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ECON-E201 Lecture 27 Notes- Markets: Monopolistic Competition and Oligopolies 12-6-16 ∙ Characteristics of Monopolistic Competition o Monopolistic competition- market situation in which large number of firms produce  similar but not identical products ▪ Entry to industry relatively easy o Significant number of sellers in highly competitive market ▪ Implications: ∙ Small market share ∙ Lack of collusion/cooperation ∙ Independence o Differentiated products ▪ Product differentiation- distinguishing of products by brand name, color, etc.  (minor attributes) ▪ Differentiate perfectly: ∙ Producer is a monopoly ∙ Significant influence on price ▪ Differentiate imperfectly: ∙ Producer is monopolistic competitor ∙ The more successful at differentiation, the more control over price o Sales promotion and advertising ▪ Can increase demand for firm ▪ Can differentiate firm’s product(s) ▪ Should be continued to point at which additional revenue from one more dollar of  advertising just equals that one dollar of marginal cost ▪ Firms use trademarks, words, symbols, and logos to distinguish their product  brands from goods/services sold by other firms ▪ Successful brand image contributes to firm’s profitability ▪ Forms of advertising: ∙ Direct marketing ∙ Mass marketing ∙ Interactive marketing o Easy entry of firms in long run ∙ Profit Maximization for Monopolistic Competition o Profit maximization occurs when MR = MC ▪ Profit = Total Revenue (�� ∗ ��) – Total Cost (������ ∗ ��) o Short Run Profit or Loss ▪ Positive economic profits: �� > ������ ▪ Negative economic profits: ������ > �� > ������ ▪ Shut down: ������ > �� o Long Run: Enter or Leave ▪ Firms enter: �� > ������ ▪ Firms leave: ������ > �� (next)∙ Comparing Perfect Competition with Monopolistic Competition o Short run profit: o Short run loss: o Long run (firms enter):o Long run outcome: o Perfect vs. Monopolistic: o Efficiency ▪ In perfect competition, long-run equilibrium occurs where average total cost is  minimized ▪ Does not occur in monopolistic competition ▪ Some argue inefficiency not necessarily waste of resources; cost arises from  product differentiation that allows consumers to have more choice ∙ Clicker Questions o Which of the following is an example of a monopolistically competitive firm or  market?: McDonald’s, gas stations, Gap t-shirts, cell phones, Holiday Inn hotel ▪ All of the above o What happens to the monopolistically competitive firm’s curves in the long run if it  earns positive economic profit? ▪ The firm’s demand curve decreases o In the long run, perfect competitors and monopolistic competitors earn zero  economic profits. How are they different? ▪ Monopolistically competitive firms have excess capacity, and perfectly  competitive firms do not ▪ Monopolistically competitive firms mark up their products, and perfectly  competitive firms do notECON-E201 Lecture 25 Notes- Markets: Monopoly 11-29-16 ∙ Characteristics of a Monopoly o Market power- ability to influence the market by influencing total quantity available for  sale; particularly influences market price o Monopolist- single supplier of good/service for which no close substitute exists o Source of monopoly is barrier to entry- allows firm to make long-run economic profits ▪ Ownership of resources without close substitutes ▪ Problems in raising sufficient capital ▪ Economies of scale ▪ Legal/governmental restrictions ▪ Natural barriers o Legal Barriers to Entry ▪ Create legal monopoly- market in which competition and entry are restricted by  granting of an ownership of resources without close substitutes ▪ Public franchise (ie. US Postal Service, delivers first-class mail) ▪ Government license (ie. license to practice law or medicine) ▪ Patent and copyright o Natural monopoly- arises from peculiar production characteristics in an industry ▪ Usually arises when there are large economies of scale ▪ One firm can supply entire market at lower price than 2+ firms can o Cartels- association of producers in an industry that agree to set common prices and  output quotas to prevent competition ▪ Ex. OPEC o Monopolist’s demand = market demand ▪ Monopolist is the industry ▪ A monopoly is a price setter, not price taker, like a firm in perfect competition ▪ Demand for monopoly’s output is market demand ▪ To sell larger output, monopoly must set lower price ∙ Monopoly vs. Perfect Competition Monopoly Perfect Competition Single seller One of many sellers Faces market demand Perfectly elastic demand (price takers) Must lower price to sell more Must only produce more to sell more MR < P All units sold for same price (P = MR)


o What happens to the monopolistically competitive firm’s curves in the long run if it earns positive economic profit?



If you want to learn more check out What do you call choosing location of firm based on taxes, which impedes perfect market competition?

o Monopoly is a single seller of well-defined good/service with no close substitutes ▪ The more imperfect substitutes there are, the greater the price elasticity of  demand of monopolist’s demand curve ▪ However, demand curve has elastic, unit elastic, and inelastic portions ▪ Recall, if demand is elastic, fall in price brings increase in total revenue ∙ Increase in quantity sold outweighs decrease in price per unit (MR > 0) ∙ As price falls, total revenue increases ▪ ∙ Monopoly Costs, Revenues, and Profits o Price searcher- firm that must determine price-output combination that maximizes  profit, because it faces downward-sloping demand curve Quantity Price ($) Total  Revenue ($) Marginal  Revenue ($) Total  Cost ($) Marginal  Cost ($) Profit ($) 0 20 0 0 5 0 -5 1 18 18 18 13 8 5 2 16 32 14 17 4 15 3 14 42 10 22 5 20 4 12 48 6 28 6 20 5 10 50 2 36 8 14 6 8 48 -2 48 12 0


How are they different?



Don't forget about the age old question of An example of one of the open­ended question would be, “How many social media sites do you use?

∙ Clicker Questions o Which of the following is an example of a monopoly market?: United States Postal  Service, a tub of popcorn at the movies, Lipitor (cholesterol medicine) prior to  11/30/11, snacks in a hotel mini-fridge, City of Bloomington Water ▪ All of the above o If the monopolist sells 1000 units at $10 and 1200 units at $9, what is the marginal  revenue? ▪ ���� =Δ���� Δ��= $4 o Using the table above, what’s the total revenue, marginal revenue, marginal cost,  and profit for two units? ▪ TR = $32▪ MR = $14 ▪ MC = $4 ▪ Profit = $15 o Using the table above, what’s the total revenue, marginal revenue, marginal cost,  and profit for one unit? ▪ TR = $18 ▪ MR = $18 ▪ MC = $8 ▪ Profit = $5ECON-E201 Lecture 24 Notes- Markets: Perfect Competition (cont.) 11-17-16 ∙ 3 Types of Short Run Output: Profit or Losses o Short Run Profits ▪ Profit maximized where ���� = ���� ▪ Profit = (�� − ������) ∗ ������������ o Minimization of Short Run Losses ▪ Losses minimized where ���� = ���� ▪ Loss = ������ − ���� when ������ > ���� o Short Run Shutdown Price ▪ Short run break-even price- price at which firm’s total revenues equal its costs ∙ Firm is just making normal rate of return on its capital investment ▪ Short run shutdown price- price that just covers average variable costs ∙ Occurs just below intersection of marginal cost curve and average variable  cost curve ▪ As long as price per unit sold > average variable cost per unit produced, firm can  cover at least part of opportunity cost of investment in the business (part of its  fixed costs) o 3 outcomes in profit-maximizing short run: ▪ Positive economic profits- price greater than average total cost (�� > ������) ▪ Negative economic profits (still produce)- average total cost greater than price,  but price greater than average variable cost (������ > �� > ������) ▪ Negative economic profits (shut down: �� = 0)- average variable cost greater than  price (������ > ��) ∙ The Perfect Competitor’s Short Run Supply Curve o What does the supply curve for the individual firm look like? ▪ Marginal cost curve above short run shutdown point ▪ Competitive firm’s short run supply curve is its marginal cost curve equal to and  above point of intersection with average variable cost curve o Factors that influence industry supply curve (from module 3a): ▪ Firm’s productivity ▪ Factor costs ▪ Taxes and subsidies ▪ Number of firms o How is the market (or “going”) price established in a competitive market? ▪ Recall module 3a; price established by interaction of all suppliers (firms’ MC  curves) and all demanders ∙ The Long Run Equilibrium: Exit and Entry o Profits and losses act as signals for resources to enter or leave an industry o Long Run Adjustments ▪ In short run equilibrium, firm may make economic profit, break even, or incur  economic loss ▪ Outcome determines how industry adjusts in long run ▪ May enter or exit industry OR change plant size o Summary ▪ Economic profits (�� > ������)- signals firms and resources to enter market; price  falls to break-even price due to increase in supply ▪ Economic losses (�� < ������)- signals firms and resources to exit market; price  increases to break-even price due to decrease in supply ▪ At break-even (�� = ������)- resources will not enter or exit because market is  yielding normal rate of return∙ In long run, perfectly competitive firm will make zero economic profits (normal  rate of return) o Long run industry supply curve- market supply curve showing relationship between  price and quantities forthcoming after firms have had time to enter or exit industry ▪ Use textbook to define (only need to know definitions): ∙ Constant-cost industry (no external economies or diseconomies) ∙ Increasing-cost industry (external diseconomies) ∙ Decreasing-cost industry (external economies) ∙ Clicker Questions o Why would you continue to produce if you were incurring a loss in the short run? ▪ You can as long as you can pay your employees ▪ You can for a while and wait for the market price to rise ▪ You can for a while and wait for costs to fall o Based on the completed table (Lecture 23 Notes), what’s the price firms must  receive to break even, and what’s the quantity they will produce? ▪ Break-even point: $3.93/pizza ▪ Quantity: 11 pizzas o Based on the completed table, what’s the shutdown price and quantity? ▪ Shutdown point: $2.47/pizza ▪ Quantity: 9 pizzasECON-E201 Lecture 28 Notes- Markets: Monopolistic Competition and Oligopolies (cont.) 12-8-16 ∙ Characteristics of Oligopoly o Oligopoly- market situation in which there are very few dominant sellers o Each seller knows that other sellers will react to its changes in price and quantity o Small number of firms o Interdependence ▪ Strategic dependence- situation in which one firm’s actions regarding price,  quality, advertising, and related changes may be strategically countered by  reactions of one or more other firms in industry o Why oligopoly occurs: ▪ Economies of scale ▪ Barriers to entry ▪ Mergers ∙ Vertical merger- companies that deal with different factors of production  merging ∙ Horizontal merger- companies of same type merging; buying out competition o Firms have some degree of market power- each one can affect market price ▪ Creates some inefficiency in resources allocation ▪ To the extent that US oligopolies must compete with other firms from other  countries, their market power is limited o Explaining pricing and output behavior of oligopoly markets: ▪ Reaction function- manner in which one oligopolist reacts to change in price,  output, or quality made by another oligopolist in industry ∙ Strategic Behavior and Game Theory o Game Theory- way of describing various possible outcomes in any situation involving  2 or more interacting individuals when those individuals are aware of the interactive  nature of their situation and plan accordingly ▪ Strategy- any rule used to make a choice; any potential choice that can be made  by players in a game o Cooperative game- players explicitly cooperate to make themselves better off o Noncooperative game- players neither negotiate nor cooperate at all ▪ Dominant strategy- always yields highest benefit o Zero-sum game- any gains within the group are exactly offset by equal losses by end  of the game o Negative-sum game- players as a group lose at end of the game o Positive-sum game- players as a group are better off at end of the game o Behavior Types ▪ Opportunistic behavior- actions that ignore possible long-run benefits of  cooperation and focus only on short-run gains ∙ Implies noncooperative game ∙ Not realistic; we make repeat transactions ▪ Tit-for-tat strategic behavior- cooperation that continues as long as other players  continue to cooperate o Price leadership- practice in many oligopolistic industries in which largest firm  publishes its price list ahead of competitors, who then match those announced prices ▪ Ex. Airlines, oil companies o Price war- pricing campaign designed to drive competing firms out of market by  repeatedly cutting prices ▪ Ex. Cell phone companies, PC hardware/software∙ The Prisoner’s Dilemma o You and Professor Graf rob a bank and get caught o You are separated and given these options: ▪ Both confess and get 7 years in jail ▪ Neither confess and get 3 years in jail ▪ One confesses, other does not ∙ Confessor goes free ∙ One who does not confess gets 15 years o What would you do? Remember, no cooperation o Payoff matrix:

Graf confesses Graf doesn’t confess You confess Graf: 7 years You: 7 years Graf: 15 years You: go free You don’t confess Graf: goes free You: 15 years Graf: 3 years You: 3 years


o If the monopolist sells 1000 units at $10 and 1200 units at $9, what is the marginal revenue?



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▪ If both players use dominant strategy, both confess o Nash equilibrium- each player makes best decisions he/she can, taking into account  decisions of others ▪ Does not necessarily mean best cumulative payoff for all players involved ▪ In many cases, all players might improve their payoffs if they could somehow  agree/cooperate on strategies different from Nash equilibrium ▪ Both confess o Pareto optimum- most beneficial outcome ▪ Both don’t confess ∙ Comparing Market Structures Market  Structure # of  Sellers Unrestricted  Entry and  Exit Ability to Set  Price Long-Run  Economic  Profits  Possible Product  Differentiation Nonprice  Competition Examples Perfect  competition Numerous Yes None No None None Agriculture Monopolistic  Competition Many Yes Some No Considerable Yes Toothpaste,  toilet paper,  soap Oligopoly Few Partial Some Yes Frequent Yes College  textbooks Pure  monopoly One Not for entry Considerable Yes None  (product is  unique) Yes Local telephone  companies,  some  electric  companies

We also discuss several other topics like animesh aditya

ECON-E201 Lecture 21 Notes- Firms and Industries: Basic Structures, Production, and Costs 11-8-16 ∙ The Firm’s Goal o Firm- institution that hires factors of production and organizes them to produce/sell goods  and services o Goal- maximize profit ▪ Failing means being eliminated or bought out by other firms with same goal ▪ Must report profit so firm pays right amount of tax and is open/honest about financial  standing with bank and lenders o Accountants measure profit using Internal Revenue Service (IRS) rules based on standards  established by Financial Accounting Standards Board o Economists measure profit based on opportunity cost ∙ Accounting vs. Economic Profit o Firm’s decisions respond to opportunity cost and economic profit o Opportunity cost of producing good usually measured in dollars (forgone other uses of its  factors of production) ▪ Includes implicit and explicit costs o Explicit costs- paid directly in money o Implicit costs- accumulated when firm: ▪ Uses its own capital ∙ Economic depreciation- change in market value of capital over given time period ∙ Interest forgone- return on funds used to get capital ▪ Uses its owners’ time or financial resources o Cost of Owner’s Resources ▪ Owner often supplies entrepreneurial ability/labor ▪ Profit- return to entrepreneurship ▪ Normal profit- return an entrepreneur can expect to receive on average ▪ Opportunity cost of owner’s labor spent running business is wage income that owner  misses out on by not working in best alternative job o Economic profit- firm’s total revenue minus its total cost (TR – TC) ▪ Total cost of production- sum of explicit and implicit costs ▪ Normal profit is part of total costs, so economic profit = profit over and above normal  profit o Economic Accounting Summary ▪ To maximize profit, must make 5 decisions: ∙ What goods/services to product, in what quantities ∙ How to produce- production technology to use ∙ How to organize/compensate managers/workers ∙ How to market/price products ∙ What to produce itself, what to buy from other firms o Firm’s constraints (more detail in textbook)- profit limited by 3 features of environment: ▪ Technology ▪ Information ▪ Market ∙ Systems and Organizations o Firm organizes production by combining/coordinating productive resources using mix of 2  systems: ▪ Command system- managerial hierarchy ∙ Commands pass downward through hierarchy, information (feedback) passes  upward ∙ Used when easy to monitor ▪ Incentive system- market-like mechanisms to induce workers to perform in ways that  maximize firm’s profit∙ Use when hard to monitor o Principal-agent problem- devising compensation rules that induce an agent to act in best  interests of a principal ▪ Ex. Stockholders of a firm are principals, managers are their agents o 3 Types of Business Organizations ▪ Proprietorship- firm with single owner ∙ Advantages: o Proprietor answers to no one else o Owner gets all profits o Profits are taxed the same as owner’s other income ∙ Disadvantages: o Owner has unlimited liability- complete legal responsibility for all debts and  damages, up to amount equal to entire wealth of owner ▪ Partnership- firm with two or more owners ∙ Advantages: o More than one person available for specialized management o Partners can pool financial capital in order to have larger business base ∙ Disadvantages: o Partners have unlimited liability for debts o Must agree on management structure and how to divide up profits (taxed as  personal income) o If one partner cannot pay their share of debt, other partners responsible o When partner leaves or dies, partnership usually ends ▪ Corporation- owned by one or more stockholders/shareholders ∙ Advantages: o By law, shareholders have limited liability; owners have legal liability only for  initial value of their investment o Personal wealth of shareholders not at risk if firm goes bankrupt ∙ Disadvantages: o Double taxation of corporate income o Hybrids ▪ S Corporation- all net profits passed directly to individual owner(s) and are taxed as their  income ▪ Limited Liability Company (LLC)- in addition to avoiding double taxation, also have  limited liabilities of corporation ∙ Clicker Questions o What is the goal of the firm? ▪ Maximize economic profit o Recall: Opportunity cost measures… ▪ All explicit and implicit costs o Which of the following is true about the different types of profit?: Accounting profit includes  normal and economic profit, economic profit includes normal and accounting profit, normal  profit includes economic and accounting profit, accounting profit includes only economic  profit, none of the above ▪ Economic profit includes normal and accounting profit OR none of the above o What’s the best way to solve the principal-agent problem?: Performance evalutations, pay  per performance (commission pay), monitoring performance, stock options (ownership) in  company, compensation based on specific goals (sales or profit) ▪ All of the above; up to principalECON-E201 Lecture 26 Notes- Markets: Monopoly (cont.) 12-2-16 ∙ Price Discrimination vs. Price Differentiation o Price discrimination- selling given product at more than one price, with difference  being unrelated to differences in cost of production ▪ Among units of a good ∙ Ex. Quantity discounts; however, some quantity discounts that reflect lower  costs at higher volumes are not price discrimination ▪ Among groups of buyers ∙ Ex. Airline tickets ▪ Price differences that arise from cost differences are not price discrimination ▪ Necessary Conditions ∙ Firm must face downward-sloping demand curve ∙ Firm must be able to separate markets at a reasonable cost ∙ Buyers in various markets must have different price elasticities of demand ∙ Firm must be able to prevent resale of product or service o Price differentiation- establishing different prices for similar products to reflect  differences in marginal cost in producing those goods to different groups of buyers ∙ Profit Maximization o Why produce where MR = MC? ▪ Producing less than were MR = MC: incremental revenue > incremental cost ▪ Producing past where MR = MC: incremental cost > incremental revenue o Ex. ▪▪ As a single-price monopoly, firm maximizes profit by producing 15,000  enrollments per year and selling them for $9,000 each ▪ By price discriminating, firm can increase its profit; if doing so, it converts  consumer surplus into economic profit ▪ With perfect price discrimination: ∙ Profit-maximizing output increases to the quantity at which price = marginal  cost ∙ Economic profit increases above that made by a single-price monopoly ∙ Monopoly Output and Inefficiency o Scenario: ▪ Start with perfectly competitive market in long-run equilibrium ∙ ����:���� = ���� ∙ ���� = ���� ∙ ���� = ���� ∙ Zero economic profits ▪ Assume industry is acquired by one firm with no impact on cost ▪ ▪o The Social Cost of Monopolies ▪ Because price exceeds MC, marginal social benefit exceeds marginal social  cost, and deadweight loss arises ▪ Monopoly redistributes portion of consumer surplus by changing it to producer  surplus ▪ Rent seeking makes deadweight loss larger (loss to producer surplus)ECON-E201 Lecture 23 Notes- Markets: Perfect Competition 11-15-16 ∙ Characteristics of Perfect Competition o Perfect competition- market structure in which decisions of individual buyers/sellers have no  effect on market price o Price taking- take price of firm’s product as given, because firm cannot influence its price ▪ Firm can sell as much as it wants at going market price ▪ No incentive to sell at lower price ▪ Attempts to charge higher price result in no sales ▪ No single firm can influence price; must “take” equilibrium market price ▪ Each firm’s output is perfect substitute for those of other firms; demand for each firm’s  output is perfectly elastic o Many buyers/sellers o Homogeneous (identical) products o No barriers to entry/exit o Buyers and sellers have equal access to information o Ex. Perfectly competitive firm is a price taker (ie. must sell for $5) ▪ Firm’s demand curve perfectly elastic; it will sell all units for $5 ∙ Will not be able to sell at higher price ∙ Will not choose to sell more units at lower price ∙ Profit-Maximizing Rate of Production o Firm produces level of output that will maximize profits given market price o Economic profit = total revenue – total cost = ���� – ���� o Total revenues- price per unit times total quantity sold ▪ ���� = �� ∗ �� ▪ �� determined by market in perfect competition ▪ �� determined by producer to maximize profit o Total cost = explicit cost plus implicit cost ▪ ���� = ���� + ���� o Short Run Decisions ▪ Whether to produce or shut down temporarily ▪ If choice is to produce, what quantity to make o Long Run Decisions ▪ Whether to increase or decrease plant size ▪ Whether to stay in or leave industry (table on next page)o Completed Table: Pizzas Marginal  Revenue ($) Total  Revenue ($) Total  Cost ($) Variable  Cost ($) Average  Variable  Cost ($) Average  Total Cost ($) Marginal  Cost ($) 0 0.00 0.00 15.00 0.00 0.00 0.00 0.00 1 5.00 5.00 19.75 4.75 4.75 19.75 4.75 2 5.00 10.00 23.50 8.50 4.25 11.75 3.75 3 5.00 15.00 26.50 11.50 3.83 8.83 3.00 4 5.00 20.00 29.00 14.00 3.50 7.25 2.50 5 5.00 25.00 31.00 16.00 3.20 6.20 2.00 6 5.00 30.00 32.50 17.50 2.92 5.42 1.50 7 5.00 35.00 33.75 18.75 2.68 4.82 1.25 8 5.00 40.00 35.25 20.25 2.53 4.41 1.50 9 5.00 45.00 37.25 22.25 2.47 4.14 2.00 10 5.00 50.00 40.00 25.00 2.50 4.00 2.75 11 5.00 55.00 43.25 28.25 2.57 3.93 3.25 12 5.00 60.00 48.00 33.00 2.75 4.00 4.75 13 5.00 65.00 54.50 39.50 3.04 4.19 6.50 14 5.00 70.00 64.00 49.00 3.50 4.57 9.50 15 5.00 75.00 77.50 62.50 4.17 5.17 13.50 16 5.00 80.00 96.00 81.00 5.06 6.00 18.50

Don't forget about the age old question of What is the area of accounting that serves the decisionmaking needs of internal users?

▪ Do not need separate column for fixed cost; find where quantity is 0 ▪ Profit-maximizing rate of production- maximizes total profits; difference between total  revenues and total costs ∙ Rate at which marginal revenue = marginal cost ∙ Marginal revenue- change in total revenue divided by change in output ∙ Marginal cost- change in total cost divided by change in output ▪ ONLY for perfect competition, price = marginal revenue ▪ For individual firm, marginal revenue = price = average revenue = demand ∙ All located on horizontal demand curve for firm∙ Profit-maximizing quantity is 12; where MC curve intersects demand curve o Profit Maximization ▪ Economic profits = ���� − ���� ▪ Profit-maximizing output occurs when ���� = ���� ▪ For perfectly competitive firm, occurs at intersection of firm’s demand curve (price) and  its marginal cost curve ∙ �� = ���� ∙ Types of Short Run Output: Profits or Losses o Short run average profits or average losses determined by comparing average total costs  with price (average revenue) (�� = ������) at profit-maximizing quantity (���� = ����) o In short run, perfectly competitive firm can make economic profits (�� > ������) or economic  losses (�� < ������) ∙ Clicker Questions o Which is an example of a perfectly competitive market?: Corn, gas stations, lawn service,  free software, eBay ▪ All of the above o Based on the completed table, where is profit maximized? Why? ▪ 12 pizzas o Once we determine the profit-maximizing quantity, what will determine economic profits or  losses in the short run? ▪ Comparing price to average total costECON-E201 Lecture 22 Notes- Firms and Industries: Basic Structures, Production, and Costs  (cont.) 11-10-16 ∙ 4 Market/Industry Types o Perfect competition ▪ Many firms (thousands), each selling identical product ▪ Many buyers ▪ No restrictions on entry of new firms to industry ▪ Firms and buyers well-informed about prices and products of all firms in industry o Monopolistic competition ▪ Many firms (less than perfect competition- hundreds), each selling similar but not  identical product (known as product differentiation) ▪ Each firm has an element of market power ▪ No restriction on entry of new firms to industry o Oligopoly ▪ Small number (tens) of firms competing ▪ Might produce almost identical OR differentiated products ▪ Barriers to limit entry into market o Monopoly ▪ One firm produces entirety of output of industry ▪ No close substitutes for product(s) ▪ Strict barriers to entry to industry protect firm from competition by other firms ∙ 2 Measures of Concentration o Four-firm concentration ratio- percentage of total industry sales accounted for by four largest  firms in industry o Herfindahl-Hirschman Index (HHI)- square of percentage market share of each firm summed  over largest 50 firms in industry o Textbook p. 238 gives more detail- save this info for final exam o Larger measure of market concentration means less competition exists in industry o Ex. Concentration measures for U.S. Economy ▪ Useful indicator of degree of competition present in given market ▪ Market with HHI < 1000 is highly competitive ∙ 1000 < HHI < 1800 moderately competitive ∙ HHI > 1800 uncompetitive ∙ Short Run vs. Long Run o Firm makes decisions to achieve main goal of profit maximization; all can be put into time  frames of short run and long run o Some choices critical to survival of firm, others irreversible or very costly to reverse o Some choices easily reversed/less critical; still influence profit o Short run- time period when at least one input, like plant size (capital), cannot be changed,  while others can, like labor ▪ Plant size/capital- physical size of factories a firm owns/operates to produce output o Long run- time period in which all factors of production can be varied ▪ Decisions not easily reversed ▪ Sunk cost- incurred by firm, cannot be changed ∙ If a firm’s plant has no resale value, amount paid for it is a sunk cost ∙ Irrelevant to firm’s decisions o Short/long run apply to planning decisions made by managers ▪ Firm always operates in short run in sense that decisions can only be made in present ▪ Some decisions result in long-term commitment of resources ∙ A Firm’s Inputs and Outputs o Output/time period = some function of capital and labor inputs ▪ �� = ��(��, ��) where �� = output/time period, �� = capital, �� = labor ▪ Functions mostly linear; nonlinear more realistico Production- any activity resulting in conversion of resources into products that can be used  in consumption o Production function- relationship between inputs and output o Total product- total output produced in given period o Average physical product- total product divided by variable input o **Marginal physical product- physical output due to addition of one more unit of a variable  factor of production ▪ Change in total product occurring when a variable input is increased and all other inputs  held constant ▪ Also known as marginal product or marginal return ∙ Total, Average, and Marginal Productivity o Law of Diminishing Marginal Returns- observation that after some point, successive equally sized increases in a variable factor of production added to fixed factors of production will  result in smaller increases in output ▪ Constraint of fixed factor hinders variable factor o Ex. Production function of corn Labor Input (Workers) Total Product Average Product Marginal Product 1 10 10 10 2 26 13 16 3 36 12 10 4 40 10 4 5 35 7 -5

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∙ Input on horizontal axis of graph, output on vertical ∙ When marginal product > average product, average product curve rising ∙ When marginal product < average product, average product curve decreasing ∙ Average product curve intersected by marginal product curve at average product  curve’s maximum point ▪ Total product curve similar to PPC o With fixed amount of factory space and capital goods, more workers can add to total output ▪ Additional increments of quantity produced will lessen as more labor added ▪ Beyond certain point, as more workers added, they may have to wait for more space or  capital goods or make goods manually ∙ Short Run Costs to the Firm o To produce more output in short run, firm must employ more labor, increasing its costs o We describe the way a firm’s costs change as total product changes by using 3 cost  concepts and 3 types of cost curves: ▪ Total cost- sum of fixed and variable costs∙ Fixed costs- do not vary with output ∙ Variable costs- vary with rate of production ∙ ���� = ������ + ������ ▪ Average cost ▪ Marginal cost ▪ Table of costs: Output Total  Fixed  Costs Total  Variable  Costs Total  Costs Average  Fixed  Costs Average  Variable  Costs Average  Total  Costs Marginal  Costs 0 $20 $0 $20 --- --- --- --- 1 $20 $10 $30 $20 $10 $30 $10 2 $20 $14 $34 $10 $7 $17 $4 3 $20 $19 $39 $6.67 $6.33 $13 $5 4 $20 $40 $60 $5 $10 $15 $21

∙ Clicker Questions o (Without looking at completed table) If hiring 3 workers produces 36 bushels of corn and  hiring 4 workers produces 40 bushels, what’s the average and marginal production for 3  workers? For 4? ▪ Average for 3- 12 ▪ Marginal for 3- 10 ▪ Average for 4- 10 ▪ Marginal for 4- 4 **Very important
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