topic 2.3 theory of the firm. cost theory fixed cost: costs that do not vary with changes in output...
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Cost Theory
Fixed Cost: costs that do not vary with changes in output
example: rent
Variable Cost: costs that vary with quantity of output produced
example: labor, materials, fuel
Total Cost: sum of fixed cost and variable cost at each level of output
TC= FC + VC
Average Total Cost: AFC + AVC or ATC= FC/Q
Marginal Cost: The increase in total cost that arises from an additional unit of output
MC= ∆TC/ ∆QAccounting Cost + Opportunity Cost
= Economic Cost
Average Fixed Cost: Fixed costs divided by the quantity output
AFC= FC/Q
Average Variable Cost: Variable costs divided by the quantity of output
AVC= VC/Q
Short-Run
Law of Diminishing Returns:
each additional unit of variable input eventually yields a decreasing output
RevenuesTotal Revenue: The total amount of
money received from the sale of a good or service at any given quantity of output.
Marginal Revenue: The additional revenue added to the total revenue that isgained from selling one more unit.
Average Revenue: Total revenue divided by the number of units sold
Profit An increase in wealth that an investor has
from making an investment taking into account all of the costs of that investment including the opportunity cost
Normal profit: minimum profit necessary to attract or retain producers in a perfectly competitive market. Usually equal to the opportunity costs.
Supernormal profit: profit that exceeds normal profit.
Perfect Competition
>Numerous buyers and sellers of which none are able to influence the market.
>Everyone is privy to all information >Products are homogeneous >No barriers to entry and no barriers
to exit.
Perfect Competition
Thou shalt produce where MC = MR. Efficiency in perfect Competition is both
allocatively and productively efficient Allocative efficiency occurs when output is
at society's optimum level. P=MC Productive efficiency is when a firm
produces at the lowest possible cost per unit. AC=MC
Monopoly
>One firm >Unique product, no close substitutes>Considerable control over price>Entry of additional firms are blocked>No effort in advertising
Monopoly (continued) Sources of Power1. Status secured by patents,
economies of scale, or resources ownership
2. Not regulated by government3. Costs of production make a single
producer more efficient than a large number of producers
Monopoly vs. Perfect CompetitionDisadvantages higher price lower output abnormal profit Produces where Average costs are higher
(inefficient)Advantages Capable of using economies of scale
therefore reducing costs and increasing output
Natural MonopolyMonopoly that arises because a
single firm can supply a good or service to an entire market at a smaller cost than could two or more
Monopolistic Competition
Large number of small firms. (Almost) perfect knowledge. Differentiated products. No barriers to entry or exit. In the short-run abnormal profits can
be earned (at MC=MR) In the long-run only normal profits
can be earned.
Oligopoly
Competition between a few firms many buyers, few sellers differentiated products Barriers to entry present If one firm reduces its price
competitors will follow example
Oligopoly (continued)
Non-collusive Oligopoly: firms compete against each other in a normal way
Collusive Oligopoly: firms try to come to an agreement to reduce the amount of competition.
Cartels: OPEC
Price Discrimination
Different people are charged different prices for exactly the same good.
Conditions>Time>Income>Age