Economics 12-13 Flashcards
12-13
Short run
The time period over which some factors of production are fixed. Typically, we assume that capital is f ixed in the short run so that a f irm cannot change its scale of operations (plant and equipment) over the short run.
Long Run
All factors of production (costs) are variable in the long run.
Breakeven
Total Costs (Fixed & Variable) = Total Revenue
Average Total Costs = Average Revenue = Price
Economic Profit = 0
Shut Down Points
If AR >= ATC - continue operation
If AR >= AVC but AR < ATC, continue in Short Run but shut down in Long Run
If AVC > AR, shut down in short term and exit in Long Term
Short-run Shut Down Point
If average revenue is greater than average variable cost in the short run, the f irm should continue to operate, even if it has losses.
long-run shutdown point.
In the long run, the firm should shut down if average revenue is less than average total cost.
Price Taker
When market is in perfect competition, firm is price taker ie takes price set by market
Marginal Revenue = Price
Price Searcher
- set their own prices
- demand curve is downward sloping
- marginal revenue =/= price
- Imperfect Competition
Breakeven/Shutdown in Imperfect Competition
TR=TC: Breakeven
TC > TR > TVC: continue in SR, shut down in LR
TVC > TR: shut down in SR & LR
As Marginal Revenue =/= Price –> analysis based on totals is needed
Holds for both price taker and price searcher
minimum efficient scale
The lowest point on the LRATC corresponds to the scale or plant size at which the average total cost of production is at a minimum.
Under perfect competition, firms must operate at minimum eff icient scale in long-run equilibrium, and LRATC will equal the market price. Recall that under perfect competition, firms earn zero economic pro it in long-run equilibrium. Firms that have chosen a different scale of operations with higher average total costs will have economic losses and must either leave the industry or change to the minimum eff icient scale.
Economies of Scale
- The downward-sloping segment of the LRATC curve indicates that economies of scale (or increasing returns to scale) are present.
- Economies of scale result from factors such as labor specialization, mass production, and investment in more efficient equipment and technology.
- In addition, the firm may be able to negotiate lower input prices with suppliers as it increases in size and purchases more resources.
- A firm operating with economies of scale can increase its competitiveness by expanding production and reducing costs.
Diseconomies of Scale
- The upward-sloping segment of the LRATC curve indicates that diseconomies of scale are present.
- Diseconomies of scale may result as the increasing bureaucracy of larger firms leads to ineff iciency, problems with motivating a larger workforce, and greater barriers to innovation and entrepreneurial activity.
- A f irm operating under diseconomies of scale will want to decrease output and move back toward the minimum eff icient scale.
Constant returns to scale
There may be a relatively flat portion at the bottom of the LRATC curve that exhibits constant returns to scale, or relatively constant costs across a range of plant sizes.
5 Factors that are examined when studying market structures
- Number + Size of Firms
- Differentiation of Products
- Bargaining Power of Firm wrt Price
- Barriers to Entry/Exit
- Competition on Factors other than price
Perfect Competition
- Many small firms
- Identical Products
- Perfectly Elastic DC - no control of price
- Low Barriers to Entry
- No factor other than price considered
Monopolistic Competition
- Large Number of Firms
- Good substitutes but differentiated
- Downward Sloping - relatively elastic
- Low Barriers
- Differentiated through Features, Marketing, Quality
Oligopoly
- Few Large Firms
- Good Substitutes or differentiated
- Downward sloping DC - elasticity dependant on industry
- High Barriers typically due to Economies of Scale
- Differentiated through Branding, Marketing, Quality & Features
Monopoly
- Single Large Size
- No substitute
- Downward sloping curve - relatively inelastic
- High Barrier
- Sources of monopoly: patent, copyright, control of natural resource, usually backed by specific laws & government regulations
4 models of Oligopoly
- Kinked Demand Curve Model
- Cournot Duopoly Model
- Nash Equilibrium Model
- Stackelberg Dominant Firm Model
Kinked Demand Curve Model
Assumes competitor is unlikely to match price increases done by a competitor but likely to match price decreases. Hence, the DC below the current price is less elastic and above the current price is more elastic. With a kink in the demand curve, we also get a gap in the associated MR curve, as shown in Figure 12.8. For any firm with a MC curve passing through this gap, the price where the kink is located is the firm’s prof it-maximizing price.
Cournot Model
- In Cournot’s duopoly model, two f irms with identical MC curves each choose their preferred selling price based on the price the other firm chose in the previous period.
- Firms assume that the competitor’s price will not change.
- The long-run equilibrium for an oligopoly with two f irms (duopoly), in the Cournot model, is for both firms to sell the same quantity, dividing the market equally at the equilibrium price.
- The equilibrium price is less than the price that a single monopolist would charge, but greater than the equilibrium price that would result under perfect competition.
- With a greater number of producers, the long-run market equilibrium price moves toward the competitive price.
Stackelberg Model
- While the Cournot model assumes the competitors choose price simultaneously each period, the Stackelberg model assumes pricing decisions are made sequentially. One firm, the “leader,” chooses its price first, and the other firm chooses a price based on the leader’s price.
- In long-run equilibrium, under these rules, the leader charges a higher price and receives a greater proportion of the f irms’ total prof its.
Nash Equilibrium
- A Nash equilibrium is reached when the choices of all firms are such that there is no other choice that makes any firm better off (increases prof its or decreases losses).
- The Cournot model results in a Nash equilibrium. In equilibrium, neither competitor can increase pro its by changing the price they charge.
Rules Based Models
- These models are early versions of rules-based models, which fall under the heading of what are now generally termed strategic games.
- Strategic games comprise decision models in which the best choice for a firm depends on the expected actions (reactions) of other firms.
Collusion
competitors making a joint agreement to charge a given price—or, alternatively, to agree to speci fic levels of output.
Eg: OPEC Cartel
- Cartel-member countries agree to restrict their oil production to increase the world price of oil.
- Members sometimes choose to “cheat” on the cartel agreement by producing more than the amount of oil they have agreed to produce.
- If members of a cartel do not adhere to the agreement (taking advantage of the higher market price but failing to restrict output to the agreed-upon amount), the agreement can quickly break down.
Conditions of collusive agreements
- There are fewer firms.
- Products are more similar (less differentiated).
- Cost structures are more similar.
- Purchases are relatively small and frequent.
- Retaliation by other firms for cheating is more certain and more severe.
- There is less actual or potential competition from firms outside the cartel.
Dominant Firm Model
In this model, a single firm has a signi ficantly large market share because of its greater scale and lower cost structure—the dominant f irm (DF). In such a model, the market price is essentially determined by the DF, and the other competitive firms (CFs) take this market price as given.
A price decrease by one of the CFs, which increases QCF in the short run, will lead to a decrease in price by the DF, and CFs will decrease output or exit the industry in the
long run. The long-run result of such a price decrease by competitors below P* would then be to decrease the overall market share of competitor firms and increase the market share of the DF.
What do regulators use to measure degree of monopoly or market power of firms in an industry?
Regulators often use market shares (percentages of market sales) to measure the degree of monopoly or market power of f irms in an industry. Often, mergers or acquisitions of companies in the same industry or market are not permitted by government authorities when they determine that the market share of the combined firms will be too high and, therefore, detrimental to the economy.
Concentration Measures
Market or industry concentration measures are often used as an indicator of market power.
- N-firm concentration ratio
- Herfindahl-Hirschman Index (HHI)
N-Firm Concentration Ratio
- sum of the percentage market shares of the largest N firms in a market.
- While this measure is simple to calculate and understand, it does not directly measure market power or elasticity of demand.
- limitation: it may be relatively insensitive to mergers of firms within an industry.
Her indahl-Hirschman Index (HHI).
- sum of the squares of the market shares of the largest f irms in the market.
- reduces limitation of M&A impact found in the N-firm concentration ratio
Business Cycle
The business cycle is characterized by fluctuations in economic activity. The business cycle has four phases: expansion (real GDP is increasing), peak (real GDP stops increasing and begins decreasing), contraction or recession (real GDP is decreasing), and trough (real GDP stops decreasing and begins increasing).
Ways to show Business Cycles
Classical Cycle: Based on Real GDP relative to a beginning value
Growth cycle: refers to changes in % difference between real GDP and its longer-term trend or potential value (average line)
Growth rate cycle: refers to changes in the annualized percentage growth rate from one period to the next and tends to show both peaks and troughs earlier than the other two measures and thus is the preferred measure.
Expansion
An expansion features growth in most sectors of the economy, with increasing employment, consumer spending, and business investment. As an expansion approaches its peak, the rates of increase in spending, investment, and employment slow but remain positive, while in flation accelerates.
Contraction
A contraction or recession is associated with declines in most sectors, with inf lation typically decreasing.
Recovery
When a contraction reaches a trough and the economy begins a new expansion or recovery, economic growth becomes positive again and in flation is typically moderate, but employment growth might not start to increase until the expansion has taken hold convincingly.
Measure of Expansion & Contraction
Economists commonly consider two consecutive quarters of growth in real GDP to be the beginning of an expansion, and two consecutive quarters of declining real GDP to be the beginning of a contraction.
Credit Cycles
- refer to cyclical f luctuations in interest rates and the availability of loans (credit).
- Typically, lenders are more willing to lend, and tend to offer lower interest rates, during economic expansions.
- Conversely, they are less willing to lend, and require higher interest rates, when the economy is slowing (contracting).
- Credit cycles may amplify business cycles. Widely available or “loose” credit conditions during expansions can lead to “bubbles” .
- expansions tend to be stronger, and contractions deeper and longer lasting, when they coincide with credit cycles.
- They do not always coincide, however, as historical data suggest credit cycles have been longer in duration than business cycles on average.
