What’s this unit about
How a profit max firm producing differentiated products interacts with its customers and decides what quantity to produce.
Profit max point 1
where MRS of feasible set (demand curve) meets MRT of isoprofit curve.
Larger firms tend to produce output at lower cost per unit due to
economies of scale/ increasing returns to scale.
Dilbert law of firm hierarchy theory
- built in DEoS, as increasing number of production workers will need increase in layers of management. Therefore increasing production workers requires more than a proportional increase in supervision and management.
- Only way to increase inputs proportionally would be to reduce intensity of supervision = less productive.
Maths for Dilbert law of firm hierarchy DEoS
- if every 10 employees at a lower level must have a supervisor at a higher level, then firm has 10^X production workers will have x levels of management, 10^x/10 = 10^x-1 supervisors at the lowest level
Opportunity cost of capital
amount of income investor could’ve received by investing the unit of capital elsewhere.
Diminishing marginal returns in cost reductions
As Q rises, TC rises and firm needs to employ more production workers, but over time as TC rises and Q rises, AC falls as Q rises at a faster rate. This is until a particular point, when MC = AC, and then after this cost minimising point, there will be decreasing returns to scale and when production increases past this point, AC rises.
P and MC and isoprofit curves relationship
- Isoprofit curves slop down at points where p>mc
- Isoprofit curves slope up at points where p< mc
Let’s say Q is increased from 20 to 21, revenue changes for 2 reasons:
- Extra car sold at the new price, but since new price is lower at Q= 21, loss of, in this case £80, on each of the other cars
- Gain in revenue as now 21 x new price
Therefore MR = 21x(new price) - 20(old price - new price)
At some point, the gain on the extra car is outweighed by the loss on the others, so the MR< 0
MR and MC relationship
For MR>MC at any value of Q, revenue from selling an extra car greater than the cost of making that car, for MC>MR every new car produced would lose profit as cost of new car outweighs revenue from new cars. So produce at MC=MR
Point E - the allocation in a price setting market is where isoprofit curve meets demand curve and MC = MR.
- what’s it Pareto efficiency?
Point E is not Pareto efficient, as you can make a Pareto improvement by selling a 33rd car for a bit less than 5440.
- MC = AR is the Pareto efficient point.
- The movement from E to F is not a Pareto improvement as PS is likely lower, and it is on a lower isoprofrit curve, but the position F itself is the Pareto efficient point
What’s the DWL
Since the firm will choose E, there is a loss of potential societal surplus which is our DWL.
How does PED affect firm decisions?
- Firm would never choose point where demand curve is inelastic, because MR is negative there, it would be better to decrease Q always, to raise revenue and decrease costs.
- So firm always chooses point where elasticity greater than
The lower the PED
More the firm will raise price above marginal = higher profit margin/ markup on products
- when demand is elastic, can not increase price by too much or they will decrease demand by a lot, so deadweight loss is much lower, much bigger reduction in total societal surplus.
What else is PED useful for
Tax makers to see effects of implementation of a tax.
Market failure =
when an outcome results in a Pareto inefficient allocation.
Monopoly rents =
form of economic profits which arise due to restricted completion in selling a firm’s product. E.g. luxury car
Firm will be in strong position if
there are few firms producing close substitutes for its own brand = more inelastic = more market power = more bargaining power.
Competition policy:
- Market power allows high prices and profits for firms at the expense of consumers.
- Or they collude to keep prices high
Why does AC fall and then rise again?
Economies of scale/ increasing returns to scale and then diseconomies of scale/ decreasing returns to scale.
What is MC?
How much it costs to increase output by one unit at a given point.
- meets AC at its bottom
Why does MC = AC at bottom of AC
So when MC<AC, every extra unit to produce costs less than the current AC so AC falls.
When MC>AC every extra unit to produce costs more than the current AC so AC rises.
- so only place AC is not decreasing or increasing is when AC = MC, is at the stationary, i.e minimum point
What is isoprofit curve
Combinations of price and quantity of good which gives same level of profit.
- firms want to be on highest isoprofit curve
Profit = TR - TC
= PQ - C(Q)
Therefore as isoprofit is constant
K = PQ-TC
P = K/Q + TC/Q
P = AC + K/Q
If we set k = 0, P=AC is the zero profit curve
