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What is Economics?
Economics = the study of how people use their scarce resources to satisfy their unlimited wants. How to allocate scarce resources among competing needs. The study of the production, distribution and consumption of goods and services.

Types of economics
Normative - The economics of what is. This is descriptive of fact and theory without opinion.

Micro Economics examines the factors that influence individual economic choices. Examines how markets coordinate the choices of various decision-makers Looks at specific economic unit e.g. Price of specific product, employment of specific firm, etc Macro Economics studies the performance of the economy as a whole Focuses on the big picture e.g. government, household, firms in the nation, etc.

Positive - The economics of what should be. This is economics where ones opinion is offered.

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Need, Want and Demand

Demand, Wants, and Needs

Consumer demand and wants are not the same thing Wants ignore the importance of ability to buy as expressed by a persons budget E.g. wanting expensive cars, designers clothing, long holidays, want a CAT certificate (but do not want to attend lectures or study at home), ... Nor is demand the same as need Need focuses on the willingness and again ignores the ability to purchase E.g. Need in-campus accommodation, need medical treatment, need a car, ...

Needs - A need is something you have to have, something you can't do without i.e. I am hungry, I need food. Wants - A want is something you would like to have. It is not absolutely necessary, but it would be a good thing to have. i.e. I want a hamburger, French fries, and a soft drink. Demands - Human wants backed by buying power and willingness. i.e. I have money to buy this meal.

Scarcity
There is not enough of everything that people want (and need) to go around. Some people will get things and others will not. That is a fact. The question is then, how do we determine who gets what. Scarcity is at the heart of economics. If there were no scarcity, there would be no need for economics.

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Scarcity refers to the fact that there is a limited quantity of almost all things that people want. These things are called goods. Goods are any items that are desired by people. Most goods are available in scarce quantities.

Economists assume that people act to maximize their own happiness This does not mean people are greedy some people get happiness from others happiness This happiness that economists assume people maximize is called utility We also assume all people act rationally

The reason that there is scarcity of goods (and services) is that there is scarcity of resources that are used to make goods. Resources are all the raw elements that go into the production of a good or service.

Workforce and their skills Stock of capital assets Limited natural resources

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Opportunity cost
Scarcity forces us to make choices Whenever you make a choice, you must pass up another opportunity Opportunity Cost is the next best alternative forgone when using a resource So your opportunity cost of seeing a movie might be studying or going on a date or maybe reading a book. But not all 3 -- only the one you value next best.

Utility Analysis
Utility is the sense of pleasure, or satisfaction, that comes from consumption The utility that a person derives from consuming a particular good depends on persons tastes or preferences for different goods and services likes and dislikes

Total Utility (TU) the total satisfaction that people derive from spending their income and consuming goods. Marginal Utility (MU) - the change in total utility when consumption of a good changes by one unit.

Law of Diminishing Marginal Utility -

eventually, a point is reached where the marginal utility obtained by consuming additional units of a good starts to decline, ceteris paribus.

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Utility Maximisation

Example If Im really hungry, I get a lot of satisfaction from first slice of pizza. If I keep eating pizza, the satisfaction from the 8th slice would be much less than that of the first slice.

Suppose that we have the following bits of information The price of pizza is $8 The rental price of a movie video is $4 After tax income equals $40 per week To see you income is allocated between two goods so as to maximize utility, suppose we start with some combination of pizzas and videos If we can increase utility by reallocating our expenditures we will do so, and we will continue to make adjustments as long as utility can be increased when no further utility-increasing moves are possible, we have arrived at the equilibrium combination

Pizza & Video Rentals

Marginal Marginal Utility Utility of Pizza of Videos Pizza Total Marginal per Dollar Video Total Marginal per Dollar Consumed Utility Utility Expended Rentals Utility of Utility of Expended Per Week of Pizza of Pizza (price=$8) per Week Videos Videos (price=$4) (1) (2) (3) (4) (5) (6) (7) (8) 0 1 2 3 4 5 6 0 56 88 112 130 142 150 0 1 2 3 4 5 6 0 40 68 88 100 108 114 -

Pizza & Video Rentals

Marginal Marginal Utility Utility of Pizza of Videos Pizza Total Marginal per Dollar Video Total Marginal per Dollar Consumed Utility Utility Expended Rentals Utility of Utility of Expended Per Week of Pizza of Pizza (price=$8) per Week Videos Videos (price=$4) (1) (2) (3) (4) (5) (6) (7) (8) 0 1 2 3 4 5 6 0 56 88 112 130 142 150 56 32 24 18 12 8 7 4 3 2 1 1 0 1 2 3 4 5 6 0 40 68 88 100 108 114 40 28 20 12 8 6 10 7 5 3 2 1

Suppose you start off spending your entire budget of $40 on pizza at a total utility of 142. If you give up one pizza, you free up enough money to rent 2 videos and total utility increases from 142 to 198.

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Pizza & Video Rentals

Marginal Marginal Utility Utility of Pizza of Videos Pizza Total Marginal per Dollar Video Total Marginal per Dollar Consumed Utility Utility Expended Rentals Utility of Utility of Expended Per Week of Pizza of Pizza (price=$8) per Week Videos Videos (price=$4) (1) (2) (3) (4) (5) (6) (7) (8) 0 1 2 3 4 5 6 0 56 88 112 130 142 150 56 32 24 18 12 8 7 4 3 2 1 1 0 1 2 3 4 5 6 0 40 68 88 100 108 114 40 28 20 12 8 6 10 7 5 3 2 1

Utility-Maximising Condition

Consumer equilibrium is achieved when the budget is completely spent and the last dollar spent on each good yields the same utility

MUp MUv Pv Pp
Where MUp is the marginal utility of pizza, pp is the price of pizza, MUv is the marginal utility of videos, and pv the price of videos

Reduce consumption of pizza to 3 units, you give up 18 units of utility from the 4th unit of pizza but gain a total of 32 units of utility from the 3rd and 4th videos, another utilityincreasing move Thus, by trial and error, we find that the utility-maximizing equilibrium condition is 3 pizzas and 4 videos per week, for a total utility of 212 and an outlay of $24 on pizza and $16 on videos

DEMAND AND SUPPY

Demand
Demand indicates how much of a good consumers are both willing and able to buy at each possible price during a given time period, other things constant A person who wants something he/she cannot afford does not demand the good in an economic sense; no matter how badly he/she wants it. E.g. DD for Pepsi, DD for Nissan cars, DD for child care services, DD for residential apartments, ...

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Demand Schedule & Demand Curve for Pizza

Law of Demand says that quantity demanded varies inversely with price, other things constant The higher the P, the smaller the quantity demanded The lower the P, the larger the quantity demanded E.g. the higher the fees of child care services, the lower the quantity demanded for child care services.

(a) Demand Schedule

(b) Demand Curve

Price per Pizza a) $15 b) 12 c) 9 d) 6 e) 3 Quantity Demanded per Week (millions) 8 14 20 26 32

$18 $15
Price per Pizza

$12 $9 $6 $3 $0 8

b c d e

14

20

26

32

Millions of Pizzas per week

Demand and Quantity Demanded

Demand for pizza is not a specific quantity, but rather the entire relation between price and quantity demanded, and is represented by the entire demand curve An individual point on the demand curve shows the quantity demanded at a particular price

Changes in demand
a b c d e D 8 14 20 26 32
Millions of pizzas per week

$15.00 Price per quart 12.00 9.00 6.00 3.00 0

Change in Demand - a change in the desire or means to purchase the good, thus there is a change in quantity demanded at EVERY price. Change in Demand - a shift of the demand curve A demand curve is drawn under the assumption of ceteris paribus. When this assumption is relaxed, the entire demand curves shifts

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Change in Demand vs. Change in Quantity Demanded

This is a very important distinction. In short - a change in demand is a shift in the WHOLE demand curve. People are willing to buy more (or less) at every price.

Change in Quantity Demanded (DQd) movement along a demand curve A change in quantity demanded can only be caused by a change in the price of the good. Changes in Quantity Demanded Increase in Qd - a movement to the right along a demand curve Decrease in Qd - a movement to the left along a demand curve

Increase in Demand
P

Increase in Quantity demanded

P

A B

D Qd

D Qd

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1 Changes in Consumer Income

Increase in demand - demand curve shifts to the right

Goods can be classified into 2 broad categories depending on how the demand for the good responds to changes in money income Normal goods: demand increases when income increases & decreases when income decreases
E.g. Income increase, demand for fried chicken from KFC increases.

Decrease in demand - demand curve shifts to the left

Inferior goods: demand decreases when income increases & increases when income decreases
As income increases, consumers tend to switch from consuming these goods to consuming normal goods E.g. 2nd hand car, 2nd hand clothes, re-threaded tyre

2 Changes in the Prices of Related Goods

The Price of other goods & other factors are assumed constant along a given demand curve If 2 goods are substitutes, an increase in the Price of one shifts the demand for the other rightward
Conversely, if a decrease in the Price of one shifts the demand for the other good leftward E.g. Price of margarine increase, quantity demanded for margarine will fall, demand for butter will increase.

3 Changes in Consumer Expectations If individuals expect income to increase in the future, current demand increases and vice versa
Eg If government servants expect a salary increment of 10% next year, their Demand for goods and services will increase.

If 2 goods are complements, an increase in the Price of one shifts the demand for the other leftward
A decrease in the price of one shifts the demand for the other rightward E.g. Price of PCs increase, quantity demanded for PCs will fall, demand for printers will fall.

If individuals expect prices to increase in the future, current demand increases and decreases if future prices are expected to decrease
E.g. If consumers expect the price of Proton cars will fall in 3 months time, demand for proton cars now will fall.

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4 Changes in Consumer Tastes

Tastes are a persons likes and dislikes as a consumer
Difficult to say what determines tastes but clearly they are important

5 Availability of credit If it is easier to borrow money (credit cards have lower interest rates or are easier to obtain, etc.), do you think people will buy more or less of a good at a given price? Probably more. Since people can buy things that couldnt buy before, their means have (in a sense) increased. So an increase in the availability of credit will increase demand.

And whatever factors change taste will clearly change demand

E.g. More people prefers local fruits, then the demand for local fruits will rise.

Supply
Supply indicates how much of a good producers are willing and able to offer for sale per period at each possible price, other things constant Law of supply states that the quantity supplied is usually directly related to its price, other things constant The lower the price, the smaller the quantity supplied The higher the price, the greater the quantity supplied

Supply Schedule and Curve for Pizzas

Supply Schedule Price per Pizza $15 12 9 6 3 Quantity Supplied per Week (millions) 28 24 20 16 12 Price

$15 12 9 6

Producers offer more for sale at higher prices than at lower prices the supply curve slopes upward.

3 0 12 16 20 24 28
Millions of pizzas per week

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1 Changes in Technology

2 Changes in the Prices of Relevant Resources

If the price of some relevant resource increases supply decreases shifts to the left For example, if the price of mozzarella cheese falls, the cost of pizza production declines supply increases shifts to the right

Price per quart

Suppose a new high-tech oven bakes pizza in half the time, and this cause the supply curve shifts from S to S'.

$15.00 12.00 9.00 6.00 3.00 0 12 16 20 24 28 Millions of pizzas per week

g

S'

3 Uncontrollable factors Certain industries are particularly susceptible to uncontrollable factors, such as changes in the weather
A good example is agriculture where bad whether can diminish or obliterate supply.

4 Changes in Producer Expectations

If suppliers expect higher prices in the future, they may begin to expand today current SS shifts rightward SS increases Eg If a firm expects the chicken will rise in a few months time due to Eid celebration, the firm will start to rare more chicken now.

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5 Changes in the Number of Producers

If that number increases, supply increases shifts to the right If the number of producers decreases, supply will decrease shift to the left Eg As the number of pirated VCD producers fall, the Supply of pirated VCD will fall.

6 Taxes and subsidies

Increase in tax on the good decreases supply Raises the cost of production Decrease in tax on the good increases supply Lowers the cost of production

A subsidy is an amount the paid to the producer for each unit of a good produced Increase in Subsidy on the Good Increases Supply
Lowers the costs of production

7 Availability of credit

If it is easier for the firm to borrow money, the firm will be able to produce more
Thus Supply increases

Decrease in Subsidy on the Good Decreases Supply

Raises the costs of production

If it is more difficult for the firm to borrow money, the firm will have to produce less
Thus Supply decreases

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The Market for Pizzas

Equilibrium price
Consumers want to pay as little as possible, but suppliers want to charge as much as possible. The two sides of the market have to compromise at some price between these two extremes. When the quantity that consumers are willing and able to pay equals the quantity that producers are willing and able to sell, the market reaches equilibrium

Suppose the initial Price price is $12, producers supply 24 million pizzas $15.00 per week as shown by 12.00 the supply curve while consumers demand 9.00 only 14 million excess quantity 6.00 supplied (or surplus) of 10 million pizzas per 3.00 week 0
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Surplus c

D
20 24 Millions of pizzas per week

Also called market price or market clearing price

The Market for Pizzas

Price Alternatively, suppose the price is initially $6 per pizza. At this price $15.00 consumers demand 26 12.00 million pizzas but producers supply only 16 9.00 million an excess quantity demanded (or a 6.00 shortage) of 10 million pizzas per week. 3.00

Disequilibrium Prices
S

Markets do not always reach equilibrium quickly. Disequilibrium is usually temporary as the market gropes for equilibrium However, as a result of government intervention in markets, disequilibrium can sometimes last a long time
To have an impact, a price floor must be set above the equilibrium price and a price ceiling must be set below the equilibrium price Effective price floors and ceilings distort markets in that they create a surplus and a shortage, respectively In these situations, various nonprice allocation devices emerge to cope with the disequilibrium resulting from the intervention

Shortage D
16 20 26 Millions of pizzas per week

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Effects of a Price Floor

The federal government often regulates the prices of agricultural commodities in an attempt to ensure farmers a higher and more stable income than they would otherwise earn. To achieve higher prices, the federal government sets a price floor a minimum selling price that is above the equilibrium price
$2.50 $1.90 This surplus milk will spoil if it sets on store shelves. As a result of this price support program, the government spends billions of dollars buying and storing surplus agricultural products.

Effects of a Price Ceiling

Sometimes public officials try to keep prices below the equilibrium levels by establishing a price ceiling, or a maximum selling price

S Surplus

A common example is rent control in some cities. The market-clearing rent is $1,000 per month with 50,000 apartments being rented. Now suppose the government decides to set a maximum rent of $600. At this ceiling price, 60,000 rental units are demanded, but only 40,000 are supplied (a shortage).

$1000

$600
Shortage

D
0 14 19 24 Millions of gallons per month

0 40 50 60

D
Thousands of rental units per month

CONSUMER SURPLUS AND PRODUCER SURPLUS

Consumer surplus measures the welfare that consumers derive from their consumption of goods and services, or the benefits they derive from the exchange of goods. Consumer surplus is the difference between what consumers are willing to pay for a good or service (indicated by the position of the demand curve) and what they actually pay (the market price). The level of consumer surplus is shown by the area under the demand curve and above the ruling market price Producer surplus is a measure of producer welfare. It is measured as the difference between what producers are willing and able to supply a good for and the price they actually receive. The level of producer surplus is shown by the area above the supply curve and below the market price

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CONSUMER SURPLUS AND PRODUCER SURPLUS

Elasticity
4 basic types used: Price elasticity of demand Price elasticity of supply Income elasticity of demand Cross elasticity of demand

We know, from the Law of Demand, that price and quantity demanded are inversely related. Now, we are going to get more specific in defining that relationship We want to know just how much will quantity demanded change when price changes? That is what elasticity of demand measures.

Price elasticity of demand (PED)

Elasticity of Demand (Ed) measures the responsiveness of Qd of a good to a change in its P. Ed = %D in Qd %D in P Note that D means change Also note that the law of demand implies Ed is negative. We will ignore the negative sign only when discussing elasticity of demand.

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Demand Curve for N

Take for example the calculation of the price elasticity of demand for N when the price of N increase from $1.40 to $1.60 each. Arc elasticity Price elasticity between a and b = 9.52 / 13.33 = 0.71

Categories
The price elasticity of demand can be divided into three general categories If the percent change in quantity demanded is smaller than the percent change in price, demand is inelastic quantity demanded is relatively unresponsive to a change in P If the percent change in quantity demanded just equals the percent change in price unit-elastic demand If the percent change in quantity demanded exceeds the percent change in price, demand is said to be elastic quantity is responsive to changes in price
D

$1.60 1.40

a b

ED

Point elasticity Price elasticity between a and b = 9.09 / 14.29 = 0.64

Dq (q q) / 2 Dp (p p) / 2

Price per N

0 Thousands per day 200 220

Inelastic absolute value between 0 and 1.0 unresponsive Unit elastic absolute value equal to 1.0 Elastic absolute value greater than 1.0 responsive

Constant Elasticity Demand Curves

(a) Perfectly elastic (b) Perfectly inelastic
D' Price per unit Price per unit

(c) Unit elastic

Relatively Inelastic

E D= p

Price per unit

E D= $10 6 a

E D= 0

b D" 60 100 Quantity per period

Quantity per period

Quantity per period

Relatively Elastic

Demand curve in (a) indicates consumers will demand all that is offered at the given price, p. If the price rises above p, quantity demanded drops to zero perfectly elastic demand curve.

Demand curve in (b) is vertical, quantity demanded does not vary when the price changes no matter how high the price, consumers will purchase the same quantity perfectly inelastic demand curve.

(c) shows a unit-elastic demand curve where any percent change in price results in an identical offsetting percent change in quantity demanded.

Qd

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Elasticity
If demand is price If demand is price elastic: inelastic: Increasing price would Increasing price would reduce TR (% Qd > % increase TR P) (% Qd < % P) Reducing price would Reducing price would increase TR reduce TR (% Qd < % (% Qd > % P) P)

Demand, Price Elasticity and Total Revenue

$100 90 80 70 60 50 40 30 20 10 0

(a) Demand and Price Elasticity

a b

Elastic ED > 1 Unit elastic ED = 1

c

Price per unit

Inelastic ED < 1
d e 100 200 500 D 800 900 1,000 Quality per period

Where demand is elastic, a decrease in price will increase total revenue because the gain in revenue from selling more units exceeds the loss in revenue from selling at the lower price.

(b) Total Revenue

$25,000 Total re venue

TR = p x q

Where demand is inelastic, a price decrease reduces total revenue because the gain in revenue from selling more units is less than the loss in revenue at the lower price.

Total revenue

Quantity per period

500

1,000

Determinants of Price Elasticity of Demand

1 Availability of Substitutes
The greater the availability of substitutes for a good and the closer the substitutes, the greater the goods price elasticity of demand E.g. sports shoes : Nike and Adidas Tooth paste : Colgate and close-up, etc Insulin has no substitutes if diabetic and demand is very inelastic. Habit forming goods such as cigarettes and drugs

2 Proportion of Consumers Budget The less expensive a good is as a fraction of our total budget, the more inelastic the demand for the good is (and vice versa). Example: Price of cars go up 10% (from $20,000 to $22,000) Price of box of matches goes up 10% (from $0.50 to $0.55) Demand is more effected by the price of cars increasing. Matches are bought infrequently and the price is only a very small part of total spending few people will notice the rise.

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3. Necessities vs. Luxuries The more necessary a good is, the more inelastic the demand for the good (and vice versa).
Example: Insulin

4. The importance of the good Goods, which take a small part of consumers total budget often, yield inelastic demand schedule.
If the price of table salt falls by 2% per kilo, few consumers would increase their rate of consumption of salt.

5. The time period the longer the time period the buyer can wait before effecting a repeat purchase of the good, the more elastic is the buyers demand for that good. The reason for this is that the longer time period gives the buyer more time to find and hence switch to substitute goods. Demand is more elastic in the long run than in the short run.

Other Elasticity Measures

1 Income Elasticity of Demand
The income elasticity of demand measures how responsive demand is to a change in income Measures the percent change in demand divided by the percent change in income
Goods with income elasticities less than zero (-ve) are called inferior goods demand declines when income increases
E.g. used clothing, recycled plastic containers, etc.

Normal goods have income elasticities > zero demand increases when income increases. (necessities vs luxuries)
E.g. furniture, clothing, electrical appliances, etc
Elasticity Negative Inelastic Elastic Value -ve 0-1 1 Type of goods Inferior Necessity Luxury Example Inter-city bus Basic food stuffs Yatchs, sports cars

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2 Cross Elasticity of Demand

Cross elasticity of demand is defined as the percent change in the demand of one good divided by the percent change in the price of another good. If an increase in the price of one good leads to an increase in the demand for another good, their cross-price elasticity is positive the two goods are substitutes. Eg Tea and coffee. If an increase in the price of one good leads to a decrease in the demand for another, their cross-price elasticity is negative the two goods are complements. Eg PCs and printers.
Perfect complements Complements Unrelated goods Substitutes Perfect substitutes -1 -ve 0 +ve +1

E1,2 = % D in Qd of Good 1 % D in P of Good 2 Note that the sign DOES matter for this elasticity also!

Price Elasticity of Supply

The price elasticity of supply measures how responsive producers are to a price change
The price elasticity of supply equals the percent change in quantity supplied divided by the percent change in price
If the price increases from p to p', the quantity supplied increases from q to q' The price elasticity of Es, is

Price Elasticity of Supply

S

p' p

Where D q is the change in quantity supplied and D p is the change in price.

Price per unit

Since the higher price usually results in an increased quantity supplied, the percent change in price and the percent change in quantity supplied move in the same direction the price elasticity of supply is usually a positive number

q'

Quantity per period

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Categories of Supply Elasticity

The terminology for supply elasticity is the same as for demand elasticity If supply elasticity is less than 1.0, supply is inelastic If it equals 1.0, supply is unit elastic If it exceeds 1.0, supply is elastic The next exhibit illustrates some special cases of supply elasticity to consider
(a) Perfectly elastic

Constant-Elasticity Supply Curves

(b) Perfectly inelastic (c) Unit elastic

S' Price per unit Price per unit Price per unit ES =

S" ES = 1 $10

ES = 0

Quantity per period 0

Quantity per period 0

10

20Quantity per period

At one extreme is the horizontal supply curve. Here producers will supply none of the good at a price below p, but will supply any amount at a price of p, as in (a).

The most unresponsive relationship is where there is no change in the quantity supplied regardless of the price, as shown in (b) where the supply curve is perfectly vertical.

Any supply curve that is a straight line from the origin such as shown in (c) is a unit-elastic supply curve.

Determinants of Price Elasticity of Supply

1. The existence of surplus capacity If surplus capacity exists suppliers can more easily react to price rises and supply will be more elastic. It is possible to produce more with the same quantities of labor and capital, by extending overtime, by keeping old machinery in use a little longer, or by using or making a better use of spare factory space.

2. Ease of entry into the market elasticity may be influenced by the ease with which firms can enter and leave the market. Natural barriers: There may be limited amount of land and skills so that it is difficult to increase supply. Production may be very expensive, as in the case of oil drilling for gas, so that it is possible for relatively few firms only. Artificial barriers: Large monopolies

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Importance of Elasticity
Relationship between changes in price and total revenue Importance in determining what goods to tax (tax revenue) Influences the behaviour of a firm

COST
Sunk Cost - A cost, once paid, that can never be recovered. For instance, you buy a license to sell food. Whether you sell the food or not - you have paid for this cost and can not sell it or get your money back in any way. we are always concerned with future costs and benefits since the past cannot be changed.

For instance, if you are in line at BML ATM and the other line is going faster - should you switch lines? Yes. It doesnt matter how long you have committed to one lane - your goal is to get out fastest and you pick the lane that from that moment on, will suit you best in meeting that goal. What is done - is done.

Total Fixed Cost (TFC) - costs which do not vary with output. the costs of fixed inputs (capital) Total Variable Costs (TVC) - any cost that varies with the quantity of output produced. the costs of variable inputs (labor) Total Cost (TC) - sum of all costs of production TC = total fixed costs + total variable costs

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A Firms Short Run Costs

Cost Curves for a Firm

TC
Cost 400
($ per year)

300

Total cost is the vertical sum of FC and VC.

VC

200

Variable cost increases with production and the rate varies with increasing & decreasing returns.

100 50
0 1 2 3 4 5 6 7 8 9

Fixed cost does not vary with output

FC
10 11 12 13 Output

Marginal Cost (MC) - the additional cost of producing one more unit of output. Average Variable Cost (AVC) = TVC / Q Average Fixed Cost (AFC) = TFC / Q Average Total Cost (ATC) = TC / Q

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Cost Curves
120 100
Cost ($/unit)

Summary
In the short run, the total cost of any level of output is the sum of fixed and variable costs: TC=FC+VC
MC

80 60 40 20 0 0 Output (units/yr)

Profit maximization point is when MC= MR A firm may continue to produce as long as the MR exceeds its AVC, as in doing so it will be making a contribution towards covering its fixed costs.

ATC AVC AFC

AFC is decreasing AVC and ATC are U-shaped, reflecting increasing and then diminishing returns. Marginal cost curve (MC) falls and then rises, intersecting both AVC and ATC at their minimum points.

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Short-run and long-run production decisions

In the short-run if:
TR > TVC continue production. TR = TVC normal production. TR < TVC cease production. AR = Price =VC continue production.

MARKET STRUCTURES

In the short-run AR = AVC. In the long-run AR = ATC. In the long run, a firm will only continue in production if the price at which their product is sold at least equals the average total cost of production.

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Fundamentally, there are two extremes to the market structures. At one end, is the perfect competition and the other is the monopoly.

Characteristics of Perfect Competition

Large number of buyers and sellers. Firms sell identical (homogenous) product. No barriers to entry or exit. Buyers and sellers have perfect information Firms have no say in stating prices (Price Taker)

Imperfect Competition
Pure Competition Monopolistic Competition Pure Monopoly

Oligopoly

Market Structure Continuum

Perfect Comp. is our "Benchmark" Model meaning it is not very realistic, but will be used to compare with more realistic models

DEMAND CURVE OF THE INDIVIDUAL FIRM

Imperfect Market
Imperfect competition is a market situation where individual firms have a measure of control over the price of the commodity in an industry.
a firm that can affect the market price of its output can be classified as an imperfect competitor. Normally, imperfect competition arises when an industry's output is supplied only by one, or a relatively small number of firms.

Under perfect competition the firm is a price taker. The demand curve for the firm is horizontal so that the price equals AR which is the same as MR.

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Imperfect Market
An imperfect market is a situation where individual firms have some measure of control or discretion over the price of the commodity in an industry
This imperfect competition does not necessarily mean that a firm can arbitrarily put any price on its commodity an imperfect competitor does not have absolute power over price

Forms of imperfect competition

Monopoly Oligopoly Duopoly Monopolistic competition

Aside from discretion over price, imperfect competitors may or may not have product differentiation/variation

MONOPOLY
Monopoly exists when one producer supplies the entire market. One large seller and many potential buyers. No close substitutes exist. High barriers to entry such as economies of scale, legal protection etc The firm is a price setter(and thus quantity taker) or a quantity setter (and price taker) Long-run supernormal profits (due to the barriers to entry) and subjected to regulations by government and NGOs

Types of Monopoly
Pure monopoly industry is the firm! Actual monopoly where firm has >25% market share Natural Monopoly high fixed costs gas, electricity, water, telecommunications, rail

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Monopolistic Competition

Oligopoly
1 Relatively Large Numbers: Small market share, No

collusion & Independent actions

2 Product Differentiation: Product Attributes, Services,

Location, Brand Names and Packaging

3 Easy Entry and Exit: Firms are free to set up

business.
4 Non-price Competition Advertising: Each

monopolistic firm differentiates its products through advertisements

Few large firms dominate the market. They may produce homogeneous product (oil). Cartels often form. (OPEC) Complex use of product differentiation, barriers to entry and high level of influence on prices in the market Interdependence of firms i.e. how their rivals will react. 2 to 6

Duopoly
Two usually large firms dominate. Each producer has some control over price and output, but most consider the possible reactions of the competitor firm. Duopolists, like oligopolist, can act competitively or collusively. Extensive non-price competition exists
Type of market Perfect competition Monopolistic competition

Features of the four market structures

Number of firms Freedom of entry Nature of product Examples Implications for demand curve faced by firm Horizontal: firm is a price taker Downward sloping, but relatively elastic Downward sloping. Relatively inelastic (shape depends on reactions of rivals) Downward sloping: more inelastic than oligopoly. Firm has considerable control over price

Very many Many / several

Unrestricted

Homogeneous (undifferentiated)

Cabbages, carrots (approximately) Plumbers, restaurants Cement cars, electrical appliances Local water company, gas and electricity in many countries

Unrestricted

Differentiated

Undifferentiated Oligopoly Few Restricted or differentiated

Monopoly

One

Restricted or completely blocked

Unique

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