lecture 14 and 15 Flashcards
what are the firms goals?
- to maximize profit
(or minimize costs)
what do firms choose?
- quantity (how much to produce at a given market price)
what are the contraints that firms face in their maximization problem?
- technology and input costs
- demand curve
what is the cost of firms?
- firms combine inputs to produce final goods and services
- using a production function to represent how inputs are combined to generate a final good
- each input has a cost
what are the inputs and the costs of a cost function?
- labour (L) → wage (w)
- capital (K) → rental cost (r)
L and K depend on the quantity produced (Q)
Cost= wL+ rK
Q: C(Q)
explain the cost minimization problem
- how to find the lowest cost of achieving a certain production function, that is, to minimize costs by choosing L and K for a given level of r and w
what are the implications of the minimization problem?
- different input costs (w,r) will lead to different choices of (L,K)
- different levels of production (Q) will lead to different choices of (L,K)
- this implies that labor and capital can be written as functions of input costs and the quantity produced: L(w, r, Q), K(w,r, Q)
what are the different types of costs?
- fixed costs (FC) → costs that do not change with Q
- Variable costs (VC) → costs that change with Q
-Total cost of production (TC)= FC+VC
what are the main differences betwwen economic costs and accounting costs?
economic costs include opportunity costs
what is the average cost (AC)?
- average unitary cost of each unit produced
- AC (Q) = (TC (Q)) / Q
- usually U-shaped
what is the marginal cost (MC)?
- additional cost of produing one more unit of output, that is the cost of increasing production by 1 unit
- 𝑀𝐶 = Δ𝑇 / Δ𝑄, or 𝑀𝐶 = 𝑑𝑇𝐶(𝑄) / 𝑑Q
- mostly upward sloping
Compare MC and AC
- MC > AC: AC is increasing
- MC < AC: AC is decreasing
- MC = AC at the minimum of AC
- That is, MC and AC cross at the
minimum of AC - MC is crucial to determine the level of output that maximizes profit
what are economies of scale or increasing returns?
- technological advantages of large- -scale production
- production increases proportionally more than inputs
- implication: with economies of scale, doubling the production less than doubles total cost
→ AC is decreasing in Q
What are the other types of retuns of scale? Explain
- Constant return → production increase in the same proportion as inputs
More generally: 𝑄 𝛼𝐿, 𝛼𝐾 = 𝛼𝑄(𝐿,𝐾) - Decreasing return → production increases proportionally less than inputs
More generally: 𝑄 𝛼𝐿, 𝛼𝐾 < 𝛼𝑄(𝐿,𝐾)
What is the formula of profits?
Profits = Total Revenue – Total Cost = TR - TC
- Total cost (TC(Q)) includes opportunity costs
- Economic profits might differ from accounting profits
We can write profits as:
𝜋 = 𝑃𝑄 − 𝑇𝐶 = (𝑃 − 𝐴𝐶)𝑄
- (𝑃 − 𝐴𝐶) → unitary profit (profit per unit of output)
- Zero economic profits when P = AC
What is a monopoly and his key feature?
- when there is only one supplier of the good (one firm)
- key feature of monopolies: the firm can choose both the quantity produced and the price
Explain the trade-off between price and quantity
- the monopolist is contrained by the demand curve
- if it chooses a high price, it will only be able to sell a small quantity
- if it wants to sell a large quantity, it must choose a lower price
There are 2 differents approach to maximizate profit. Explain the less usual one
- Contraint: the demand curve
→ the trade-off between P and Q that the firm ir constrained to make
→ slope of MRT - Isoprofit curve
→ the trade-off the firm is willing to make between P an Q and still achieve the same level of profits
→ slope of MRS - MRS=MRT (slope of demand curve is equal to the slope of the isoprofit curve
There are 2 differents approach to maximizate profit. Explain the main approach
- present the same optimal choice without isoprofit curves
- the firm will choose the quantity produced (Q) to maximize profits
→ MR=MC
- marginal revenue (MR) → change in total revenue obtained by producing and selling on extra unit
→ the MR curve has the same intercept as the demand curve, and it is twice as steep
- marginal cost (MC) → the cost of producing one extra unit
What is the intuition behind MR and MC?
- MR > MC → the increase in total revenue from selling 1 extra unit is smaller than the cost of producing (the firm could increase profits by increasing Q)
- MR < MC → the increase in total revenue from selling 1 extra unit is smaller than the cost of producing it (the firm can increase profits by decreasing Q)
What are the implications of a monopoly?
A monoplost doesn’t:
- take the price as give
however, the monopolist is constrained by the demand curve
- have a supply curve
For a given demand curve, there is just one quantity the monopolist is willing to supply
- produce where MC=P
Hoe does the elasticity of demand affect firm’s decisions?
- price elasticity of demand is related to the ffirm’s marginal revenue (MR)
𝑀𝑅 = 𝑑𝑇𝑅 / 𝑑Q = P (1 +1/𝜀D)
What is the relatioship between the firm’s profit margin and markup and the elasticity of demand? What does that imply?
- Profit margin: 𝑃 − 𝑀𝐶 = 𝑃 / |𝜀𝐷|
- Markup : (𝑃 − 𝑀𝐶) / 𝑃 = 1 / |𝜀𝐷|
Implication: - the less elastic the demand is, the more the firm will raise the price above the marginal cost
- this will lead to higher profit margin and markup
what is a economic surplus?
a measure of thee amount by which buyers and seller benefit from participating in the market
What is the total economic surplus the sum of?
- consumer surplus
→ difference between willingnes to pay (WTP) and price actually paid
→ alternative definition: marginal benefit→ the dollar value of consumer of another unit of a good (WTP)
→ area above price paid and below the demand curve, for a given price and quantity - producer surplus
→ difference between price received and marginal cost
→ area above MC and below price, for a given (P,Q) - government revenue (if relevant)
What is tthe welfare analysis of a monopoly and perfect competition?
under a monopoly there is a deadweight loss (DWL)
- total surplus is not maximized
- the monopoly outcome is not pareto efficient (this is only achieved when toatal surplus is as large as possible)
under perfect competition, the total surplus is maximized
- WTP (or maginal benefit) is equal to MC
- pareto efficient
What are the conditions for pareto efficiency?
the good is:
- produced up to the point where MB=MC
- allocated to consumers with the highest MB (or WTP)
- the good is produced by the producers with the lowest MC
