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Fixed Costs (FC):
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Costs that do not vary with level of output in the short run; includes fixed costs
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Variable Costs:
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Cost that varies with the level of output in the short run
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Total Cost
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All cost of production; sum of variable costs and fixed costs
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Short Run Costs
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TC(Q)= FC+VC(Q)
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Isocosts
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Combination of Inputs that yield the same costs; can be rearranged into slope-intercept form
Isocosts further from the origin are associated with higher costs
Isocosts further from the origin are associated with higher costs
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Average Fixed Costs (AFC):
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FC/Q
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Average Variable Costs (AVC)
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VC(Q)/Q
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Average Total Cost (ATC)
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C(Q)/Q
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Marginal Cost (MC)
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∆C/∆Q
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Output Expansion Path
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The locus of tangencies tracked out by an isocost line of given slope as it shifts outward into the isoquant map for a production process
Figure 9.15: Line E is the Output Expansion Path for Isocosts TC1-3/r
Figure 9.15: Line E is the Output Expansion Path for Isocosts TC1-3/r
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Long Run Average Cost Curve
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Defines the minimum average cost of producing alternative levels of output allowing for optimal selection of both fixed and variable inputs
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Economies of Scale
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Economies of Scale (Increasing Returns to Scale): Declining portion of the Long-Run average cost curve as output increases
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Diseconomies of Scale (Decreasing Returns to Scale)
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Rising portion of the long-run average cost curve as output increase
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Constant Returns to Scale
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Portion of the Long Run Average Cost Curve that remains constant as output increases
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Reasons for Increasing & Decreasing Returns to Scale
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Reasons for Increasing Returns: Advantage of specialization in capital and labor- becoming more adept at a task
Reasons for Decreasing Returns: Problems with coordination and control- as an organization gets larger, it's harder to get people to work together
Reasons for Decreasing Returns: Problems with coordination and control- as an organization gets larger, it's harder to get people to work together
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Economic profit:
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the difference between total revenue and total cost, where total cost includes all costs—both explicit and implicit—associated with resources used by the firm.
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Accounting profit
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is simply total revenue less all explicit costs incurred.- does not subtract the implicit costs.
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The Four Conditions For Perfect Competition
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1. Firms Sell a Standardized ProductThe product sold by one firm is assumed to be a perfect substitute for the product sold by any other. 2. Firms Are Price TakersThis means that the individual firm treats the market price of the product as given. 3. Free Entry and ExitWith Perfectly Mobile Factors of Production in theLong Run 4. Firms and Consumers Have Perfect Information
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Perfect Competition
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The implications of these conditions are: - a single market price is determined by the interaction of demand and supply (that buyers and seller cannot affect)- firms earn zero economic profits in the long run.
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The Short‐Run Condition For Profit Maximization
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to maximize profit the firm will choose that level of output for which the difference between total revenue and total cost is largest.• Marginal revenue: the change in total revenue that occurs as a result of a 1‐unit change in sales. • To maximize profits the firm should produce a level of output for which marginal revenue is equal to marginal cost on the rising portion of the MC curve.
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Short‐Run Output Decisions under Perfect Competition
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To maximize short‐run profits, a perfectly competitive firm should make two decisions: - 1. Whether to produce?• If P < AVC, marginal revenue is not enough to cover variable costs.• Firm should shut down its plant to minimize it losses.- 2. If yes, then produce in the range of increasing marginal cost where P = MC
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Shutdown condition:
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if price falls below the minimum of average variable cost, the firm should shut down in the short run.
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The short‐run supply curve
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of the perfectly competitive firm is the rising portion of the short‐run marginal cost curve that lies above the minimum value of the average variable cost curve
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TR > TC (or ATR > ATC)
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you are making profit.
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TC > TR > VC (or ATC > ATR > AVC)
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In short run,- Keep operating (despite loss). Firm is covering VC plus part of FC obligation. So will lose less money than by folding
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If TR < TC (or ATR < ATC) in long‐run
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Stop producing, you are losing money.
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Profits are maximized when MR = MC
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Marginal revenue per unit sold = marginal cost of producing last unit
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General equilibrium analysis
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the study ofhow conditions in each market in a set ofrelated markets affect equilibrium outcomesin other markets in that set.
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Monopolistic Competition
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Firm's D = Market D• Profit max at Q where MR = MC• Pricing with market power• No barriers to entry• Differentiated products Markets and Pricing
A
A
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Monopoly
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Firm's D = Market D• Profit max at Q where MR = MC• Pricing with market power• Maintain barriers• Single product
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Perfect comp.
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Firm's D = P• Profit max at MR = P = MC• No barriers to entry• Homogeneous products
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The Invisible Hand Theorem
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Theorem of the invisible hand: an equilibrium produced by competitive markets will exhaust all possible gains from exchange.- Equilibrium in competitive markets is Pareto optimal.
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Second Welfare Theorem
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he second theorem of welfare economics says that, under relatively unrestrictive conditions:- Any allocation on the contract curve can be sustained asa competitive equilibrium.• The significance of the second welfare theorem is that the issue of equity in distribution is logically separable from the issue of efficiency in allocation.
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Barriers to negotiation
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1)Negotiating can involve time and money -not worthwhile if few benefits 2)Negotiating with large groups inherently difficult and costly 3)How to divide surplus
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Property Rights
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No free‐market economy can function successfully without laws that govern the use of private property.• Invisible hand mechanism can function properly only when all resources sell for prices that reflect their true economic value
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Optimal structure of property rights:
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places burden of adjustment on party that can accomplish it at the lowest cost.
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Regulation vs. Taxation
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Advantage of tax is that it concentrates pollution reduction in hands of firms that can do so in least costly way.• Direct regulatory approach could achieve same outcome if regulators know each firm's MC of reducing pollution.• Taxing negative externalities can increase efficiency. O/w output level is too high to maximize economic surplus.
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Functions of Government
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1. Provision of public goods 2. Direct redistribution of income
Concerns about fairness and efficiency are inextricably linked in both these areas• Public Choice: how societies make choices between competing public projects:- Majority voting- Cost‐benefit analysis• Rent‐seeking threatens our social welfare17
Concerns about fairness and efficiency are inextricably linked in both these areas• Public Choice: how societies make choices between competing public projects:- Majority voting- Cost‐benefit analysis• Rent‐seeking threatens our social welfare17
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Public Goods
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Pure public good: a good that has a high degree of:- Nondiminishability: one person's consumption of good has no effect on amount available for others-
Nonexcludability: cannot exclude non payers from consuming good- Each person consumes the same amount of it.
Nonexcludability: cannot exclude non payers from consuming good- Each person consumes the same amount of it.
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Collective good
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a good that is excludable and has a high degree only of nondiminishability.
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Majority voting:
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by this standard, projects favored by a majority—in either a direct referendum or a vote taken by elected representatives—are adopted and all others are abandoned.• Majority voting obscures important differences in intensity with which different voters hold their preferences
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Cost‐Benefit Analysis
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Cost‐benefit analysis: an alternative to majority voting that attempts to take explicit account of how strongly people feel about each of the alternative sunder consideration.• Cost‐benefit analysis measures intensity of preferences by estimating WTP for alternatives:- WTP of supporters, net of WTP of opponents to prevent programs
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Rent seeking
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Gains from public choices or from changes in regulations are often large and concentrated in the hands of a few- Costs are often spread among many- So those who stand to benefit from a change may organize and lobby for it- Such rent seeking often leads to results where benefits<costs• Private parties might spend large sums to raise their odds of being chosen as beneficiaries- Gains from government projects can be squandered by competition among potential beneficiaries- Example: lobbying for cable TV franchise to earn monopoly profits21
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Fairness and Efficiency
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Material rewards for effort and risk taking necessarily lead to inequality.• Inefficient solutions make the economic pie smaller for everyone, rich and poor alike.- If efficient solutions are adopted, it must be possible for everyone to receive a larger slice.- Rawls argues inequality accepted to a degree, so long as rewards produce sufficiently large increase in total output available for distribution, raising income for everyone.
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