Economic Management #4: Costs and Market Structure

[samvara]

Home sick, orthodontist braces rewire plus emotionally wrought catch up with father (of the good but tiring kind) left me wrung out, headachy and determined to cower in isolation.

Read chapter 10 of text (which is huge and not going to be summarised) and reviewed worked example results from wk 3 workshop thoughtfully posted on webct.

1. Why would a farmer claim to be losing money farming while still showing a decent profit?
   • Accounting profit = total revenue minus total explicit costs
   • Economic profit = total revenue minus total explicit and implicit costs (value of time spent, interest in investment, opportunity cost of not selling and investing in something else)
2. As a manufacturer increases output, which would decrease?
   • Average fixed cost (e.g. proportion of each item to, say, rent goes down)
3. Ophthalmologist performs cataract and Lasik surgery. If a competitor starts offering Lasik as well causing a decrease in price it will:
   • reduce the opportunity cost for performing cataract surgeries (not losing as much by not doing Lasik)
4. If a firm's average cost is falling (economies of scale) with output then:
   • Marginal cost is less than average cost (cost to create one more item is less than average cost to create each item)
5. New sandwich bar. Start-up costs will be $2,000 and cost per sandwich will be $3
   • Total cost of producing 25 sandwiches: = Fixed Cost + Variable Cost*Number of items = 2,000 + 3*25 = $2,075
   • Marginal cost of the next sandwich = $3 (every new sandwich costs $3)
   • Fixed cost of producing 25 sandwiches = $2,000 (must spend this much to be able to make sandwiches)
   • Start off hiring 2 sandwich makers, then hire 2 more. Person 1 makes 30, person 2 makes 22; explain effect on total and average cost. Law of diminishing returns has kicked in, total cost and average cost will rise (total cost curve will get steeper)
   • Five years later average costs have increased - why? Economies of scale is not working out - efficiency problem somewhere.
6. Football tickets sell for $6 and line wait is 30 mins, your job (you choose your hours) pays $8 per hour. Resale is $20
   • Opportunity cost for ticket = $6 + $8/4 = $10
   • Opportunity cost of attending game versus free-to-air TV = $20 (cost of resale)
   • If you have to work on the day of the game, should you resell? Yes, $20 - $10 = $10 profit

That was fun!

ETA: Have gone on to read lecture slides...

Long run Cost Functions:

1. All inputs are variable in the long run - how costs vary with output depends on the nature of economies of scale.
2. Every long run output point must have a corresponding short run output point.
   • because each plant size has a set of short run cost curves associated with it and the long run is the period in which we change plant size
   • scaling up means moving to bigger plant size but for each plant there are a set of short run cost curves which tell how costs change when output volume changes for that particular scale of plant

Ridiculously complicated graph that ever so slightly reminds me of Eccentrica Gallumbits, the Triple-Breasted Whore of Eroticon 6 AKA the Envelope of SAC (short-run average total cost curve) curves.

Cost Curves 

• declining LAC reflects economies of scale
• constant LAC reflects constant returns to scale
• increasing LAC reflects dis-economies of scale

Product-level economies include specialisation and learning curve effects.
Plant-level economies include choice of technology and product mix
Firm-level economies include distribution and transportation or economies in marketing, sales promotion or R&D of multi-product firms.

.off to talk about Markets...

Pure Competition (implies price = marginal cost)

• a very large number of buyers and sellers (firms are small relative to the market)
• homogeneous products (cannot charge ore than market price - identical other other products. The technical term for this is price takers, there's no point withholding supply or dropping prices, must minimise costs)
• complete knowledge of all relevant market infirmation
• free entry and exit (no barriers)

Total Revenue = Price x Quantity produced... TR = P x Q

• under pure competition, price is given for the forms and equals market price, therefore Marginal Revenue MR, is simple equal to Price P. Every additional unit sold earns the market price P.
• If P > MC, additional profit can be earned by producing more
• If P < MC then last units sold below cost and additional profit can be earned by producing less

Monopoly (implies monopoly price is well above marginal cost and super normal profits are possible)

• only one firm in market area
• low cross price elasticity with other prodtcs
• no interdependence with other competitors
• substantial entry barriers

Monopolistic Competition (implies price in the long run is equal to average cost)

• a large number of firms, some of which may be dominant in size
• differentiated products (hairdressers, cafes, restaurants)
• independent decision making by individual firms
• easy entry and exit

Oligopoly (implies uncertainty about price and profit outcomes and strategic interaction between firms)

• only a few firms in the market area
• products may be differentiation, or not
• large degree of interdependence with other competitors
• competitive advantage from
  1. lack of substitutes
  2. barriers to entrants (competitors)
  3. buyer power (threat of concentration of buyers)
  4. supplier power
  5. rivalry

Comments

[maharetr]

<3

I saw this and thought of you (well, mostly kenobi, but you too :P)