1.5 Big Ideas.. Key concepts. Webnote 150-Theory of the Firm

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1 1.5 Big Ideas.. Key concepts 1

2 See webnote Models-webnote 151 2

3 Perfect Competition 1. Efficient lowest point on AC (see economies of scale) 2. Homogenous 3. Large number of small firms ( 000 s) 4. No barriers to entry + exit of industry 5. Nearest example: farmer 6. No price power / Price taker 3

4 MISTIC monopolisitc 1. Inefficient (not at lowest pointon AC) 2. Branding is common local pizza. 3. Large number of small firms ( 00 s)_ 4. No major barriers to entry 5. bakery in Kaiserswerth 6. Little price power 4

5 oligopoly 1. Inefficient (economies of scale may result in lower unit costs than PC or monopolistic 2. Branded products or 5 firms (up to 100 possible but concentration of market share is between a small number of firms)possible e.g. microsoft,apple, linux.. 4. major barriers to entry e.g set up costs 5. Collusion/anti competitive behaviour: coca cola see Mexico clip in webnote 151, Ford, Aldi etc 6. Price power 5

6 monopoly 1. Inefficient(economies of scale may result in lower unit costs than PC or monopolistic-s ee fig 1 below) 2. Branded products if in final goods market or 5 firms possible e.g. microsoft and?? 4. major barriers to entry e.g set up costs 5. Price power unless a legal monopoly 6

7 Theory of the Firm 4 Targets for each of the 4 models 1. Price and output of 4 models 2. Profit Maximisation: profit finder where MR=MC 3. Efficiency 4. Supernormal profits 7

8 The Big Ideas Costs of firms: tell us about profit and efficiency (ac,mc,avc,afc,atc (ac),srac,lrac) Revenues of firms (ar (=demand=price),mr,) Profit: TR-TC, ar>ac (supernormal profit. 4 Models: price + output in LR + SR, profit levels, efficiency (unit cost/ac), price power, R+D, Economies of Scale) + barriers to entry. 8

9 1.Goals of firms Other focus points E.g.Revenue maximisation,sales growth maximisation,profit maximisation. 2. Price discrimination (price power) 9

10 A1:Short Run Average Total Cost A2:TOTAL COSTS +REVENUES Z TR P TC= P/C x q TC X K TC O (b) TFC AFC MC ATC ATC: Average Total Cost = C + E which is TC/q Q (c) (d) (e) O TVC AVC b Q X and Z = break even points K = max profit quantity of production shaded areas = economic loss a Every Firm must cover its AVC in the Short Run or it must shut down 10

11 Know your cost diagramswebnote 153 F: Long Run ATC Depends on Internal + External (DIS) Economies of Scale P LRATC Economies of Scale unit cost falling Diseconomies of Scale unit cost rising O Q 11

12 Revenues + Profits is the firm a price taker or a price maker? Webnote 151 DIAGRAM A: Firm is a price taker P D Industry ( firms) S P Firm FIRM HAS NO PRICE POWER and = price taker Pm D = Price=AR=MR 0 0 Q 12

13 Revenues + Profits Normal or supernormal? AR = price AR=AC AC 2 AC 1 AR>AC Pro,it max. output 13

14 Barriers to Entry resources follow profits! Normal or supernormal? High S/N profits cause entry and if barriers are absent then price will fall from P2 to P1. Ar=AC and profits will be Normal. d s1 AR = price AR >A C AR =A C A C 2 A C 1 p2 p1 s2 Pro,it max. output Of course if firms can set up barriers then the S.N profits can be protected into the long run and this is typical in oligopoly and monopoly. 14

15 Goals of firms webnote

16 16

17 4 Models:Webnotes Evaluate the 4 models. The above webnotes will give you a nice summary of the advantages and disadvantages of each of the 4 models. Exam question could focus on just ONE model or a comparison of TWO 17

18 See Webnote 1591 Accurate Diagrams. 18

19 Watch out for: in Oligopoly Kinked demand curve/price rigidity/ interdependence DIAGRAM A: Equilibrium for an Oligopolist competing on price cuts C+ R Firm A MC P1 B AC C 0 Q1 Q MR Game theory 19

20 Watch out for: price discrimination 20

21 Watch out for: 5 goals of firms 21

22 9 Bits to look our for DMR/Returns to scale Economies of scale Efficient resource allocation (AC curve) 3 goals of a Firm Price discrimination Goals of firms: Profit maximisation vs sales growth vs sales revenue maximisation Kinked demand curve (oligopoly) Collusion (oligopoly) Compare + contrast (evaluate) the 4 models models: evaluate 1 or 2 of the 4 models 22

23 Big Questions for 99 Big Questions for webnote 99: 1. With diagrams explain why are costs important for firms? 2. Is a focus on revenue or costs more important for a firm? 3. Select two type of competitive firm and evaluate which is the best model for society. 4. Does monopoly work? 5. Draw the revenue and cost curves for firms in Perfect competition, monopolistic, oligopoly and monopoly. 6. What is the best competitive model. Give reasons? 23

1.5 Big Ideas.. Key concepts. Webnote 150-Theory of the Firm

1.5 Big Ideas.. Key concepts. Webnote 150-Theory of the Firm 1.5 Big Ideas.. Key concepts 1 9 Bits to look our for DMR/Returns to scale Economies of scale Efficient resource allocation (AC curve) 3 goals of a Firm Price discrimination Goals of firms: Profit maximisation