E&S Chapter 2 Firms Decisions PDF

CHAPTER 2: FIRMS’ DECISIONS Economics & PART 2.1 – Society Dr Que VU PRODUCTION AND COST  SMU Classification: Restricted Cost Profit A Firm’s...

CHAPTER 2: FIRMS’ DECISIONS Economics & PART 2.1 – Society Dr Que VU PRODUCTION AND COST  SMU Classification: Restricted Cost Profit A Firm’s Producti structur Maximiz Problem on e a-tion Revenue, Production Different General Cost, Process Types of Rules Profit Production Cost Accountin Function Measures g vs. Marginal of Costs Economic Product Profit Law of diminishing return AGENDA  PART 2.1 LEARNING OBJECTIVES  Understand the firm’s problem and the difference between accounting profit vs. economic profit.  Understand the production function, marginal product and how are they related?  Differentiate among various types of costs? Understand the relationship among them and impact to the output level.  Understand the concept of “economies of scale”.  Differentiate cost in long-run to short-run (optional self read for interest only)? Accounting vs. Economics Profit FIRMS’ PROBLEM  FIRMS’ PROBLEM Profit maximization To maximize profit, a firm needs to know: Revenue, costs  How to Profitty o calculate Profit? 1 Production Cost How to 2 maximize structures profit? 3 Revenues  TOTAL REVENUE, TOTAL COST, AND PROFIT Profit = Total revenue (TR) –Total (Opportunity) costs (TC) Total revenue = Price x Quantity Explicit costs Costs that require an actual outlay of money by the firm (e.g. paying wages to workers, materials…) Implicit costs Costs that incurred but not able to be seen, i.e. non-monetary outlay (e.g. cost of the owner’s time…) Total (Opportunity) Costs = Explicit Costs + Implicit Costs  ACCOUNTING VS. ECONOMIC PROFITS Economic profit is the correct measure to evaluate whether a business is economically profitable. All of our subsequent analysis in this chapter involving profits refers to economic profit (cost  ACTIVITY: ACCOUNTING VS. ECONOMIC PROFITS JELANI’S GELATO SHOP Jelani owns a small gelato shop on campus using her $50,000 savings as initial investment. In addition, every year, Jelani needs to  pay $25,000 for raw materials, and  pay $15,000 in rent and electricity, water bills Jelani expects that she will be able to sell 15,000 pints of gelato a year at the price of $6 each. Calculate her profit.  ACTIVITY: ACCOUNTING VS. ECONOMIC PROFITS JELANI’S GELATO SHOP (CONT.) Expenses Revenues Rent Goods sold Raw Materials Total Cost: $40,000 Total revenue: $90,000 Total (Accounting) Profit: $90,000- $40,000=$50,000  ACTIVITY: ACCOUNTING VS. ECONOMIC PROFITS JELANI’S GELATO SHOP (CONT.) However, Jelani can work at the local coffee shop for $30,000 a year if she does not run her own shop. In addition, currently, her $50,000 savings is enjoying interest rate of 5% per year. Implicit Opportunity CostTime: Interest Earned on Savings:  ACTIVITY: ACCOUNTING VS. ECONOMIC JELANI’S GELATO SHOP PROFITS (CONT.) Expenses Revenues Rent Goods sold $15,000 $90,000 Raw Materials Jelani’s $25,000time $30,000 Interest on savings $2,500 Total Cost: $72,500 Total Economic Profit: $90,000 - $72,500=$17,500 Difference between accounting and econ profit Production Process Marginal Product Law of diminishing return PRODUCTION  PRODUCTION PROCESS What is production? INPUTS Production OUTPUT process Example:A Cake shop Inputs Output Shop, ovens, mixers…. Cake (pieces) Labor, ingredients, electricity..  PRODUCTION AND MARGINAL PRODUCT A firm, making T-shirt, the daily quantity of output produced varies with the number of workers (ignore Marginalallproduct: other costs for now). ∆ 𝑜𝑢𝑡𝑝𝑢𝑡 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 additional 𝑀𝑃 = output for each additional unit of ∆ 𝑖𝑛𝑝𝑢𝑡 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 input. L Q MPL No. No. T- No. of T-shirt Workers shirts (more) ∆L = ∆Q = 20 0 0 1 Specializatio ∆L = 1 20 ∆Q = 25 n: 1 ∆L = 2 45 ∆Q = 30 1 ∆L = 3 75 ∆Q = 25 1 Law of Diminishing ∆L = 4 100 ∆Q = 20 Returns 1 ∆L = 5 120 ∆Q = 15 1 Different Types of Cost Measures of Cost Typical Cost Curves COST STRUCTURE  INPUT AND COSTS Different types of Inputs Fixed Fixed Costs inputs (FC) Costs that are the same regardless of quantity produced: rent, depreciation (machinery…) Variable Variable inputs costs (VC) Costs that vary with quantity produced: labor, ingredients, Total electricity.. costs (TC) TC = FC + VC Short run vs. Long run !!!  DIFFERENT MEASURES OF COSTS Average Total (per unit cost) Fixed costs (FC) Average fixed costs: 𝐹𝐶 𝐴𝐹𝐶= (AFC) 𝑄 Variable costs (VC) Average variable costs: 𝑉𝐶 (AVC) 𝐴𝑉𝐶= 𝑄 Total costs (TC) Average total costs: TC = FC + VC (ATC) ATC = AFC + AVC ∆ 𝑇𝐶 𝑇𝐶2 − 𝑇𝐶 1 𝑀 𝐶= Marginal Marginal cost (MC) = ∆𝑄 𝑄2 − 𝑄 1 Additional Cost for an additional last unit of out DIFFERENT TYPES OF COSTS Q FC VC TC Knit scarves business: 0 18 0 18 1 18 15 Angel paid $18 for two 33 pairs of knitting 2 18 25 43 needles (Fixed Cost- 3 18 30 48 FC) 4 18 32 50 To produce more 5 18 36 54 scarves, she needs 6 18 44 62 more yarn, time….. 7 (Variable Cost- VC) 18 58 8 18 78 76 96 TC = FC + VC Total Cost: 9 18 104 122 10 18 136 154  DIFFERENT MEASURES OF COSTS Q FC VC TC AFC AVC ATC MC 0 $18 $0 $18 1 18 15 33 2 18 25 43 3 18 30 48 4 18 32 50 5 18 36 54 6 18 44 62 7 18 58 76 8 18 78 96 9 18 104 122 10 18 136 154 DIFFERENT COST CURVES ATC = AFC + AVC  Except AFC, all other cost curves have a U shape. Specialization vs. Law of diminishing return.  MC intersects with ATC and AVC at their bottom.  Most efficient scale  DIFFERENT COST CURVES When MC < ATC, When MC > ATC, ATC is falling. ATC is rising. Current Quantity Produced: Q1 =10 units with current ATC1=$3 Calculate the new ATC when the firm produce the 11th unit if: Case 1: 11th unit costs MC=$2 Case 2: 11th unit costs MC=$4  PROFIT MAXIMIZATION  PROFIT MAXIMIZATION GENERAL RULES Firm's Profit Maximization Problem: Choose the quantity level produced to maximize its profit. Assume firm is currently profiting at the quantity level of Q Question: Should it produce more? How much more? One additional unit of output Additional Additional Cost Revenue Marginal Cost Marginal whatRevenue can earn from what have to pay in providing that unit into the order to produce that  PROFIT MAXIMIZATION GENERAL RULES One additional unit of output Additional Additional Cost Revenue Marginal Cost Marginal Revenue (MC) 𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡=𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 − 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 (MR) 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡=𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒−𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝐶𝑜𝑠𝑡 Producing that additional unit can increase Profit Producing that additional unit will decrease Profit “Rational people Will produce until think at the margin”  PROFIT MAXIMIZATION GENERAL RULES We already know about the MC and its shape. BUT  How MR look like? What determine MR? (hint: it comes from the market)  How to determine the firm’s supply curve?  How firms make decision: We know general rules for profit maximization but specifically what does that mean? Other situations: Making a loss? Closing down?  CHAPTER 2: FIRMS’ DECISIONS PART 2.2 – FIRMS IN PERFECTLY COMPETITIVE MARKETS  SMU Classification: Restricted AGENDA PERFECTLY COMPETITIVE MARKETS Market Other Structure Firms’ Profit Firms’ Market and Firms’ Maximizatio Supply Outcomes Demand n Quantity Decisions Curve.  PART 2.2 LEARNING OBJECTIVES  Explain the characteristic of Marginal Revenues for a firm in perfectly competitive market.  Understand how perfectly competitive firms identify profit maximization output.  Understand how do firms make other supply decisions in short-term and long term for perfectly competitive market.  Understand market outcomes in the perfectly competitive market. Perfectly Competitive Market Revisit Market Demand vs. Firm’s Demand PERFECT COMPETITION  PERFECT COMPETITIVE MARKET STRUCTURE No one has 1. Nature of the market good/service One homogeneous, identical power. good/service 2. Number of buyers and sellers Everyone is Many buyers and many sellers a price taker. Drawbac Accept all the ks? risks/opportunities coming from changes of market price  PERFECT COMPETITIVE MARKET STRUCTURE 3. Entry and exit conditions Free entry and Fast responses to Long - exit Short - Responses run to other the changes in run market prices conditions rather Often just the than price (even no changes in scale, price change still but also can be enter/exit market). quick enter/exits … Totally new E.g.: temporary enter/exit usually closed down or take time. stock up to sell more Cause the shift of Cause the the supply curve movement along THE FIRM’S DEMAND CURVE What does that mean to be a simple PRICE TAKER ? THE THE MARKET FIRM NO need to worry about your customer base (you are too small) Flat demand curve at market price  THE FIRM’S DEMAND CURVE: HIGHLY COMPETITIVE MARKET https://medium.com/agorapulse-stories/how-to-build- It is good if you are a-profitable-business-in-a-highly-competitive- environment-42ed4df64603 visionaries, but it is not easy! Successors Profit Maximization and Profit Calculation SR-LR Supply Decisions LR Market Outcomes FIRMS’ CONDUCT UNDER PERFECT COMPETITION  SUPPLY DECISION: PROFIT MAXIMIZATION Profit Maximization General M MC Rules: R Costs/ Price MC Every units sold will have a same marginal revenue equals to market Market PRICEprice. P1 Market Price MR1 is = Demand For Curve the = Marginal fir Qa Q1 Qb m The Revenue Quantity Firm  SUPPLY DECISION: PROFIT MAXIMIZATION Perfect Δ Profit Competitive Q TR TC Profit MR MC = MR - MC Market. 0 $0 $6 -6 Current Market 1 20 14 6 Price (used to calculate total 2 40 24 16 80 48 32 revenue) 3 60 36 23 180 4 80 50 30 Calculate the 5 100 66 34 profit 6 120 85 35 column 7 140 105 35 Find the 8 160 126 24 quantity that 9 180 150 30 maximize 10 200 176 24 36 the firm’s  SUPPLY DECISION: PROFIT MAXIMIZATION Perfect Δ Profit Competitive Q TR TC Profit MR MC = MR - MC Market. 0 $0 $6 Current Market 1 20 14 Price (used to calculate total 2 40 24 revenue) 3 60 36 4 80 50 Fill in the 5 100 66 table. 6 120 85 Find the 7 140 106 quantity that 8 160 128 maximize 9 180 152 the firm’s 10 200 178 37 profit.  SUPPLY DECISION: PROFIT CALCULATION Profit = TR – TC Costs, P Find Q MC TR = P × Q = $120 where MR = MC ATC TC = ATC × Q = $85 P1 = $20 MR1 Profit = (P – ATC) × Q ATC1 = $14.16 Q1 = 6 Q If P1 > ATC: Profit >0 38  SUPPLY DECISION: PROFIT CALCULATION Profit = (P – ATC) × Q Costs, P MC ATC ATC2 = $12 MR2 P2 = $10 Find Q where MR If P2 ATC: Profit 0 = MC Q2 = 2 Q Profit = (P – ATC) × Q 39  SUPPLY DECISION: CHANGES IN PRICES There is a change in the Wait! Price Market cannot change market price, interventions itself. Shift of market demand and/or The MC curve supply curve determines the THE firm’s quantity at Costs/ Pric MARKET Price different price levels, e Market Supply i.e., Firm’sMC Supply Curve. THE P1 FIRM MR1 P1 P2 MR2 P2 Market Demand Quantit Q2 Q1 Quantit  SUPPLY DECISION: PRICE ELASTICITY The impact of price changes on supply decision Market price increases, firms choose to produce more — how much more? %∆𝑄 Price elasticity of supply = %∆ 𝑃 Cost Cost Elastic/ Inelastic/ s/ s/ Pric Flat Pric Steep e Supply e Supply P1 Marginal Cost increases more P2 drastically! Quantity Quantity  SUPPLY DECISION: SUPPLY CURVE The whole MC curve is the firm’s supply curve? Interpretation: Does the firm supply for all price levels? (at different quantity levels of course) A hotel that gets a lot of Discount During Off- seasonal business. The Season? average total cost per day of running the hotel is $65. During the off-season (when there are a lot of empty rooms), a tourist offers $50 for a room.  SUPPLY DECISION: SUPPLY CURVE The whole MC curve is the firm’s supply curve? Interpretation: Does the firm supply for all price level? Short – run(at different Longquantity - run levels Exit ofShutdown course) A short-run decision A long-run decision not to produce to leave, i.e., no anything because of longer participate in market conditions. the market. Cost No revenue: TR=0 No revenue: TR=0 Benefi Cost savings = VC Cost savings = TC t  SUPPLY DECISION: SHORT-RUN SUPPLY CURVE In short-run Fixed cost has already been paid (sunk cost): - If you choose to operate, you can earn total revenue (TR) but need to pay Total Variable Cost (VC). Need to compare between Total Revenue Total Variable Cost 𝑃 ×𝑄 vs. 𝐴𝑉𝐶 × 𝑄 vs. AVC > AVC: Benefit of opening is more than the OPEN cost (even though you still might make a loss, you’ll see later) < AVC: Cost incurred is more than benefit generated from opening. CLOSE  SUPPLY DECISION: SHORT- RUN SUPPLY CURVE Hotel example: P=$50 < ATC=$65  Loss =$15 if accept. BUT Accept or not accept still lost $, but our decision based on P vs. AVC which one will lose less? Case 1: Assume ATC = $65, AVC=$40 < P; AFC=$25 Not Loss AFC = $25 (no AVC) incurred Accept AcceptCover AVC = $40, Cover $10 for AFC => Loss for $15 (remaining AFC) Case 2: Assume ATC= $65, AVC=$55 >P; AFC=$10 Not Loss AFC = $10 (no AVC) incurred Accept Accept Cover AVC = $50 -> Loss $5 for AVC Loss AFC = $10 -> Total loss =$15  SUPPLY DECISION: SHORT-RUN SUPPLY CURVE Costs MC If P > AVC, then the firm ATC produces Q where P = MC. Profit: P>ATC AVC Loss: P ATC, then the firm produces Q on theThe MCfirm’s curve. long run supply curve is the portion of its MC curve above ATC. Exit Market: If P < ATC, then firm exits in Q  SUPPLY DECISION: SUMMARY If P ATC: Business is profitable! If P ATC: Business is making a loss Long term: exit the market Short term: need AVC to Costs, P ATC decide: MC P < AVC temporary shutdown AVC P > AVC continue to Why they still choose to operate produce at MR=MC? AFC Q 48  MARKET OUTCOMES: PROFIT IN LONG-RUN Free entry and exit in the long-run firms in the market are making positive profit Currently, New firms enter due to attractive profit, shifting market (not supply due to to the highright. Price) is rse Costs/ reve ere T h e th Pric Market Supply Price w h en ATC e e tru e losseMC s ar THE FIRM P1 P1 MR1 P2 P2 MR2 P3 P3 MR2 Market Demand Quantit Q 3 Q1 Quantit  MARKET OUTCOMES: PROFIT IN LONG-RUN In the long run, the number of firms can change due to entry and exit:  If existing firms earn positive profit:  New firms enter, market supply shifts right  P falls, reducing profits and slowing entry  If existing firms incur losses:  Some firms exit, market supply shifts left  P rises, reducing remaining firms’ losses Zero  Until profit is zero (P = min ATC) profit ???  COMPETITIVE MARKET SUMMARY Firms in Competitive Market face a horizontal marginal revenue Firms’ Profit Maximization/Lost Minimization rule: Short run Decision Long run Decision if , produce (but if , stay in business. keep a watch on ). if , cease operation. if , exit business. Short run supply curve: Long run supply curve: portion of MC above portion of MC above AVC ATC In the long run all firms in competitive market have zero CHAPTER 2: FIRMS DECISION PART 2.3 – OTHER MARKET STRUCTURES  SMU Classification: Restricted Monopoly Firms’ Conduct Discussion Market Market Marginal Revenue Advantages and Structure and Profit Disadvantages Sources of Maximization of Monopoly Market The Monopoly Profit Policy Power Welfare Cost of Responses Firms’ Monopoly Demand Price Discrimination CurveOther Monopolistic Competition Market Structure Oligopoly AGENDA  LEARNING OBJECTIVES  Understand the reason why monopolies arise and the monopoly firms’ demand. Monopoly Profit Maximization decision: Characteristic of MR curve? How do monopolies choose their P and Q? How do monopolies affect society’s welfare?  How can monopoly use price discrimination to capture even more welfare? What can the government do about monopolies?  Characteristics of Monopolistic Competition and Oligopoly? Short run and long run profit/loss of  Market Structure Sources of Monopoly Power Monopoly Firms’ Demand MONOPOLY MARKET  MONOPOLY MARKET STRUCTURE 1. Nature of the Seller has good/service No close substitution full market power and 2. Number of buyers and sellers is the price Only one seller maker. Can a monopolist charge as high as possible? Entry/exit condition?  SOURCES OF MONOPOLY POWER Barriers to Entry Circumstances that prevent potential competitors from entering the market. 1. Legal market power The firm is protected by rules and regulation and other firms are excluded from making, using, or selling an invention. 2. Monopoly Resources The firm solely owns the key resource esp. raw material, that are critical to the production of a final good. 3. Economies of scale (Capital A single firm can produce the entire market at Requirement) lower cost than could several firms, often with  THE FIRM’S DEMAND CURVE If a monopolist is a sole seller in the market, what is the firm’s demand? Competitive Market Demand(Downward = Firm’s Firm Price Demand sloping) MC PMarket Monopoly Firm Quantity Flat demand curve PMarket= MR= AR  Firms’ Marginal Revenue Curve and Profit Maximization The Monopolist’s Profit Welfare Cost of Monopoly FIRMS’ CONDUCT  SUPPLY DECISION: MARGINAL REVENUE The table shows the Q P TR AR MR market demand for a monopoly. 0 $60 $0 - 1 55 55 2 50 100 3 45 135 4 40 160 1. Fill in the missing 5 35 175 spaces of the table. 6 30 180 2. What is the relation between P and AR 7 25 175 (average revenue)? 8 20 160 3. Between P and MR? 9 15 135 10 10 100  SUPPLY DECISION: MARGINAL REVENUE Q P MR P, MR 0 $60 $60 1 55 55 50 Firm (Market) 2 50 45 40 Demand curve 3 45 35 30 4 40 25 20 5 35 15 10 MR 6 30 5 0 7 25 -5 Q -10 8 20 -15 -20 9 15 -25 10 10 -30 -35 0 1 2 3 4 5 6 7 8 9 10 61  SUPPLY DECISION: PROFIT MAXIMIZATION Profit Maximization General M MC Rules: R Costs and Step 1: Revenue MC The profit-maximizing quantity Qmax is where MR = MC. P Step 2: At the quantity level Qmax find P on the demand D curve (price consumer MR willing to pay for that quantity) Quantity Qmax Profit-maximizing output 62  THE MONOPOLIST’S PROFIT Step 3: Costs and Revenue Find ATC at that MC quantity. ATC As with a competitive firm, P (P – ATC) x Q ATC Can P < ATC, i.e. D firm is making a loss? MR n h a ve Qmax Quantity Ca on g- i n l profit ??? run 63  THE WELFARE COST OF MONOPOLIES Competitive market equilibrium (accumulation of many small firms) Price quantity = QC Deadweight MC loss PC = MCC PM total surplus is maximized PC = MCc MCM Monopoly market equilibrium D (one firm serve the whole MR market) quantity = QM QM QC Quantity PM > MCM 64  THE WELFARE COST OF MONOPOLIES When an additional unit is sold in the market: P vs. MC value to cost of the buyers of an resources needed to additional unit produce that unit Competitive market equilibrium:  Social efficient quatity atthe value exactly equals the cost of production. Monopoly equilibrium: stop at quantity such that  The monopoly Q is too low – where value to society is still higher than the cost.  Monopoly results in a deadweight loss: some gain from trade is unrealized. 65 DISCUSSION  SUGGESTED TOPICS 1. What are the potential issues on society and economy of monopoly? Ans: - If its essential goods, Consumers subjected to (no choice) to suffer to monopoly’s choice - Monopoly can artificially make Pm increase the price - Less choice for consumer - Lack of innovation 2. Any advantages of monopoly?  COMPETITION VERSUS MONOPOLY Competition Monopoly Similarities Goal of firms Maximize profits Maximize profits Rule for maximizing MR = MC MR = MC Can earn economic profits in Yes Yes SR? Differences Number of firms Many One Marginal revenue MR = P MR < P Price P = MC P > MC Produces welfare-maximizing Yes No level of output? Entry in the LR? Yes No 68 Can earn economic profits in No Yes  Monopolistic Competition Oligopoly OTHER MARKET STRUCTURE  THE FOUR TYPES OF MARKET STRUCTURE Number of firms? Many firms One firm Type of products? Few Differentiated Identical firms products products Monopoly Oligopoly Monopolistic Perfect Competition Competitio Tap water SmartphoneNovels n Electricity Cigarettes Movies Agricultural product 70  MONOPOLISTIC COMPETITION CHARACTERISTICS  Many sellers but have to compete over customers.  Strategy: Product Differentiation  Each seller offer a slightly different version of the final product: A price makera monopoly in their not price taker: own i.e face small submarket a downward sloping firm’s demand curve (a subset of market demand curve). Short-run economic profit similar to the monopoly  Free Zero economic profit in long-run where entry and exit just like perfectly  MONOPOLISTIC COMPETITION SHORT-RUN PROFIT/LOSS Low ATC High ATC Price Price profit MC MC P ATC losses ATC ATC ATC D P D MR MR Q Quantity Q Quantity  MONOPOLISTIC COMPETITION LONG-RUN EQUILIBRIUM Firms are making profit in short run: New firms enter the market  Increase number of products  Reduces demand for each firm  Demand curve shifts left; prices fall ….. Until…..  Each firm’s profit declines to zero: P = ATC (i.e. D curve tough ATC curve) Prices BUT If losses in thecharged short run: arethe still higher than marginal cost Firm reverse happens does not produce at efficient scale.  OLIGOPOLY CHARACTERISTICS  Market Concentration: majority of the market is dominated by a small number of firms.  A firm’s decisions about P or Q can affect other firms and cause them to react  The firm will consider these reactions when making decisions  Best off when they cooperate and together act like a monopolist Key feature in oligopoly markets: the tension between cooperation and self-interest.  CHAPTER 2 CHECKLIST  Firm’s Problem - Explicit Cost, Implicit Cost and Opportunity Cost. - Accounting vs Economic Profit  Production Function and Marginal Product - Law of diminishing return - Slope of production function and marginal product  Cost Structure  Different Types of Cost: - Differences between VC, FC - How to Calculate  Different Measures of cost: - Total vs. average vs. marginal  Typical Cost Curves: Shapes (and reasons behind) of AVC, ATC, AFC and MC for a typical firm.  Relationship between MC and ATC  Profit Maximization/Loss Minimization general Rules explanation  CHAPTER 2 CHECKLIST  Firms in Perfect Competitive Markets: - Perfect Competitive Market Structure and derived Demand curve for firms from the market condition. - Relationship among market price, marginal revenue and average revenue. - Profit Maximization Strategy for Firms in Perfect Competitive Market - Price Elasticity of Supply - Supply Curve in Short-term and Long term: - Decisions of shutdown in short run and exit in long run. - Profit in Short run and Profit in Long run  CHAPTER 2 CHECKLIST  Firms in Monopoly Markets:  Sources of monopoly power and monopolist’s firm demand.  Relationship among market price, marginal revenue and average revenue.  Profit Maximization Strategy for Monopoly Firm and welfare implication.  Pros and Cons of Monopoly Market and Government’s policies.  Firms in Monopolistic Markets:  The characteristic of monopolistic markets  Similarity and differences compared to a perfectly competitive market and a Monopoly market  Firms in Oligopoly Markets: Characteristic of the market.  Appendix SHORT-RUN VS. LONG-RUN COSTS (OPTIONAL SELF READ) COSTS IN THE SHORT RUN & LONG RUN Short run, SR:  Some inputs are fixed (e.g., factories, land)  The costs of these inputs are FC (fixed Cost) Long run, LR:  All inputs are variable (e.g., firms can build more factories or sell existing ones) Hence, in the long run  ATC at any Q is the cost per unit using the most efficient mix of inputs for that Q (e.g., the factory size with the lowest ATC)  LRATC WITH 3 FACTORY SIZES Firm can choose Avg from three factory Tota sizes: S, M, L. l Each size has its Cost own SRATC curve (Short run ATC). ATCS ATCM ATCL The firm can change to a different factory size in the long run, but not in the short run since once the factory Q starts producing, they are producing  LRATC WITH 3 FACTORY SIZES To produce less than Avg QA, firm will choose Tota size S in the long l run. ATCS ATCM Cost ATCL To produce between LRATC QA and QB, firm will choose size M in the long run. Q To produce more QA QB than QB, firm will choose size L in the long run.  A TYPICAL LRATC CURVE In the real world, factories come in many sizes, each with its own SRATC ATC curve. So a typical LRATC LRATC curve looks like this: Q  COSTS IN SHORT AND LONG RUN Economies of scale Long-run average total cost falls as the quantity of output increases  Increasing specialization among workers  More common when Q is low Constant returns to scale  Long-run average total cost stays the same as the quantity of output changes Diseconomies of scale Long-run average total cost rises as the quantity of output increases Increasing coordination problems in large organizations.  ECONOMIES AND DISECONOMIES OF SCALE Economies of ATC scale: ATC falls as Q increases. LRATC Constant returns to scale: ATC stays the same as Q increases. Q Diseconomies of scale: ATC rises as Q increases.