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    Chapter 8 Production, Costs Markets SECOND

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    Soha Hassan
    - Production decisions depend on the type of market, but how to produce does not. Short run has fixed factors while long run all factors are variable. - Costs include total, fixed, variable, average, and marginal. Average total cost initially decreases then increases with output due to diseconomies of scale. - Market structures include perfect competition, monopoly, monopolistic competition, and oligopoly which is concentrated. Profit maximization occurs where marginal revenue equals marginal cost.

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    Chapter 8 Production, Costs Markets SECOND

    Uploaded by

    Soha Hassan
    30 views25 pages
    - Production decisions depend on the type of market, but how to produce does not. Short run has fixed factors while long run all factors are variable. - Costs include total, fixed, variable, average, and marginal. Average total cost initially decreases then increases with output due to diseconomies of scale. - Market structures include perfect competition, monopoly, monopolistic competition, and oligopoly which is concentrated. Profit maximization occurs where marginal revenue equals marginal cost.

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    Chapter 8 Production, costs markets SECOND

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    - Production decisions depend on the type of market, but how to produce does not. Short run has fixed factors while long run all factors are variable. - Costs include total, fixed, variable, average, and marginal. Average total cost initially decreases then increases with output due to diseconomies of scale. - Market structures include perfect competition, monopoly, monopolistic competition, and oligopoly which is concentrated. Profit maximization occurs where marginal revenue equals marginal cost.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    30 views25 pages

    Chapter 8 Production, Costs Markets SECOND

    Uploaded by

    Soha Hassan
    - Production decisions depend on the type of market, but how to produce does not. Short run has fixed factors while long run all factors are variable. - Costs include total, fixed, variable, average, and marginal. Average total cost initially decreases then increases with output due to diseconomies of scale. - Market structures include perfect competition, monopoly, monopolistic competition, and oligopoly which is concentrated. Profit maximization occurs where marginal revenue equals marginal cost.

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    © All Rights Reserved
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    Download as pdf or txt
    of 25

    Production, Costs, Markets

    Production
    • Decisions about the quantity to be produced
    & the price to charge depend on the type of
    market.
    • But, decisions about how to produce a given
    output do not depend on the type of market.
    These decisions are similar for all types of
    firms in all types of markets.
    Short run/ Long run
    • To study the relationship between a firm`s
    output decisions & its costs we distinguish
    between: Short run & long run.
    • The short run is a time frame in which the
    quantity of at least one of the factors of
    production is fixed.
    • For most factories land, capital &
    entrepreneurship are fixed while labor is the
    variable factor.
    • To increase output in the short run, the firm
    must increase the quantity of the variable
    factor (labor).
    • Short run decisions are easily reversed. ( hire
    more to produce more, hire less to produce
    less).
    • The long run is a timeframe in which the
    quantity of ALL factors of production can be
    changed.
    • However long run decisions cannot be easily
    reversed.
    • In the short run, the relation between output
    & labor, (variable factor), is reflected in 3
    concepts:
    • Total Product (TP): is the total amount
    produced.
    • Marginal product( MP): is the change in TP
    that results from a one unit increase in labor.
    • Average product(AP): is total product divided
    by quantity of labor
    • Labor TP MP AP
    • 0 o
    • 1 4 4 4
    • 2 10 6 5
    • 3 13 3 4.33
    • 4 15 2 3.75
    • 5 16 1 3.2
    • NB.. From the previous table the ``Law of
    diminishing returns`` exists:
    • `` as increasing amounts of labor are applied
    to a FIXED factor, a situation must be reached
    where eventually MP & AP of labor diminish``
    • Ex. As more workers are using the same
    capital & working in the same space, as more
    workers are added, there is less & less for the
    additional worker to do that is productive.
    Costs in the short run
    • The following are the kinds of costs in the
    short run:
    • Total fixed cost(TFC) : is the cost of the firm`s
    fixed factors. TFC does not change with
    output.
    • Total variable cost: is the cost of the firm`s
    variable factor ex. Wages. TVC is directly
    related to output.
    • Total Cost (TC): TC= TFC + TVC
    • Marginal cost (MC): is the increase in TC as a
    result of a one unit increase in output.
    • Average fixed cost (AFC): is the total fixed cost
    per unit of output . TFC/Q
    • Average variable cost (AVC): is TVC per unit of
    output . TVC?Q
    • Average total cost (ATC): is TC per unit of
    output. TC/Q OR ATC= AFC+ AVC
    • Why does ATC decrease, at first, as output
    increases, THEN EVENTUALLY ATC INCREASES AS
    OUTPUT INCREASES?
    • To answer remember that ATC= AFC+AVC
    • As output increases AFC falls. But eventually as
    output increases , ever larger amounts of labor
    are needed to produce an additional unit of
    output, so AVC increases more quickly than the
    fall AFC, thus ATC increases.(look at the following
    table):
    • L Out. TFC TVC TC MC AFC AVC ATC
    • 0 0 25 0 25
    • 1 4 25 25 50 6.25 6.25 6.25 12.5
    • 2 10 25 50 75 4.17 2.50 5 7.50
    • 3 13 25 75 100 8.33 1.92 5.77 7.69
    • 4 15 25 100 125 12.5 1.67 6.67 8.33
    Long Run Costs
    • In the long run all factors of production are
    variable.
    • The law that governs production is
    ``economies & diseconomies of scale``(returns
    to scale)
    • Economies of scale: are features of a firm`s
    technology that lead to falling ATC as output
    rises (with given factor prices).
    • Economies of scale occurs when % increase in
    output exceeds % increase in all factors of
    production.
    • This occurs due to excellent & greater
    specialization of factors of prod.
    • Diseconomies of scale are features of a firm`s
    technology that lead to increasing ATC as
    output rises.
    • With given factor prices, diseconomies of
    scale occur when % increase in output is less
    than the % increase in all factors of prod.
    • Main reasons behind diseconomies of scale
    are difficulties of managing a very large
    enterprise. The larger the firm, the greater the
    challenge of organizing it, management
    complexity brings up increasing ATC.
    MARKET STRUCTURE
    • 1-Perfect competition:
    • Extremely large number of firms.
    • Products are identical.
    • Freedom of entry & exit.
    • Ex. Cotton of a certain type cultivated by an
    extremely large no. of farmers
    • THUS, every firm is a PRICE TAKER.
    • 2-Monopoly
    • One single producer
    • Product has no close substitutes.
    • Barriers to entry .
    • Ex. Gas, water, electricity firms.
    • Monopolistic competition:
    • Many producers.
    • Products have many close substitutes.
    • Freedom of entry & exit.
    • Ex. Frozen food, canned food, ladies` clothing..
    • Advertisement & promotion are important.
    • 4- Oligopoly
    • Few firm
    • Every firm tries to respond to other firm`s
    strategies ex. Price wars, advertisement…
    • Sometimes there is a kind of formal
    agreement between rivals , thus barriers to
    entry are created.
    Measures of Concentration
    • One of the measures of concentration to assess
    market structure is the 4 firm concentration
    ratio: which shows the % of the value of sales
    accounted for by the 4 largest firms .
    • The range of the concentration ratio is 0 in
    perfect competition & 100% in monopoly.
    • Primarily a low concentration ratio indicates a
    high degree of competition, & high concentration
    ratio indicates an absence of competition.
    • However when addressing that ratio we should
    take into account:
    • - Geographical scope of the market( the biggest 4
    US car producers account for 92% of cars sold by
    US producers, but they account for a smaller % of
    the US total car market including imports.
    • -Barriers to entry. Some industries are highly
    concentrated but have easy entry. Thus the
    concentration ratio doesn`t measure the barriers
    to entry.
    • - Markets are usually narrower than
    industries, ex. The pharmaceutical industry
    has a low concentration ratio, however it
    operates in many separate markets for
    individual products, so this industry that
    seems competitive includes firms that are
    monopolies or near monopolies in markets for
    certain drugs. Also firms might switch from
    one market to another depending on profit
    opportunities.
    Profit maximization behavior
    If a firm seeks to maximize profits ( so that the
    difference between total revenue & total cost
    is at the greatest level.), the following should
    be applied:
    Produce the level of output where :
    Marginal revenue= marginal cost
    MR is the increase in total revenue as a result of
    a change in sales. If MR>MC expand, if
    MC>MR contract, thus stop when MR=MC
    Profit maximizing output & price
    • P Q TC TR MC MR Profit or loss
    • 20 1 26 20 26 20 -6
    • 18 2 36 36 10 16 0
    • 16 3 42 48 6 12 6
    • 14 4 50 56 (8) (8) 6
    • 12 5 60 60 10 4 0
    • Notice TC is given, TR= P.Q,
    • MC= change in TC/ change in Q
    • MR=change in TR/ Change in Q
    • From the previous table profit maximization
    output is 4 at a price of 14 per unit, as the
    firm applies MR=MC

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