Test 2 Review Chapter 5, 8 & 9
Test 2 (11/20) 20 multiple choice questions & 2 essay questions Chapter 5, 8 and 9 Orange Scantron, Pencil, Caculator, ID (R number) Suggestions: Notes, Quiz, HW and Sample Questions
Chapter 5: The Manager s Role in the Production Process The Production Function To maximize profits when labor or capital vary in the short run, the manager will hire: Labor until the value of the marginal product of labor equals the wage rate: VVVVVV LL = ww, where VVVVVV LL = PP MMMM LL Capital until the value of the marginal product of capital equals the rental rate: VVVVVV KK = rr, where VVVVVV KK = PP MMMM KK Q8 5-3
The Production Function Algebraic Forms of Production Functions Commonly used algebraic production function forms: Linear: QQ = FF KK, LL = aaaa + bbbb, where aa and bb are constants. Leontief: QQ = FF KK, LL = min aaaa, bbbb, where aa and bb are constants. Cobb-Douglas: QQ = FF KK, LL = KK aa LL bb, where aa and bb are constants. Q5 5-4
The Production Function Cost-Minimization Input Rule Capital Input (K) CC 1 rr CC 2 rr AA MMMMMMMM KKKK = ww rr QQ II =100 units 0 CC 2 ww CC 1 ww Labor Input (L) 5-5
The Cost Function The Cost Function Mathematical relationship that relates cost to the cost-minimizing output associated with an isoquant. Short-run costs Fixed costs: FFCC Sunk costs Short-run variable costs: VVVV QQ Short-run total costs: TTCC QQ = FFFF + VVVV QQ Long-run costs All costs are variable No fixed costs 5-6
Short-Run Costs The Cost Function Total costs Variable costs Fixed costs TTTT QQ = FFFF + VVVV QQ VVVV QQ FFFF FFFF FFFF 0 Output 5-7
ATC, AVC, AFC and MC ($) The Relationship between Average and Marginal Costs in Action Minimum of ATC MMCC The Cost Function AAAAAA AVVVV 0 Minimum of AVC AAFFFF Output 5-8
LRAC ($) Economies and Diseconomies of Scale The Cost Function LLLLLLLL Economies of scale Diseconomies of scale 0 QQ Output 5-9
Multiple-Output Cost Function Economies of scope Multiple-Output Cost Function Exist when the total cost of producing QQ 1 and QQ 2 together is less than the total cost of producing each of the type of output separately. CC QQ 1, 0 + CC 0, QQ 2 > CC QQ 1, QQ 2 Cost complementarity Exist when the marginal cost of producing one type of output decreases when the output of another good is increased. MMMM 1 QQ 1, QQ 2 QQ 2 < 0 5-10
Multiple-Output Cost Function Multiple-Output Cost Function in Action Suppose a firm produces two goods and has cost function given by CC = ff + aaqq 1 QQ 2 + QQ 2 2 1 + QQ 2 cost complementarities: aa<0 economies of scope:f > aaqq 1 QQ 2 5-11
Multiple-Output Cost Function Multiple-Output Cost Function in Action Suppose a firm produces two goods and has cost function given by CC = 100 0.5QQ 1 QQ 2 + QQ 1 2 + QQ 2 2 If the firm plans to produce 4 units of QQ 1 and 6 units of QQ 2 Does this cost function exhibit cost complementarities? Yes, cost complementarities exist since aa = 0.5 < 0 Does this cost function exhibit economies of scope? Yes, economies of scope exist since 100 > 0.5QQ 1 QQ 2 5-12
Perfect Competition Chapter 8: Perfect Competion Price Market Price Firm S PP ee DD ff = PP ee D 0 Market output Firm s output 8-13
Perfect Competition Short-Run Profit Maximization In Action $ MMMM AAAAAA PP ee AAAAAA QQ Profit DD ff = PP ee = MMMM 0 QQ Firm s output 8-14
Perfect Competition Short-Run Loss Minimization In Action $ MMMM AAAAAA AAAAAA AAAAAA QQ PP ee Loss DD ff = PP ee = MMMM 0 QQ Firm s output 8-15
$ Perfect Competition The Shut-Down Case In Action MMMM AAAAAA AAAAAA AAAAAA QQ AAAAAA QQ PP ee Loss if shut down Fixed Cost DD ff = PP ee = MMMM Loss if produce 0 QQ Firm s output 8-16
Perfect Competition Short-Run Firm Supply Curve In Action $ Short-run supply curve for individual firm MMMM AAAAAA PP 1 PP 0 0 QQ 0 QQ 1 Firm s output 8-17
Perfect Competition Long-Run Competitive Equilibrium $ MMMM Long-run competitive equilibrium AAAA PP ee DD ff = PP ee = MMMM 0 QQ Firm s output 8-18
Long-Run Competitive Equilibrium In the long run, perfectly competitive firms produce a level of output such that PP = MMMM MC=MR P=AC PP = mmmmmmmmmmmmmm oooo AAAA Perfect Competition 8-19
Monopolist s Demand In Action Monopoly Price Monopolist s power is constrained by the demand curve. PP 0 A PP 1 B DD ff = DD MM 0 QQ 0 QQ 1 Output 8-20
Sources of Monopoly Power Monopoly Economies of scale Economies of scope Cost complementarity Patents and other legal barriers Q20 8-21
Profit Maximization In Action Monopoly Price PPPPPPPPPPPPPP = PP MM AAAAAA QQ MM QQ MM MC ATC PP MM AAAAAA(QQ MM ) Profits QQ MM MR Demand Quantity 8-22
Price Profit-Maximizing Monopolistically Competitive Firm In Action PPPPPPPPPPPPPP = PP AAAAAA QQ QQ MC ATC Monopolistic Competition PP AAAAAA(QQ ) Profits QQ MR Demand Quantity 8-23
Price Long-Run Monopolistically Competitive Equilibrium MC Monopolistic Competition Long-run monopolistically competitive equilibrium ATC PP Demand 1 QQ MR 1 Quantity of Brand X 8-24
Long-Run and Monopolistic Competition In the long run, monopolistically competitive firms produce a level of output such that: PP > MMMM MR=MC PP = AAAAAA > mmmmmmmmmmmmmm oooo aaaaaaaaaaaaaa cccccccccc Q15 Monopolistic Competition 8-25
Profit Maximization in Four Oligopoly Settings Chapter 9: Conditions for Cournot Oligopoly There are few firms in the market serving many consumers. The firms produce either differentiated or homogeneous products. Each firm believes rivals will hold their output constant if it changes its output. Barriers to entry exist. 9-26
Profit Maximization in Four Oligopoly Settings Cournot Oligopoly: Reaction Functions A function that defines the profit-maximizing level of output for a firm given the output levels of another firm is called a best-response or reaction function. 9-27
Profit Maximization in Four Oligopoly Settings Conditions for Stackelberg Oligopoly A single firm (the leader) chooses an output before all other firms choose their outputs. All other firms (the followers) take as given the output of the leader and choose outputs that maximize profits given the leader s output. 9-28
Profit Maximization in Four Oligopoly Settings Conditions for Bertrand Oligopoly Firms produce identical products at a constant marginal cost. Firms engage in price competition 9-29
Profit Maximization in Four Oligopoly Settings Bertrand Oligopoly: Equilibrium This price war would come to an end when the price each firm charged equaled marginal cost. In equilibrium, PP 1 = PP 2 = MMMM. Socially efficient level of output. 9-30
Comparison in Oligopoly Models a. Cournot Firm One's Output Firm Two's Output Total Output Market Price Firm One's Profit Firm Two's Profit 49.33 49.33 98.66 513.33 $24,338 $24,338 b.stackelberg (leader) (follower) 111 390 $27,380 $13,690 74 37 c. Bertrand 74 74 148 20 $0 $0 d. Collusion 37 37 74 760 $27,380 $27,380 P betrand <P stackelberg <P cournot <P collution (Q3) Q betrand >Q stackelberg >Q cournot >Q collution (Q10, Q11, Q12)