VIEW M RE -TER MID 014 ing, 2 Spr P 0 121 -18 AGES
2 2. 3 THEORY OF THE FIRM INTRODUCTION Firms MNC-TNC Industry Total profit = TR - TC
3 2. 3 THEORY OF THE FIRM PRODUCTION FUNCTION Output as a function of inputs SHORT RUN AND LONG RUN COSTS SR: Time period where at least one factor of production is fixed LR: All inputs can be changed
4 2. 3 THEORY OF THE FIRM LAW OF DIMINISHING RETURNS If some inputs are increased whilst at least one other input remains fixed then, whilst the extra output produced by each extra unit of input may at first increase it will reach a point where it will diminish Example: Clear the dinner table
5 2. 3 THEORY OF THE FIRM LAW OF DIMINISHING RETURNS Point of diminishing marginal returns – the marginal output of each extra worker decreases as each worker has less and less input to work with effectively Average Output and Marginal Output-GRAPH Law of Diminishing returns only in the short run
6 2. 3 THEORY OF THE FIRM SHORT RUN COSTS Fixed and variable costs TC = FC + VC AVERAGE COSTS AND MARGINAL COSTS ATC = AFC + AVC MC = TCn – TCn-1
7 2. 3 THEORY OF THE FIRM AVERAGE VARIABLE COSTS GRAPH – Law of Diminishing Returns GRAPH – MP, AP, MC, AVC (p. 130) REVENUE TR = p x q
8 2. 3 THEORY OF THE FIRM PROFIT Economic profit: TR – TC Accounting Profit: TR – Accounting Costs: Money value costs (raw materials, energy, rent, interest and wages) Normal profit: profit needed to cover opportunity cost Super normal (abnormal) profit: extra profit
9 2. 3 THEORY OF THE FIRM PROFIT MAXIMIZING EQUILIBRIUM MR = MC (level of output, q) Quantity to be produced MR > MC, expand output MR < MC, contract output
10 2. 3 THEORY OF THE FIRM LONG RUN OUTPUT – RETURNS TO SCALE (Graph) Increasing returns to scale Input increases, output increases more than proportionately Constant returns to scale Input increases, output increases proportionately Decreasing returns to scale Input increases, output increases less than proportionately
11 2. 3 THEORY OF THE FIRM LONG RUN OUTPUT – RETURNS TO SCALE Sources of Increasing Returns to Scale Technical Economies Managerial Economies Purchasing Economies Marketing Economies Financial Economies
12 2. 3 MARKET STRUCTURE MARKET POWER The way a firm behaves, that is, how much output it decides to produce and the price it sells the product at, depends on the market structure of that product The main characteristic of market structure is the degree of competition in the market
13 2. 3 MARKET STRUCTURE IMPERFECT COMPETITION Monopolistic Competition Oligopoly – Prisoner’s Dilemma PERFECT COMPETITION MONOPOLY
14 2. 3 MARKET STRUCTURE PERFECT COMPETITION Assumptions Graph Market vs. Firm The Firm’s Supply Curve – GRAPH Break-Even Price – SR producing at a loss (below ATC) Shut-Down Point – Firm will close down (MR = MC = AVC)
15 2. 3 MARKET STRUCTURE EFFICIENCY AND OPTIMAL ALLOCATION A pure market system is likely to be both technically and allocatively efficient Technical or Productive Efficiency: output is produced with the minimum amount of inputs (ATC at min. ) Allocative Efficiency: suppliers are producing the optimal mix of goods/services required by consumers (P = MC / AR = MC)
16 2. 3 MARKET STRUCTURE MONOPOLY Assumptions Graph Monopoly and Supernormal Profits Graph
17 2. 3 MARKET STRUCTURE COMPETITION VS. MONOPOLY When no economies of scale are gained Perfect competition industry is taken over by a monopoly Prices are higher, quantities are lower and resource allocation is non-optimal When economies of scale are gained Consumer is better off under monopoly Prices are lower, quantities are greater but resource allocation is non-optimal
18 2. 3 MARKET STRUCTURE OLIGOPOLY Collusive Oligopoly Non-Collusive Oligopoly Kinked Demand Curve – GRAPH
19 2. 3 MARKET STRUCTURE THEORY OF CONTESTABLE MARKETS It argues that it is the threat of competition rather than actual competition which determines a firm’s price and output Exit Costs
20 2. 3 MARKET STRUCTURE MONOPOLISTIC COMPETITION Assumptions GRAPH
21 2. 3 MARKET STRUCTURE PRICE DISCRIMINATION Units of a product which cost the same to produce are sold at different prices to different consumers PRICE DISCRIMINATION Different prices are charged because there are different costs of production
22 2. 3 MARKET STRUCTURE PRICE DISCRIMINATION Reasons for Price Discrimination Necessary conditions for Price Discrimination GRAPH Total revenue and Price Discrimination