Transcript Theory of the Firm - Woodside Priory School

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Krugman Chapter 12
Costs of Production
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Goal of a Firm is:
 Maximize
 Profit
Profit
= Total Revenue - Total Cost
 Total
Revenue is amount firm gets from
selling goods (Price x Quantity)
 Cost
is what you give up to get something
 Explicit
Costs - Input costs that require $$ Outlay
 Implicit Costs - Input costs that do not require $$
Outlay
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Economists v. Accountants
Economist View of a
Firm
Econ
Profit
Revenue
Implicit
Costs
Explicit
Costs
Accountant View of a
Firm
Accounting
Profit
Revenue
Explicit
Costs
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Marginal Production

Coach Mose gets new basketballs and wants to pump them
up. Only 2 pumps.
# of Workers
Total Output/15min
Marginal Product
0
0
1
4
4
2
8
4
3
11
3
4
14
3
5
16
2
6
17
1
7
17
0
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Marginal Production 2
 Marginal
Product
 Additional
output that arises from an additional
unit of input (usually labor)
 Diminishing
 Sound
Marginal Product
Familiar?
 Fixed
Inputs (only 2 pumps) are a short-run
phenomenon
 Graph
Production Function! Output on Y,
Labor on X
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Production Function
Output
Labor
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Total Cost (Fixed costs + Variable
Costs) Curve
Total
Cost
Output
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Measures of Cost

Fixed - Costs that do not vary due to qty produced

Variable - Costs that do vary due to qty produced

Average Fixed Costs - FC/Qty Output

Average Variable Cost - VC/Qty Output

Marginal Cost -  in TC/ in Output
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Cotton Candy Stand

Machine costs $25 per day (only one available)

Each worker gets $25 per day
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Labor Output
0
0
1
4
2
10
3
13
4
15
5
16
FC
VC
TC
AFC
AVC
ATC
MC
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Costs of Production Sketch
Cost
MC
ATC
AVC
AFC
Output
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Short Run vs. Long Run

Short Run - Some Variables Fixed

Can’t make more factories

Can hire more workers

Long Run - No Variables Fixed

Time period is not ‘the deal”

Ford Motor Company vs. Lemonade Stand
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Long Run Average Total Cost
Cost
Economies of
Scale
Diseconomies
of Scale
LRATC
Constant Returns
to Scale
Output
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Long Run Average Total Cost
Cost
SRATC
SRATC
LRATC
SRATC
MC
MC
MC
Output
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Marginal Product
Showdown
Extra Credit Activity
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Grebe Packaging!!!!
 One
desk, one pen, one stapler. All Grebe
packaging must take place with these
materials on the one desk
1
player per team has hands on the desk
 On
“GO”
 Do
this as many times as you can in 20 seconds.
 Write “GREBE” on
 Fold it
 Staple it
paper
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Grebe Packaging!!!!

Add Player #2, #3, 4, 5…

Plot combined results on board.

Find MP.

What else did we find out?
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Krugman Chapter 13
Perfect Competition
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Perfect Competition

Consumers and producers are “price takers”

Market sets the price

Lots of buyers and sellers

Products basically identical



Think agriculture (wheat, corn, apples)
Or other commodities (gold, platinum, oil…)
No/Few Barriers to Entry/Exit
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Marginal Revenue
 Change
in total revenue from an additional
unit sold
 If
PC firms are price takers and get $6 per
apple they sell…Marginal Revenue (MR) is?
 Average
Revenue (AR) per apple if they sell
10 apples?
 MR=AR=P, but
wait…in a PC market, MR
also = Demand
 So….MR=D=AR=P…Mr. Darp!
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Graph of PC Firm
Cost
MC=S
ATC
AVC
MR=D=AR=P
Produce Where
MR=MC
Output
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PC Firm w/ SR Econ Profit
MC=S
Cost
ATC
AVC
MR=D=AR=P
Econ Profit
Produce Where
MR=MC
Drop
Down to
ATC
Output
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PC Firm w/ SR Econ Loss
MC=S
Cost
Econ Loss
ATC
AVC
MR=D=AR=P
Draw Line up to
ATC
Curve
Produce
Where
MR=MC
Output
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SR Shutdown or LR Exit
Cost
MC=S
ATC
AVC
MR=D=AR=P
If Mr Darp is below ATC in theMR=D=AR=P
LR, then Exit from Market
Temporary (SR) Shutdown if
MR. Darp is Below AVC
Output
+ Firm in PC Market in LR Equilibrium.
Then..Demand Increases, Market
Market
Firm
Adjusts
Price
MC=S
Cost
S
S
’
EcProf
ATC
AVC
MR’=D’=AR’=P
’
MR=D=AR=P
D
’
D
Quantity
Output
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Krugman Chapter 14
Monopoly
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Porter’s Forces

Threat of New Entrants

Power of Suppliers

Power of Buyers

Availability of Substitutes

Competitive Rivalry
+ Non-Price Discriminating Monopoly


Price Makers

Downward sloping demand curve (You’ll see in a second)

No supply curve

No unique P&Q
MR Darp gets split up!
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NPD Monopoly MR & Darp
Price
5
If I am currently producing 1
unit at $5 and decide to
produce 2 units…
4
I must drop the price
of BOTH units to
$4…$8 total…MR is
now only $3
3
MR
D=AR=P
Qty
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NPD Monopoly Cost Curves
Price
ATC
MC
Price/unit
DWL
Cost/unit
Ec. Profit
Produce Where
MR=MC
MR
D=AR=P
Qty
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NPD Monopoly Important Pts.
Price
ATC
MC
Productive
Efficiency
Fair
Market
Price
Socially
Efficient
MC=ATC
ATC=P
MC=P
MR
ATC of
minimized
Average
cost ofit
MC
making
making
it equals
equals peoples
peoples
for
desire fordesire
it
it
D=AR=P
Qty
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Natural Monopoly

Monopoly that arises b/c a single firm can supply a G or S to
an entire market at a lower cost than could 2 or more firms.

Implies economies of scale

Examples:



PG&E
Water Companies
“Old Skool” Cable or Phone Companies
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Natural Monopoly
If Gvmt
really
Society
best
Firm
wants
tooff
wants
the
firm to
ifproduce
the firm
here
produce
here,
produces
here.
and
earn some
must
give a perOnly
problem…
Econ
Profit
unit subsidy
Price
Econ Profit
MC
ATC
Econ Loss
MR
D=AR=P
Qty
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Perfect Price Discriminator
MC
ATC
Price
Firm will sell where
A Perfect Price
MR=MC, which is also
Discriminator
will
What MC=P,
Happened
now where
sell to
itsSeparate
goods @MR
Socially
efficient price!
different
prices
and DARP???
No DWL!!!
MR=D=AR=P
Qty
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Perfect Price Discriminator

Rational Strategy

Happens quite a bit (but not perfectly).

Paperback vs. Hardcover

Movie Ticket Pricing (seniors, students…)

Must be able to separate consumers by willingness to pay

Can increase total welfare
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Mini Project

Groups of 2-3

Find a monopoly (or monopoly-ish) from past or present

2-3 slides

Introduce Monopoly, brief history…

Analyze their market power via Porter’s 5 Forces

3-5 minutes max
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Krugman Chapter 15
Oligopoly
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So Far…Two Extremes

Monopolies and Perfect Competition

Now the ‘Tweeners


Oligopolies (CH 15)

Only a few sellers

Similar or identical items
Monopolistic Competition (CH 16)

Lots of sellers

Similar but NOT identical items
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Oligopolies

Boff Industries will sell Mexican Mochas (YUM) at Woodside
Priory School.

Assume cost of product is negligible.

Price and subsequent Qty sold appear on next slide…
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Mexican Mocha Market
QTY
0
1
Price
8
7
TR
0
7
If you were the only
game in town, How
many mochas would
you make? Why?
2
3
4
5
6
5
4
3
12
15
16
15
If a new firm came in
and made 1 mocha,
what would happen to
your total revenue?
6
7
8
2
1
0
12
7
0
If two firms were to
share the market, what
strategy would benefit
both?
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The Deal

Oligopolists best off if they can act like a collective
monopolist

Collusion: Agreement among firms about:



Quantities to produce and/or
Prices to charge
Cartel: Group of firms acting together (OPEC)
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The Problem…

Incentive to act on their own will limit the group’s ability to
act like a monopoly.

Overall, disagreements among cartel members about their
“piece of the pie”

In US and EU - Antitrust Laws

Incentive to act on their own will limit ability to act like a
monopoly

Leads to a Nash Equilibrium
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Nash Equilibrium

Firms do what is best for themselves

End up at Nash Equilibrium

Nash Equilibrium

A sub-optimal end result reached when each firm does what is
best for themselves.
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Mocha Example
QTY
0
Price
8
TR
0
1
2
3
4
7
6
5
4
7
12
15
16
5
6
7
3
2
1
15
12
7
8
0
0
 If
2 firms agree to make
2 mochas…

Both get $8 Revenue
 What
if Firm A could
secretly make a 3rd?
A’s TR. goes up to $9
 B’s TR goes down to $6
 Combined TR down to $15

 What

would B Do?
Make 3 mochas as well
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Mocha Market Nash Equilibrium
Firm A
Firm B
Make 2
Make 2
Make 3
$9
$8
$6
$8
$6
Make 3
$9
$6
$6
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Click Here, Dude!!!!!!!!!!!
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How do Oligopolists Compete?

Non-Price Competition

Product Differentiation


Make a Better Product
Advertising

Make People THINK it is better

(Or tell people it is actually better)
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Krugman Chapter 16
Monopolistic Competition
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Characteristics of Monopolistic
Competition

Many Sellers

Product Differentiation


Downward sloping demand curve
Easy entry into market

No LR Economic Profit
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Monopolistic Competitor in Long
Run Equilibrium
Price
MC
ATC
Productive
Produce
where
Efficiency
MR=MC
Price Markup
MR
Restricted Output
D=AR=P
Qty
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Monopolistic Competitor DWL
Price
ATC
MC
MC=P, Socially
Efficient
DWL
MR
D=AR=P
Qty
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DWL - What Can Be Done

Regulation



Too Hard, So many firms
Force to set price at Socially Efficient Level (P=MC)

BANKRUPTCY!

Or TONS of Subsidies…Yikes
Let it be…
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Monopolistic Competitor Making
SR Profit
Price
MC
ATC
In long run? More
firms enter, so
D=AR=P shifts left
until P=ATC
Econ Profit
MR
D=AR=P
D’=AR’=P
’
Qty
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Monopolistic Competitor Making
SR Loss
ATC
Price
MC
In long run? Firms
leave market, so
D=AR=P shifts
right until P=ATC
Econ Loss
MR
D’=AR’=P
D=AR=P
’
Qty