implicit costs
payments owed but not made by the firm for internally-provided inputs (i.e. family business, unpaid labor for a family member)
accounting profit
= total revenue - explicit costs - implicit costs
four basic assumptions of perfectly competitive markets
1) many buyers & many sellers, no firm or customer has market power
2) identical products, no variation in goods
3) free entry & exit, no barriers
4) perfect market information, full info about prices, product quality, production techniques, production costs
decision rule for perfectly competitve firm
continue to increase output as long as doing so doesn’t increase costs more than it increases revenue, producing where MC=MR
P*>ATC
economic profit>0, firm can cover costs with excess profit, will continue to produce
P*=ATC
economic profit=0, but shareholders are still content because they can still cover costs and continue to earn normal profit, firm will continue to produce
AVC<P*<ATC
economic proft=0, not covering all costs, so they will incur a loss, but they can still cover variable costs and part of their fixed costs, firm will continue to produce in the short-run as long as the price remains above the average variable cost
P*<AVC & ATC
economic profit=negative, the firm is no longer able to cover any costs and is no longer willing to produce in the short-run, shut down in the short run
perfectly competitive firm’s supply curve in the short-run
the portion of the SMC curve that lies above the AVC curve, therefore unaffected by a change in fixed costs bc it depends on changes in variable cost and quantity
change in the price of labor –> leftward shift due to decrease in supply given increase in price of a vital input, increase in VC
improvement in technology –> rightward shift due to increase in productivity and make it cheaper to produce
long-run equilibrium position for the perfectly competitive firm
profit=0 because price=LAC, firm is GUARANTEED to end up at the point where price=LAC=LMC,
lack of barriers to entry and exit render economic profits zero: high economic profits entice new firms into the market, shifting the supply curve rightward and lowering the market price, leading firms’ profit to decrease until hitting zero –> firms have losses and choose to exit the market, leading to a decrease in supply and shifting the supply curve leftward, increasing market price and driving up profits once more
why is the long-run market outcome from perfect competition good for society?
productively and allocatively efficient, basically price is always as low as it can be and the marginal benefit to society is the marginal cost of another unit
pure monopolist
single firm that is the solve provider of a good or service with NO CLOSE SUBSTITUTES, complete control over the market and can set its own price, WILL NOT HAVE A LONG-TERM PROFIT OF ZERO
examples of barriers to entry
legal protection, aka copyright or patenting that prevents others from being able to produce similar products or use similar processes (i.e thomas edison with the first cameras for films)
brand loyalty, customers are committed to one brand and uninterested or unwilling to buy from a different brand (i.e. rewards for united so i’m not going to fly american if i can save money with united)
government franchise, government allows for a one specific firm or company to provide a public service or utility in an area (i.e. PGE or SCEdison)
decision rule for pure monopolist
as long as P* > or = to AVC, monopolist will produce where MC=MR but charge the price that corresponds to the quantity produced at that point
difference between long-run equilibrium for a PC firm vs a monopolist
PC = economic profit is always zero while M can be positive, negative or zero, monopolists are more likely to earn profit because they set their prices above MR
why is the long-run market outcome under a monopoly socially undesirable?
consumers get both a lower quantity at a higher price and they produce deadweight to society by doing so, also it disincentivizes innovation and there’s a high probability of price-gauging
four main assumptions about the consumer and marketplace
1) consumer has complete market information and consumer choice set is well known
2) consumer is a price-taker (neither consumer nor supplier can set the price) with a known and finite income
3) consumer’s objective is to maximize utility subject to their given budget constraint
4) consumer must be able to ordinally rank all possible consumption bundles
slope of the budget line/ budget constraint curve
= -Px/Py, represents marginal cost of another unit of Good X in terms of Good Y
slope of indifference curve
= MRSxy, aka marginal benefit of another unit of Good X in terms of Good Y
indifference curve = budget constraint curve
marginal benefit=marginal cost, utility maximizing point for the consumer AKA equilibrium price and quantity
indifference curve
a locus of points in (X,Y) space that provide equal levels of utility to the consumer
properties of the indifference curve
negatively sloped, sacrificing one good for another therefore always a negative change in either rise or run
ICs cannot intersect due to transitivity
convex shape due to MRSxy or diminishing marginal rate of substitution of X for Y
MRSxy
the rate at which the consumer is willing to substitute X for Y, holding utility constant
travelling along it the slope gets flatter, displaying the diminishing marginal rate of substitution, aka it takes ever larger amounts of Good X to replace each unit of Good Y
substitution effect
given a change in price, the consumer will substitute towards the relatively cheaper good, causing an increase in quantity demanded of that good
