Chapter 13: Production Costs:

Producer Costs:
A production function tells us what can be produced, but we need to ask what WILL be
produced.
The level of output depends on the costs of production and the price the product will sell for.
Together those determine profit.

Explicit and Implicit Costs:

Kinds of Cost:
- Explicit: out of pocket expenses (wages and raw materials)
● Anything that can be paid for with a check
● Ex) cost of coffee in a coffee shop, hiring laborers, paying for electricity for the
coffee shop.
- Implicit: opportunity cost of using a resource here instead of someone else
● Is someone using their resources to get the greatest returns
● If someone quit their job and took another, would it be more beneficial?
● (Opportunity Costs)
Sum of Explicit Costs= Accounting Costs
Sum of Implicit and Explicit Costs= Economic Costs

Explicit Costs Are Made of Fixed and Variable Costs:

● Fixed Costs: do not change with the rate of output. (Will Always Be The Same)
○ Only in the SR, because in the SR there are some inputs that do not change.
● Variable Costs: costs of production that do change with the level of output.
○ In SR, there are resources that can vary (labor) so the costs of that resource will
also vary.
● General behavior of TC (increases),FC (stays the same) and VC (increases) as
production increases
● TC= FC+VC
The Total Cost Curve:
- TFC= TC-TVC
Marginal Costs:
Think back to the LDMR and MP

As quantity changes, there will also be a change in the total costs

Marginal Product: it measures how much extra production results from increasing the quantity of
one item

Marginal Cost: is how much it costs to get one more variable of input

Average Costs:

When Marginal Cost is less than Average Variable Cost or Average Total Cost, they
both are decreasing.

When Marginal Cost is greater than Average Variable Cost or Average Total Cost, they
both are increasing
Marginal cost will intersect Average Variable Cost and Average Total Cost at their
minimum value

Average Variable cost will initially decrease but then when LDMR comes into effect,
they will start increasing because you are paying the same amount for each input but
receiving less and less output.

Chapter 14: Perfect Competition:

Characteristics of a PC Market Structure:

1) Large number of firms and many buyers (a lot of competition)
2) Standard Product- no competition on quality, etc.
3) Easy entry and exit into and out of the industry-no extraordinary legal, financial or
technical obstacles which are insurmountable.

Market Power:
1) and 2) together make it impossible for 1 firm or a group of firms to influence the price
- If one little business firm decides to raise their price, their customers will go to a different
firm. Perfectly competitive firms have no market power
A P.C. firm is one whose output is so small compared to the total market volume that it’s output decisions
have no perceptible impact on the price of the product.
- Competitive firms are Price Takers- they only decide the quantity they want to produce,
not the price they will sell it for.
● Firms will only sell half of their wheat so that people will bid for it and pay more
● In order to change the price, firms have to do it together

Market Demand and Demand For A Individual Firm:

(The elasticity of the demand curve is perfectly el

Profit Maximizing Level of Output:

- MR=MC
Profit:
Where TC > TR, losses
Where TR > TC, profits
- Can make losses by making too little, but also by producing too much.
- We need to find the rate of production that maximizes profit—where TR exceeds TC by the largest amou
Economic Profit: When Total Revenue exceeds Total Costs
Normal Profit: When Total Revenue equals Total Costs
Economic Loss: When Total Revenue is less than total costs

Shut Down Rule

Best rule: never produce a unit of output that costs more to produce than it brings in revenue.

P>ATC, produce and profiting

P>AVC, produce and minimizing loss
P<AVC, losing money

Shut down when P=AVC

Chapter 15: Monopoly

Characteristics of Monopolies:
- One firm, producing a unique product, with high barriers to entry
- Firms are price-setters: Since they are the ”market”, have the ability to set prices (within
constraints)
Barriers to Entry
- Legal Barriers
● Legal Monopoly: is a market in which competition and entry are restricted by the
granting of a public franchise, government licensing, patent or copyright.
- Natural Barriers
● Natural Monopoly: is an industry in which one firm can supply the entire market
at a lower price than 2 or more firms can.
Implications of Market Power:

Market Demand Curve and Demand For Individual Firm:

- PC firms faces a perfectly elastic demand curve for its product
- A monopolist faces a downward sloping demand curve
 - Industry demand curve for a monopolistic industry? The same as the firm’s demand
curve since the one firm IS the industry.

Profit Maximizing Level of Output:

Doesn’t matter if our firm is perfectly competitive, or monopolistic, or anything in between: it still
follows the same old profit maximizing rule: produce where MR=MC
MR=P for the first one sold, but as more and more are sold the price must be decreased and we
lose some revenue on each to sell more
- The monopoly is the market and the firm. The market chooses the price and the firm
chooses the quantity. They get to pick everything because they have market power.

Price to Charge:
- The firm chooses their profit-maximizing level of output according to MR=MC
- They then look to the demand curve to set their price
- Their production costs determine if there is a profit from the level of output/price
combination
- If there is a profit, it will be maximized; if there is a loss, it will be minimized
- They then decide if they keep producing or shut down
Price Discrimination:
- But even if demand is fairly elastic, a monopolist may be able to extract high prices by
engaging in price discrimination
- Price Discrimination: charging various prices for the same good by selling each unit
separately, at a price each individual consumer is willing to pay.
1) First Degree (Perfect): every consumer in a market is charged the maximum
price she is willing and able to pay
2) Second Degree: charging consumers a different price for the amount of quantity
consumed.
3) Third Degree: charges a different price to different consumer groups

So Are Consumers Better or Worse Off Under a Monopolist:

- It depends
- Compared to PC industries, a monopolist generally offers less output and changes at a
higher price.
- If a monopolist can price discriminate, it will produce more output
- Opportunity for above normal profits-no entry and exit to chase away economic profit

Chapter 16 and 17: Monopolistic Competition and Oligopoly

Imperfectly Competitive Markets:
Monopolistic Competition: some characteristics of PC, and some characteristics of monopoly
Oligopoly: more than one firm, but substantial market power, especially if the firms can
coordinate
Characteristics of Monopolistic Competition:
- Somewhere in-between monopoly and perfect competition
- Many firms who produce differentiated products with low barriers to entry
- Firms have some ability to set prices, depending on how differentiated their product is
- P < MR, like with monopolies
For a Monopolistic Competition firms, the elasticity depends on how differentiated the products
are (or perceived to be)
- They are trying to convince customers that they are selling a unique product and there is
no competition with other firms. But they are
Product Differentiation:
A differentiated product is a product in the same category that has differences.
- What Sort of Differences?
1. Differentiation by style or type
- Sedans vs. SUVs
2. Differentiation by location
- Dry Cleaner Near Home vs. Cheaper Dry Cleaner Far Away
3. Differentiation by Quality
- Ordinary ($) vs. Gourmet Chocolate ($$$)
→ Branding is Critical!
Characteristics of Oligopolies:
A market dominated by a small number of firms, products can be standard or differentiated with
large barriers to entry
No one firm has a monopoly, but individual producers can affect market prices
Profits of one firm depend largely on actions market in which a few firms produce all or most of
the market supply of a good or service.of other firms
How Much Market Power Each Firm in an Oligopoly Has Depends On:
● The number of firms (the fewer, each has more power)
● Size of the firms (larger firms have more power)
● Barriers to entry (the more barriers to entry, the more power each firm has)
● Availability of substitutes (the fewer, each has more power)

This interdependence is the most important characteristic of an oligopolistic industry.

Because of this interdependence, it is more complicated to determine how (Q*, P*) are
determined than in other markets
Oligopolistic firms think strategically:
- Should they collude to set prices or try to compete to obtain the largest profits?
- Can it deter entry for other firms or try to gain more market share?
- If firms cooperate, can act as a collective monopoly and enjoy high prices
- If firms compete, can set off a price war shrinking profits towards zero

Cartels:
So what is the most stable price combination for firms under oligopoly?
For all to have relatively low prices—low enough so that no one firm will try to decrease price
more.
To stay at high prices in all firms, there must be a high degree of coordination—an agreement to
stay there.
A cartel: a group of producers who have agreed to set output and price levels.

Chapter 19 and 21: Externalities and Perfect Goods

Characteristics of Perfect Markets:
1. No Participants Have Market Power
1. Only two parties involved; the buyers of the good and the producers of the good; no one
else is affected by the production and/or use of the good.
→ Market transactions are always efficient: the “right” amount of goods are
produced, at the “right’ price, and buyers and sellers are satisfied
- Everyone in the market who wants to receive the benefit pays for the good
- Producers get compensated to give them this good
- Exactly offset each other, no costs or benefits are leaking out of this market
**P=MC (Price Can Represent Marginal Revenue)
Market Failure:
Failure: is when competition in the market fails to bring about economic efficiency
An important example of market failure is externalities

Externalities:

An externality is the people that aren’t included in the transaction. In a transaction their are
producers and consumers and outside the transaction is the rest of society. When a transaction
happens, it can have a positive or negative effect on society. It can have a negative effect by not
compensating for how it negatively impacts society or it can have a positive effect by providing
society with a benefit they didn't pay for.

- Sometimes (most of the time, but to varying extent), third parties are affected by market
transactions. But because they are not a producer or a buyer, their opinions about the
market goes unnoticed.
- External effects of a market transaction on third parties that are not directly involved in
the transaction. Externalities may be positive or negative.

Types of Goods:
Types of goods have different degrees of externalities

● Private Goods:
○ Rival in consumption: a given quantity cannot be consumed by more than two people
○ Excludable: Benefits of the good can be withheld from those who do not pay for it
○ Can be rationed efficiently by price
○ E.g., a sandwich, clothing, etc.

● Public Goods:
○ Non-rival in consumption: a given quantity can be consumed by more than one consumer
○ Non-exclusive: Benefits of the good cannot be withheld from those who do not pay for it
○ Inefficient in private markets
○ E.g., education, national security

Rival (Limited Amount of Non-Rival (Unlimited Amount

 People) of People)

Excludable (Must Pay) Pure Private Club Goods

Non-Excludable (Don't have Common Goods Pure Public Goods

to pay)

Two types of goods:

1. Public

2. Private