ECN 349 Industrial Economics-Asst. Prof. Evrim Turgutlu

ECN 349
Industrial Economics
ECN 349 Industrial Economics-

Asst. Prof. Evrim Turgutlu
Introduction
In this course we will focus on the economics of industrial
organization (IO).
IO is the study of the structure of the firms, markets and of
their interactions.
In microeconomics, idealized models of firms and markets are
analyzed.
IO takes a more realistic look at them.
It adds to the perfectly competitive model the real world
frictions: limited information, transaction costs, barriers to
entry, etc.
IO considers how firms are organized and how they compete
in such a world.

Cost Concepts
Costs provide improtant information to analyze the firm behavior.
Types of costs:
Fixed costs (F): An expense that do not vary with the level of output.
(Rent, fee government charge to operate, etc.)
When the production (operation of a firms stops), if the fixed cost could not
be recovered at all: Sunk costs
The portion of the fixed costs that can be recovered even though firm
stops operating: Avoidable costs
Variable costs (VC): Costs that change with the level of output, q.: VC
(q)

Cost Concepts
Total costs (TC): C= F+ VC
Average cost (AC or ATC): TC/q
Average variable cost (AVC): VC(q)/q
Average fixed cost (AFC): FC/q
AC (q)= AFC + AVC
Can AVC and AFC exceed AC?
Marginal cost (MC): Increment or addition to cost that results from
producing one more unit of output.
MC= dC(q)/dq

Cost Concepts
Complete the following table:
Q FC VC TC MC AFC AVC ATC

1 300 70 370 70
2 60
3 70
4 315

Cost Concepts
Q FC VC TC MC AFC AVC ATC
1 300 70 370 70 300 70 370
2 300 130 430 60 150 65 215
3 300 210 510 80 100 70 170
4 300 315 615 105 75 78.75 153.75

Cost Concepts
A cost curve summarizes an enormous amount of information. For
example, knowing that cost curve changes as wages or other factor
prices change, one can infer a firms production technology (relation
between inputs and output reflecting the maximum possible output
that can be produced from a given set inputs).
Short-run verus the Long-run:
Short run
Long run
SRAC and LRAC

Cost Concepts
Oppotunity cost: An actions opportunity cost is the value of the best
forgone alternative use of the resources employed in that action.
E.g. Suppose that there are three workers in a firm. One of them is the
owner of the firm and he does not receive a wage. The others receive a
wage of $10 per hour. Hence, an economist should measure the
opportunity cost of three workers as $30 per hour.
How can we use this information?
To decide whether it is profitable to continue an activity.
If each worker produces 1 unit of output each hour which is sold for
$9, then in one hour the owner will calculate the profit as: revenue-
cost: 27-30=-3
This means, the owner of the firm should stop producing and work for
someone else for $10 per hour.

Cost Concepts
If all costs are valued at their opportunity cost, the profit need only be
zero to make remaining in business worthwhile.
If revenues cover costs, then all resources are used in an efficient
manner.
Since opportunity cost values each resource at its most profitable
alternative use, economists sometimes say that opportunity cost
attributes a normal profit to all of the firms resources.

Cost Concepts
Economies of scale
Average costs changes with
the level of output.
If AC falls as output increases,
firm is said to have
economies of scale
(increasing returns to
scale).
AC ' (q ) 0
If AC stays constant as output
increases, firm is said to AC ' (q ) 0
have constant returns to
scale. AC ' (q ) 0
If AC decreases as output
increases, firm is said to
have diseconomies of
scale (decreasing returns
to scale).

Cost Concepts
Scale economies exist, if MC is below AC.
Scale disceonomies exist if MC is above AC.
Hence, a measure of scale economies can be
expressed as: s=AC/MC
If s>1: Economies of scale
If s<1: Diseconomies of scale

Cost Concepts
Minimum efficient scale (MES):
A firms minimum efficient scale is the smallest output (q*) it can produce
such that its LRAC are minimized.
What information can be drawn from MES?

The size of the MES plant, especially in relation to the overall market, is
useful for judging how many firms could operate in the market.

Cost Concepts
In real life, firms usually produce more than one product.
How can we specify average and marginal costs then?
Suppose a multiproduct firm, producing two products, q1 and q2.
Specification of TC and AC.
Ray scale economies (RAC)
Product-specific economies of scale (PS)
Economies of scope


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ECN 349

ECN 349 Industrial Economics-

ECN 349 Industrial Economics-

ECN 349 Industrial Economics-

ECN 349 Industrial Economics-

Q FC VC TC MC AFC AVC ATC

ECN 349 Industrial Economics-

ECN 349 Industrial Economics-

Short-run verus the Long-run:

SRAC and LRAC

ECN 349 Industrial Economics-

ECN 349 Industrial Economics-

ECN 349 Industrial Economics-

ECN 349 Industrial Economics-

ECN 349 Industrial Economics-

What information can be drawn from MES?

ECN 349 Industrial Economics-

ECN 349 Industrial Economics-

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