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Production function
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The relationship between the quantity of inputs a firm uses and the quantity of output it produces
There are diminishing returns to an input when its marginal product declines as more of the input is used
There are diminishing returns to an input when its marginal product declines as more of the input is used
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Fixed input
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an input whose quantity is constant in the short run (e.g. land)
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Variable input
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An input whose quantity the firm can vary at any time (e.g. labor)
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Long run
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The period in which all inputs can be varied
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Short run
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The period in which at least one input is fixed
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Total product curve
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Shows that the quantity of output depends on the quantity of the quantity of the variable input for a given quantity of the fixed input
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Marginal product
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The additional quantity of output that it produced by using one more input of that unit
MPL= change in quantity of output/quantity of labor=change in quantity of output generated by one additional unit of labor
MPL= change in quantity of output/quantity of labor=change in quantity of output generated by one additional unit of labor
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Total cost
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FC + VC
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Average Total Cost (ATC)
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Total cost / Quantity of output
Typically U shaped
Bottom of the U is the minimum-cost output
Marginal cost curve crosses ATC at bottom of U
Typically U shaped
Bottom of the U is the minimum-cost output
Marginal cost curve crosses ATC at bottom of U
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Market structure
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Based on two things: Number of firms (one, few, or many) and whether the goods offered are identical or differentiated
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Perfect Competition
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Many firms (each with a small market share), same product
Firm is a price taker when its actions cannot affect the market price of the product
e.g. wheat
Free entry and exit (not necessary)
P=MR
Profit Maximization: Price is greater than or equal to marginal cost
Firm is a price taker when its actions cannot affect the market price of the product
e.g. wheat
Free entry and exit (not necessary)
P=MR
Profit Maximization: Price is greater than or equal to marginal cost
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Monopoly
answer
A monopolist is a firm that is the only producer of a good that has no close substitutes
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Barrier to entry
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Control of a scarce resource
economies of scale (natural monopoly)
technological superiority
government created barriers
economies of scale (natural monopoly)
technological superiority
government created barriers
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Oligopoly
answer
An industry with only a few firms (e.g.
2 firms: duopoly
characterized by imperfect competition: firms compete but possess market power
2 firms: duopoly
characterized by imperfect competition: firms compete but possess market power
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Collusion
answer
Sellers cooperate to raise each other's profits
Strongest form up collusion- cartel: an agreement by several producers to obey output restrictions in order to increase their joint profits (OPEC)
Strongest form up collusion- cartel: an agreement by several producers to obey output restrictions in order to increase their joint profits (OPEC)
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noncooperative behavior
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firms ignore the effects of their actions on each others' profits
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Average Variable costs
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Variable cost / Quantity of output
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Average fixed cost
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Fixed cost / Quantity of output
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Average Total Cost
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Total Cost / Quantity of output
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Break even price
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Price = minimum ATC
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Shut down price
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Price = minimum point AVC
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Total price
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Price x Quantity of output
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Marginal Revenue
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Change in total revenue / Change in quantity of output
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Optimal firm pricing rules for Perfect Competition
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P > MC
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Optimal firm pricing rules for Monopoly
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MR > MC
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Optimal firm pricing rules for Oligopolistic/Monopolistic Competition
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MR > MC
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Profit per unit of output
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(Price - ATC) x Quantity
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Profits in competitive industry
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Tend toward zero in the long run with free entry/exit of firms
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HHI Rule
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Sum of squares of market shares of firms
HHI < 1000, strongly competitive
1000-1800, somewhat competitive
>1800, oligopoly!!
HHI < 1000, strongly competitive
1000-1800, somewhat competitive
>1800, oligopoly!!
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Dominant strategy
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Player's best choice
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Nash Equlibrium
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each player chooses the action that maximizes his/her payoff given the actions of other players
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Tit for tat strategy
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Ensures tacit collusion
start off with a cooperative choice in the first period and then in the second period do whatever the other player did in the previous period
start off with a cooperative choice in the first period and then in the second period do whatever the other player did in the previous period
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Spreading effect
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the larger the output, the greater the quantity of output over which fixed cost is spread, leading to lower average fixed cost
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Diminishing returns effect
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higher variable costs, less profitable
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