Production – its what firms do; they take inputs and make outputsInputs Fixedo You don’t have to increase them to increase your output Variable o You do have to increase them to increase your outputExample: (pg. 358) You own a pizza restaurant It has 2 ovens – those are your fixed input In the kitchen you can employ any number of cooks “Cooks” (or labor) is your variable inputProduction Function11/5/2014Assume you add one more unit of labor, and as a result your total output increases from 100 to 110 while you total costs increase from $400 to $460. Your marginal cost is: C. $6Firms want to maximize their profits- AVC = VC/output (Q)- TC = FC + VC- ATC = TC/Q- AVC = VC/Q- AFC = FC/Q- MC = CHANGE TC/ CHANGE Q- ATC * Q = TC- AVC * Q = VCRelationship between MC and AVC and MP and AP- If labor is the variable input- MC = (w)/MP- AVC = (w)/AP- Where (w) is the price of labor, the wage.As productivity decreases, costs per unit (Average Cost) increasesPunchline:1. Changing the “fixed” input SHIFTS your cost curves2. Changing the fixed input takes you out of the “short run” and into the “long run”CH. 12What is a Market?- The set of buyers and sellers whose actions affect the price of a product (or service)Market Structures- Perfect competitiono Very large number of firms provide this good or serviceo Easy to enter this market as a sellero All firms produce essentially the same producto There are so many other substitutes that if a firm tried to charge a price any higher than all the other firms chargedo The firm would not sell any!- Monopolistic competitiono Large number of firms provide these goods/serviceso They are substitutes for each othero They compete with each othero Ex: fast food- Oligopolyo Small number of firms provide this good/serviceo Compete with each othero Substitutes for each othero Price based on what “the other firm” is doingo Ex: overnight delivery service- Monopolyo Single firm provides this good/serviceo No other providerso No close substituteso Ex: local water companyIf a firm has no control over the price, it only has one thing that it DOES control- One that’s the quantity of output (Q) it will produce- Should it produce all that it can?- NO…remember, average costs increase as output increases beyond a certain level...- So there is some level of output that is optimalManagerial Economics – Christopher Thomas and Charles Maurice- 34 out of 38 of our manager-students felt that their firms had little-to-no control over the price they could charge for their product- the prices for their products were determined by market forces beyond their control- “although the assumption of perfect competition seem quite restrictive, many managers face market conditions that closely approximate the model of perfect competitionIf firm has no control over the price, it only has one thing that it DOES control- and that’s the quantity of output (Q) it will produce- should it produce all that it can?- NO…remember, average costs increase as output increases beyond a certain level- So there is some level of output that is optimalTotal Revenue = P * QProfits = Total Revenue – Total CostsProfits increase as Output increases- But only up to a pointWhen marginal cost exceeds price your profits start to declineA perfectly competitive firm- Has no control over the price- Can only control the level of output- Profits increase as output increases- But only up to a point- The firm should increase output up to a point where Price and Marginal Cost are equal (or come closest)- Beyond that point, profits fall- For this firm, Price = Marginal RevenueMarginal Revenue (pg. 396)- Marginal revenue = change in total revenue / change in quantity- The change in total revenue from selling one more unit of a product- Marginal utility- Marginal product- Marginal costs- Marginal revenueThe difference between P and ATC when Output = 6 is the Vertical distance between the Two curves..- This is Profit Per unitLevel of output (Q) where PROFITS are maximized is not the same level of output where PROFIT PER UNIT is maximizedMax profits where P = MC- Firm has no control over the price“Zero” profits- In economics, we assume cost calculations contain a “reasonable” profit- Zero profits means zero “excess” profits…above and beyond this “reasonable” profit11/10/201411/17/2014Exam 4: CH. 11, 12, 13, part of 15 (477 – 492)Monopoly – only seller of a product that has no close substitutes…close enough to compete away profits (pg.478)Monopoly chooses how much output to produce to maximize profits and what price to charge to maximize profitsBarriers to Entry (pg. 479)Anything that keeps new firms out of the industry when firms are earning economic profits1. Economies of scale- When its cheaper for one form (or a few big firms) to serve an entire market than a lot of little forms.2. Legal barriers like patents (pg. 480)- Patent gives producers an exclusive right to produce a good for a limited amount of time3. Control over key inputs to production (pg. 481)- Diamonds, Aluminum, CranberriesWelfare Loss of Monopoly- Consumer surplus- Producer surplus- Deadweight lossEfficiency Effects of Monopoly- If perfect competition is the “standard” for efficiency- Monopoly charged a “P” > MC- Monopoly doesn’t produce “Q” where ATC is minimized- If monopolist was forced to set a price like perfectly competitive firm, it would charge a P = MCCompared with competitive firm- Higher price - Less output- Less consumer surplus- Deadweight lossPg 491 – deadweight loss calculation using table CS = 81 – 59 = 22 * 11 * .5 = 242 * .5 = 121 consumer surplusP = MC  CS = 26 * 13 * .5 = 338 * .5 = 169 consumer surplus(59 – 35) * 2 * .5 = 24 deadweight loss- Very small deadweight loss in monopoly- Charging a P > MC produces some deadweight loss: market power (pg. 492)Market Power- Inversely related to elasticityo When demand is very inelastic, market power is largeo When demand is very elastic, market power is small- What makes demand elastic v. inelastic?o Number of substituteso Luxury v. necessity Lerner Index- {(P – MC) / (P)} = {(1) / (elasticity)}Market Power - Government intervention is not justified in every case that involves market price…o Abusive market powero Undue market powero Exorbitant market powerHowever…- Sometimes you WANT a monopoly- Local water company…Natural Monopoly- Two water companies would be wasteful &