1. http://www.bized.co.uk Copyright 2006 – Biz/ed Business Economics

2. http://www.bized.co.uk Copyright 2006 – Biz/ed The Growth of Firms

3. http://www.bized.co.uk Copyright 2006 – Biz/ed Efficiency

4. http://www.bized.co.uk Copyright 2006 – Biz/ed Productive Lowest Cost –Productive efficiency can be achieved where the same output could be produced at lower total cost –Achieved through re-organisation (e.g. to cell production), investment in new technology, training for staff and so on

5. http://www.bized.co.uk Copyright 2006 – Biz/ed Technical Minimum inputs –Technical efficiency can be achieved if the same output can be produced using fewer inputs –Can be achieved using labour saving devices, more efficient machinery, more effective re-organisation of restructuring and so on

6. http://www.bized.co.uk Copyright 2006 – Biz/ed Allocative Needs of Consumers (P = MC) Allocative efficiency occurs where the goods and services being produced match the demand by consumers P = MC – the value placed on the product by the buyer (the price) = the cost of the resources used to generate the good/service

7. http://www.bized.co.uk Copyright 2006 – Biz/ed Social MSC = MSB Social efficiency occurs where the private and social cost of production is equal to the private and social benefits derived from their consumption A measure of social welfare

8. http://www.bized.co.uk Copyright 2006 – Biz/ed Motives of Firms

9. http://www.bized.co.uk Copyright 2006 – Biz/ed Profit Maximisation Profit maximisation – assumed to be the standard motive of firms in the private sector Profit maximisation occurs where Marginal Cost = Marginal Revenue MC = MR The firm will continue to increase output up to the point where the cost of producing one extra unit of output = the revenue received from selling that last unit of output This assumes that firms seek to operate at maximum efficiency

10. http://www.bized.co.uk Copyright 2006 – Biz/ed Profit Maximisation – Diagrammatic Representation Cost/Revenue Output MR MR – the addition to total revenue as a result of producing one more unit of output – the price received from selling that extra unit. MC MC – The cost of producing ONE extra unit of production 100 Assume output is at 100 units. The MC of producing the 100 th unit is 20. The MR received from selling that 100 th unit is 150. The firm can add the difference of the cost and the revenue received from that 100 th unit to profit (130). 20 150 Total added to profit If the firm decides to produce one more unit – the 101 st – the addition to total cost is now 18, the addition to total revenue is 140 – the firm will add 128 to profit – it is worth expanding output. 101 18 140 Added to total profit 30 120 Added to total profit The process continues for each successive unit produced. Provided the MC is less than the MR it will be worth expanding output as the difference between the two is ADDED to total profit. 102 40 145 104103 Reduces total profit by this amount If the firm were to produce the 104 th unit, this last unit would cost more to produce than it earns in revenue (-105) this would reduce total profit and so would not be worth producing. The profit maximising output is where MR = MC.

11. http://www.bized.co.uk Copyright 2006 – Biz/ed Revenue Maximisation Total Revenue Average Revenue Marginal Revenue In this model the policies to achieve revenue maximisation may be different to those adopted to maximise profits

12. http://www.bized.co.uk Copyright 2006 – Biz/ed Other Objectives of Firms Sales maximisation: –Attempts to maximise the volume of sales rather than the revenue gained from them Share Price Maximisation: –Pursuing policies aimed at increasing the share price Profit Satisficing: –Generating sufficient profits to satisfy shareholders but maximising the rewards to the managers/board and avoiding attention from rivals or regulatory authorities

13. http://www.bized.co.uk Copyright 2006 – Biz/ed Economic Efficiency

14. http://www.bized.co.uk Copyright 2006 – Biz/ed Definition Economic Efficiency: When goods are produced in the least costly manner and distributed to those who value them most. Requires: –Productive Efficiency –Allocative Efficiency

15. http://www.bized.co.uk Copyright 2006 – Biz/ed Productive Efficiency There is no way to re-direct production among firms to increase total output. Firms are producing output where P= minimum average cost.

16. http://www.bized.co.uk Copyright 2006 – Biz/ed Allocative Efficiency Goods are consumed by those who most value them. There is no alternative comb. of goods that could be produced that would increase society’s well- being. Price= MC i.e. value placed on the good by consumers = cost of producing the good

17. http://www.bized.co.uk Copyright 2006 – Biz/ed Measuring Allocative Efficiency The sum of consumers’ surplus and producers’ surplus.

18. http://www.bized.co.uk Copyright 2006 – Biz/ed 2 Recall: Consumers’ Surplus The difference between what a consumer is willing to pay & what he does pay. D 1 2 345 6 7 6 4 8 $/un it units A B

19. http://www.bized.co.uk Copyright 2006 – Biz/ed Producers’ Surplus-SR perspective The difference between the amount of revenue the firm earns and the minimum amount necessary to get the firm to produce that quantity of the good in the short run. PS = Revenue - total variable costs.

20. http://www.bized.co.uk Copyright 2006 – Biz/ed 2 Producers’ Surplus-Market Selling 4 units @$6/unit. Total revenue = B + C. TVC for all firms is represented by the area under the SRS curve (why?) = C B = producers’ surplus D 1 2 345 6 7 6 4 8 $/un it units B SRS C

21. http://www.bized.co.uk Copyright 2006 – Biz/ed 2 Allocative Efficiency A + B = The sum of consumers’ and producers’ surplus. Vertical distance between D and S is the difference between value to consumer and MC to producer. What Q maximizes CS+PS? D 1 2 345 6 7 6 4 8 $/un it units B SRS C A

22. http://www.bized.co.uk Copyright 2006 – Biz/ed Allocative Efficiency & Perfect Competition Perfectly competitive markets provide the allocatively efficient quantity of a good.

23. http://www.bized.co.uk Copyright 2006 – Biz/ed Perfect Comp and Econ Efficiency Conclusion: Perfectly competitive markets are economically efficient! This is one reason why we use them as a benchmark for our study of other market structures.

24. http://www.bized.co.uk Copyright 2006 – Biz/ed Excise Taxes and Allocative Efficiency Assume the market for wheat is perfectly competitive. Shade in the sum of consumers’ and producers’ surpluses for the competitive market equilibrium.

25. http://www.bized.co.uk Copyright 2006 – Biz/ed Wheat Bushels of wheat Price/Gal. Identify the market equilibrium price and quantity. Shade in the CS + PS. D S 1.00 5 0.7 5 4 1.2 5 6

26. http://www.bized.co.uk Copyright 2006 – Biz/ed Excise Tax Add an excise tax of $0.50 per bushel to this market. What happens to market price and quantity? Shade in CS + PS in light of the tax. Compare your answer to before the tax. Is it allocatively efficient to tax this industry?

27. http://www.bized.co.uk Copyright 2006 – Biz/ed 0.50 Excise tax on wheat-50¢ Bushels of wheat Price/Gal. Price paid by elevator is $1.25 Price kept by farmer is $0.75. What is quantity? How is CS + PS affected? D S S’ 1.00 5 0.7 5 4 1.2 5 6

28. http://www.bized.co.uk Copyright 2006 – Biz/ed Conclusions on Taxes & Efficiency An excise tax cuts the quantity exchanged below the optimal level. This reduces the surplus that consumers and producers receive. Conclusion: Excise taxes reduce market efficiency.

29. http://www.bized.co.uk Copyright 2006 – Biz/ed Next Time Note: We are now one class period behind the syllabus. April 2-4: Monopoly, Ch. 22 April 9-11: Oligopoly and Monopolistic Competition, Ch. 23

30. http://www.bized.co.uk Copyright 2006 – Biz/ed Source: www.people.vcu.edu/~smitchel/21 0/lec16.ppt www.bized.co.uk/educators/16- 19/economics/.../buseconomics