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Chapter 7 Production, Firms and the Market
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Profit & the Firm The Bottom Line Incentive and reward for risks Leads to better decision making and greater productivity Accounting profit = revenue – costs Revenue = price x quantity Costs = Fixed Costs + Variable Costs Short Run – at least one resource cant be changed Long Run – all costs, including buildings, can be variable
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Production Marginal Revenue is the additional revenue earned producing one more unit of output Marginal Cost is the additional cost of that unit Profit maximized where MR = MC Productivity – maximize output from resources used Efficiency – producing at lowest cost
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Productivity factors Skills, education, experience of workforce Quantity and quality of resources State-of-the-art machinery Aim to lower cost per unit Capital-intensive (using machines) vs. Labour- intensive Economies of scale relates to the efficient use of machinery Producing more output lowers the cost per unit
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Useful Formulas Total Revenue = Price x Quantity Total Costs = Fixed Costs + Variable Costs Average Cost = Total Cost / Quantity Average Variable Cost = Variable Cost / Quantity Marginal Revenue = Total Revenue / Total Quantity Marginal Cost = Total Cost / Total Quantity Profit Max. Point where Marginal Revenue = Marginal Cost Profit in $ = Total Revenue – Total Costs
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Perfect Competition many buyers and sellers identical product price taker … no control over price no barriers to entry little non-price competition may not actually exist
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Perfect Competition Profit Maximization Quantity Revenue D=AR=MRP AC AVC Revenue Rectangle Cost Profit MC Profit Max Profit Max Quantity
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Monopolistic Competition Many firms Similar product Some influence over supply and price Easy entry Non-price competition high
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Monopolistic Competition Profit Maximization Quantity RevenueD=AR MR MC AC Profit Cost P Q
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Oligopoly Few firms dominate Products may be similar or different Influence over price varies Barriers to entry high Non-price competition high
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Oligopoly Profit Maximization Quantity Revenue D=AR AC MC MR P Q Cost Profit Kink
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Monopoly One firm dominates Unique product Price maker and control over supply Barriers to entry very high No need for non-price competition
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Monopoly Profit Maximization Quantity Revenue MC AC Profit Cost P Q D=AR MR Profit max Note: Similar to Mono. Comp. but more inelastic demand curve
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Issues Natural Monopoly – where high fixed costs make one firm the choice (e.g. utilities like public transit) Deregulation – allow competition Privatization – sell public assets to private interests Fewer bigger firms may mean collusion Third-party costs – social costs such as pollution are borne by others Public-Private Balance – govt as a provider of goods and services (health, education, etc.) increased in last 40 years as deficits soared Regulation – firms may prefer less but govt must balance with needs of individuals
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