunk cost
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a cost that has already been paid and cannot be recovered
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What would happen if the revenue that it would earn from producing is less than its variable costs of production?
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The firm would shut down
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What would happen if the price of the good is less than the average variable cost of production?
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The firm would shut down
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efficient scale
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the quantity of output that minimizes average total cost
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Marginal firm
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the firm that would exit the market if the price were any lower
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Is the long run or the short run supply curve more elastic?
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Long run
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Under what conditions would the long-run market supply curve be upward sloping?
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If an input necessary for production is in limited supply or if firms have different costs.
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Monopoly
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one seller and no close substitutes
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What cause a monopoly?
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Barriers to entry
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What are the sources of barriers to entry?
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Monopoly resources
Government regulation
The production process
Government regulation
The production process
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Monopoly resources
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a key resource required for production is owned by a single firm
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government regulation
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the government gives a single firm the exclusive right to produce some good or service
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The production process
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a single firm can produce output at a lower cost than can a larger number of firms
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Who founded Debeers in 1888?
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Cecil Rhodes
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Natural monopoly
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a monopoly that arises because a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms
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When does a natural monopoly arise?
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When economies of scale occur over a relevant range of output
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An example of a natural monopoly
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Distribution of water
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What type of goods tend to be natural monopolys
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Club goods (like a toll bridge)
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What could be a determinant of a natural monopoly?
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The size of the market
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output effect
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higher output raises revenue
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price effect
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lower price reduces revenue
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How does a monopoly maximize profit?
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By producing the Q at which MR=MC, then it uses the demand curve to find out P
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characteristics of imperfectly competitive firms
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Number of competitors
Types of products
Price control
Barriers to entry
Long run profit
Types of products
Price control
Barriers to entry
Long run profit
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What's the most monopolized market?
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Welfare
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price discrimination
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the business practice of selling the same good at different prices to different customers
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arbitrage
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the process of buying a currency low and selling it high
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perfect price discrimination
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Occurs when a firm charges the maximum amount that buyers are willing to pay for each unit.
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How do policy makers in the government respond to monopolies?
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By trying to make monopolized industries more competitive
By regulating the behavior of the monopolies
By turning some private monopolies into public enterprises
By doing nothing at all
By regulating the behavior of the monopolies
By turning some private monopolies into public enterprises
By doing nothing at all
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Synergy
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the power that results from the combination of two or more forces
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George Stigler
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A famous theorem in economics states that a competitive enterprise economy will produce the largest possible income from a given stock of resources. No real economy meets the exact conditions of the theorem, and all real economies will fall short of the ideal economy—a difference called "market failure." In my view, however, the degree of "market failure" for the American economy is much smaller than the "political failure" arising from the imperfections of economic policies found in real political systems.
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monopolistic competition
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a market structure in which many companies sell products that are similar but not identical
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oligopoly
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A market structure in which a few large firms dominate a market
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Attributes of Monopolistic Competition
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Many sellers: There are many firms competing for the same group of customers.
Product differentiation: Each firm produces a product that is at least slightly different from those of other firms. Thus, rather than being a price taker, each firm faces a downward-sloping demand curve.
Free entry and exit: Firms can enter or exit the market without restriction. Thus, the number of firms in the market adjusts until economic profits are driven to zero.
Product differentiation: Each firm produces a product that is at least slightly different from those of other firms. Thus, rather than being a price taker, each firm faces a downward-sloping demand curve.
Free entry and exit: Firms can enter or exit the market without restriction. Thus, the number of firms in the market adjusts until economic profits are driven to zero.
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two characteristics describe the long-run equilibrium in a monopolistically competitive market:
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As in a monopoly market, price exceeds marginal cost (P > MC). This conclusion arises because profit maximization requires marginal revenue to equal marginal cost and because the downward-sloping demand curve makes marginal revenue less than the price (MR < P).
As in a competitive market, price equals average total cost . This conclusion arises because free entry and exit drive economic profit to zero.
As in a competitive market, price equals average total cost . This conclusion arises because free entry and exit drive economic profit to zero.
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how monopolistic competition differs from monopoly
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As in a competitive market, price equals average total cost . This conclusion arises because free entry and exit drive economic profit to zero. MOnopoly can earn positive profit
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excess capacity
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the difference between a firm's profit-maximizing quantity and the quantity that minimizes average cost
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What could be a source of inefficiency in a monopolistically competitive market?
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The markup of price over marginal cost
The number of firms isn't "ideal"
The number of firms isn't "ideal"
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The product-variety externality
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Because consumers get some consumer surplus from the introduction of a new product, the entry of a new firm conveys a positive externality on consumers.
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The business-stealing externality
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Because other firms lose customers and profits when faced with a new competitor, the entry of a new firm imposes a negative externality on existing firms.
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How would one enforce marginal cost pricing?
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policymakers would need to regulate all firms that produce differentiated products
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T or F: the invisible hand ensures that total surplus is maximized under monopolistic competition
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False
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Which type of market is likely to spend the most resources on advertising?
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Monopolistic competition
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How much do firms typically spend on advertising?
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10-20% of their revenue
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How much does the economy as a whole spend on advertising?
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2 percent of total firm revenue is spent on advertising
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Lee Benham
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The Journal of Law and Economics in 1972, concluded that advertising fosters competition and reduces prices for consumers
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Edward Chamberlin
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published Theory of Monopolistic Competition, concluded from this argument that brand names were bad for the economy. He proposed that the government discourage their use by refusing to enforce the exclusive trademarks that companies use to identify their products.
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What are some advantages and disadvantages of advertising?
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To some extent, advertising manipulates consumers' tastes, promotes irrational brand loyalty, and impedes competition. To a larger extent, advertising provides information, establishes brand names of reliable quality, and fosters competition.
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game theory
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the study of how people behave in strategic situations
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duopoly
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an oligopoly consisting of only two firms
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collusion
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an agreement among firms over production and price (usually in an oligopoly)
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Cartel
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a formal organization of producers that agree to coordinate prices and production. Cartel is the term for the groups who work in unison.
A cartel must agree not only on the total level of production but also on the amount produced by each member.
A cartel must agree not only on the total level of production but also on the amount produced by each member.
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T or F: Oligopolists would like to and are able to form cartels and earn monopoly profits
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False: they would like to, but it is often impossible for them to do so
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Nash equilibrium
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a situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen
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when firms in an oligopoly individually choose production to maximize profit
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they produce a quantity of output greater than the level produced by monopoly and less than the level produced by perfect competition. The oligopoly price is less than the monopoly price but greater than the competitive price (which equals marginal cost).
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If the output effect is larger than the price effect, what will the firm do?
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The firm will increase production
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If the price effect is larger than the output effect, what will the firm do?
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The firm will NOT raise production, if they want to profit, they might even reduce production.
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as the oligopoly grows in size,
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the magnitude of the price effect falls.
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prisoners dilemma
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a particular "game" between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial
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dominant strategy
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a strategy that is best for a player in a game regardless of the strategies chosen by the other players
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Cooperation is rational or irrational for individuals?
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Cooperation is individually irrational
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T or F: The competitive outcome is best for society
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True: This is because it maximizes total surplus
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predatory pricing
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the practice of charging a very low price for a product with the intent of driving competitors out of business or out of a market
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payoff matrix
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a table that shows the payoffs that each firm earns from every combination of strategies by the firms
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Nash Equilibrium
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A set of strategies (one for each player) in which each player's strategy is the best option for that player, given the chosen strategy of the player's opponents
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tit-for-tat strategy
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A strategy in which a player cooperates until the other player defects and then defects until the other player cooperates again
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Prisoner's Dilemma
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A case in which individually rational behavior leads to a jointly inefficient outcome
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resale price maintenance
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price fixing imposed by a manufacturer on wholesale or retail resellers of its products to deter price-based competition
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Price Tying
answer
A tie-in sale results from a contractual arrangement between a consumer and a producer whereby the consumer can obtain the desired good (tying good) only if he agrees also to purchase a different good (tied good) from the producer.
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