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NotesAccounting versus Economic Profit (p. 55 of course packet):See the following videos for the distinction between economic and accounting costs, as well as economic and accounting profit: (This guy has energy! Plus, he’s an ACDC fan!) a look at Section 7.1 of Chapter 7 of the text at the following: can also take a look at Chapter 7 of the Perloff text assigned to the class.Mathematical Derivation of Short-run total cost (p. 56 of course packet): Recall from our lecture on isocost lines that total outlay and total cost are the same. Now, if a firm uses capital (K) and labor (L) to produce its product, then total outlay = total cost = capital cost + labor cost = PK?K + PL?L, where PK is the price of capital (i.e., cost per machine) and PL is the price of labor (i.e., cost per worker). On page 56, I give you a Cobb-Douglas production function, and in the short-run we suppose K is fixed at 4. You can see at the very bottom of page 56 how to derive the short-run total cost function. Notice that total cost increases as the firm produces more output. Why? It needs more labor to produce more of its product. Also see: Costs (p. 57 – 60 of course packet):Good videos to look at: a firm uses only capital and labor to produce its product, with K being fixed in the short-run and L being variable in the short-run, then total variable cost (TVC) is simply labor cost (or PL?L) and total fixed cost (TFC) is simply capital cost (or PK?K). In the example on page 57 of a firm operating on an hourly basis, with PL = 15, I use the total product curve provided to crank out values of TVC. Now, if you put TVC on the vertical axis and Q on the horizontal axis, you get the TVC graph depicted on this page. Check out the videos below for more help on this: get total cost (TC), you just sum up TVC and TFC, as I show their vertical sum on page 57 of the note packet.Take a look at Chapter 7 of the text at the following (which is nice for showing various calculations): can also take a look at Chapter 7 of the Perloff text assigned to the class.On pages 58 – 60, I take the newspaper example from page 41 of the course packet, assuming now that the price of capital (i.e., cost per machine on a daily basis) is $100 and the price of labor (i.e., cost per worker on a daily basis) is $50. The various costs are then generated on pages 58 and 59. Note on page 59: Average variable cost (AVC) is total variable cost per unit produced, average fixed cost (AFC) is total fixed cost per unit produced, and average total cost (ATC) is total cost per unit produced. Further, ATC = AFC + AVC. Marginal cost (MC) is the change in total cost (as well as the change in total variable cost, since total fixed cost is constant) due to a small change in Q. Also, in equation form, MC = ΔTC/ΔQ. I then use these formulas to crank out values of AVC, AFC, ATC, and MC for our newspaper example. Notice from the table of calculations we can see the graphs at the bottom of page 59 (e.g., as Q increases (i.e., we move down the table) AVC falls and then rises (e.g., 0.033 → 0.025 → 0.02 but then 0.02 → 0.022)). Also note that when MC is rising the firm is operating under diminishing marginal returns (i.e., from last column of table as L increases from 4 to 5 workers MC rises). On page 60 I illustrate relationship between ATC, AVC, and MC. Since ATC = AFC + AVC, then AFC = ATC – AVC. And since AFC falls as Q increases, the gap between ATC and AVC shrinks as Q increases. Further, when the margin (i.e., marginal cost) is less than the average (i.e., either ATC or AVC) these averages fall. The opposite holds when the margin is greater than the average. Also, MC crosses AVC and ATC at their minimums. These relationships are also illustrated in the various online links provided above.Skip p. 61. We don’t need this.Derivation of long-run average curve (LRAC) and its shape tied to returns to scale (p. 62 of course packet):Graphical derivation of Long-Run Average Cost: See Section 7.5 of Chapter 7 of the text at the following: can also take a look at Chapter 7 of the Perloff text assigned to the class.Need some energy? Check out this video on economies and diseconomies of scale: maximization (p. 63 – 64 of course packet):Take a look at Chapter 8 of the Perloff text for the rule that profit is maximized where marginal revenue (MR) equals marginal cost (MC). If MR > MC, the firm should produce more to increase profit. If MR < MC, the firm should produce less the increase profit. You can also take a look at the following video (which looks similar to the graph I have on p. 64 of the note packet): structure, conduct, performance: For this section of the course we are exploring how firms behave in different markets. Skip p. 65 – 68 of the course packet and let’s just move to various markets.Perfect competition (p. 69 – 73 of course packet):There is lots of information online about this type of market. See Chapters 8 and 9 of the Perloff text assigned to this class. You can also check out Chapter 8 of the following managerial economics text: check out Chapter 8 of the following for an introductory level presentation: is a high-energy video: one shows you how to numerically solve a problem: Key points about perfect competition:Firms are price takers (i.e., take market price as given) and so P = MR.To maximize profit, since firm will operate at quantity where MR = MC, or P = MC (since price and marginal revenue equal each other).From page 70, You can always write profit as (P – ATC)q, and so where P > ATC the firm is earning a profit. In the short-run, firm should produce as long as P ≥AVC. If P < AVC, firm should shut down production. This leads to the firm’s short-run supply curve being the portion of its MC curve at and above minimum AVC.Market supply in the short-run is thus the horizontal sum of firm MC curves (at and above AVC).In the long-run, because of free entry and exit firms reach an equilibrium where they operate at the minimum point on the long-run average cost curve (where P = LRAC = LRMC and economic profit is driven to zero).Monopoly (p. 74 – 77 of course packet):Check out Chapter 11 of the Perloff text assigned to this class. You can also find discussions of monopoly at the following: (See Chapter 9 of this introductory level text)Or: (See Chapter 8 of this text for good algebraic examples)Some videos:: From page 76 of the note packet, if you can write demand in its inverse form (i.e., P = a – bQ) then marginal revenue (MR) is MR = a – 2bQ. The above video illustrates that, as well as: below is good one for showing how to numerically solve profit-maximization problem for monopolist: Note: You can always write monopoly marginal revenue as: MR = P(1 + 1/ε), where P is price and ε is the price elasticity of demand. This is shown on p. 348 of the Perloff text, as well as p. 306 of the following text: Comparing Monopoly to Perfect Competition (p. 78 – 79 of course packet):You can see videos of comparing monopoly to perfect competition at: calculating consumer and producer surplus, market welfare, and deadweight loss in market welfare, check out the following: perhaps see: discrimination (p. 80 – 83 of course packet):Price discrimination occurs when firms charge different prices to different buyers. You can find a discussion of this topic in Chapter 12 of the Perloff text, or Chapter 10 of the following text: are some videos you can watch:(Nice overview of three types of p.d.)(Nice non-technical presentation)(Nice numerical example of third degree p.d.)In first degree price discrimination, the firm charges each consumer a unique price (given by the most each consumer is willing to pay). This leads to consumer surplus equaling zero. In second degree price discrimination, the firm sells batches of its output at different prices, and is commonly referred to as quantity discounts. In the case of third degree price discrimination, the firm segments its customers into groups and charges each group a unique price. For third degree (from p. 82 – 83 of note packet), you can check out by reading Section 12.3 of the Perloff text, or see: key takeaways of third degree price discrimination is that the profit-maximizing quantities to sell to each group are where the marginal revenues from each group are equal. Also, the group charged the higher price is the group which faces the less elastic demand.Monopolistic Competition (p. 84 – 85 of course packet):Take a look at Chapter 13 of the Perloff text, or you can see Section 8.4 of the following: are some videos too: takeaways are (i) firms sell differentiated products, leading them to have downward sloping demands; (ii) price is higher than under perfect competition; and (iii) similar to perfect competition entry and exit drive long-run profit to zero.Oligopoly (p. 86 – 91 of course packet):Oligopolies are markets dominated by a few large sellers. See Chapter 13 of the Perloff text for a discussion of oligopoly. You can also check out the following for an introduction to oligopoly: are two models I want you to look at. The first is the Cournot model. This is discussed in Section 13.3 of the Perloff text. You can also check out (This is a good one because you just need to slide values from the equations I will give you into a formula provided at this site): see: see (slides 12 – 15):(2017)/Ch12%20(oligopoly).pdfFor the Cournot model, you need to derive reaction functions and then determine the quantities such that the reaction functions cross each other. Once you know how much each firm will produce in equilibrium, you can then get the market quantity (Q), back out the price, and then get each firm’s profit. I have a numerical example on p. 89 of the note packet and the links above also provide numerical examples. For the second model, I want you to explore the case of a cartel (i.e., a form of explicit cooperation). For this story, you can find discussions of it in Section 13.2 of the Perloff text. Here are some videos: takeaways of cartel model: (i) Firms collectively behave as one (i.e., monopoly) to set market price and quantity; (ii) the market quantity should be allocated across cartel members using quotas by equating their marginal costs (If one member’s marginal cost is lower than another member’s marginal cost, then the lower cost member should produce more and the higher cost member should produce less); (iii) cartels are unstable because there is an individual incentive for each member to produce beyond its quota production level. You’ve been through enough this semester. Let’s call it a day….ciao! ................
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