JOHN HICKS
IS/LM
INVESTMENT
SAVINGS /
LIQUIDITY
MONEY SUPPLY
CONSUMER
DEMAND THEORY
MODERN ECONOMY
RESOURCE
https://www.youtube.com/watch?v=
3_lmd4XH-a4
BREAK
BRANCHES OF ECONOMICS:
MICROECONOMICS AND
MACROECONOMICS
V.S.
ECONOMIC WAY OF
THINKING???
FIND A SOLUTION, THINK LIKE AN
ECONOMIST. FIGHT SCARCITY.
ROLE OF MARKET IN ALLOCATION
OF RESOURCES
PLACE OF
TRANSACTION
WHERE BUYERS
AND SELLERS
MEET
SCARCITY
Scarcityis the fundamental
economic problem of having
seemingly unlimited human wants in
a world of limited resources. It states
that society has insufficient
productive resources to fulfill all
human wants and needs.
SCARCITY is the term economists use to
describe the phenomenon that people want
more of a commodity than is freely available.
Commodities include the physical goods
(automobiles, houses, and handbags) and
services (haircuts, airplane rides, and lawn
mowing) that households buy. Commodities
also include resources such as peoples work
effort, raw materials, and the land that is
used to produce the households products.
PRODUCTION POSSIBILITIES FRONTIER identifies
the combinations of commodities that may be produced from
scarce resources.
Movement along the production
possibilities illustrates a trade-of
between commodities.
Remember opportunity cost.
SOURCE
http://agr.mt.gov/agr/Programs/AgCl
assroom/LessonPlans/4-6/pdf/Economi
cs_x_Ag/Scarcity.pdf
FACTORS OF PRODUCTION ARE THOSE RESOURCES
WHICH ENABLE MAN TO PRODUCE GOODS AND
SERVICES.
LAND - Good quality and availability of land and
water resources is essential to food security.
LABOR refers to productive human effort.
CAPITAL resources include wide variety of
production equipment from simplest tool to the
most powerful computer network and from the
smallest storage shed to the largest factory or office
or building.
ENTREPRENEUR The inputs of manpower,
materials, machineries and money do not by
themselves ensure growth; they become productive
through the catalyst of management.
SCARCE RESOURCES. WHY?
DEMOGRAPHIC
PRESSURES
CLIMATE CHANGE
INCREASED
COMPETITION IN
LAND AND WATER
FINANCIAL CRISIS
HIGH CRIME RATES
POOR
MANAGEMENT
LACK OF
QUALIFICATIONS
OFWS
LACK OF
ENTERPRENEURAL
SKILLS
SOURCES
http://www.ijhssnet.com/journals/Vol
_4_No_6_April_2014/16.pdf
http://www.cfee.org/en/pdf/labourstu
dent1.pdf
http://www.fao.org/docrep/017/i1688
e/i1688e.pdf
http://www.henrygeorge.org/pdfs/dec
ons.pdf
REMINDER
DO NOT JUST RELY ON THE POWER
POINT.
READ LIBRARY BOOKS AND VISIT THE
NET.
BY THIS TIME, EVERYONE SHOULD
HAVE ALREADY CHOSEN an
ECONOMIST. (LOCAL or FOREIGN)
FORMAT
Title Page
Introduction ( this should explain why you have
chosen your economist )
I. Biography with picture
II. Background in Economics ( how and why he
became an economist )
III. Works and Publications ( it should have a
summary and discuss how it contributed to the
study of economics and how it helped the society
)
IV. Summary
ROAD MAP
The allocation of scarce resources takes place
largely in the market which is not so much a place
as an arrangement between people wanting to sell
goods or services and those who want to buy from
them and who have agreed means of exchange,
such as money. The market is governed by the
laws of supply and demand. Supply is the amount
of a commodity that producers will supply at a
certain price and demand is the amount people are
willing to buy at a given price. Producers can be
put an accurate price on the goods they sell by
analysing supply and demand.
HOW DO WE ALLOCATE OUR
LIMITED RESOURCES?
44
Scarcity and Individual
Choice
Unlimited variety of scarcities, based
on two basic limitations:
1. Scarce time
Limited number of hours in each day to
satisfy our desires
2. Scarce spending power
Cannot afford to buy more of the things
we want
45
Scarcity and Individual
Choice
Limitations force each of us to make
choices
Economists study
Choices
Consequences of those choices
Indirect effects of individual choice on
our society
46
Scarcity and Social Choice
Society faces a scarcity of resources
Categories of resources:
Labor
Capital
Human capital
Capital stock
Land/natural resources
Entrepreneurship
47
Scarcity and Economics
Problems studied in economics: the
scarcity of resourcesand the
choices it forces us to make
Households have limited income to
allocate among goods and services
Firms production is limited by costs of
production
Government agencies the budget is
limited, so goals must be carefully
chosen
48
Scarcity and Economics
Economists study the decisions made
by households, firms, and
governments to
Explain how our economic system
operates
Forecast the future of our economy,
Suggest ways to make that future even
better
49
Microeconomics
Micro comes from the Greek word
mikros, meaning small
Studies the behavior of individual
households, firms, and governments
Choices they make
Interaction in specific markets
Focuses on individual parts of an
economy
50
Macroeconomics
Macro comes from the Greek word
makros, meaning large
Studies the behavior of the overall
economy
Focuses on big picture and ignores
fine details
51
Positive and Normative
Economics
Positive economics: how the
economy works
Can be true or false
Can be tested by looking at the facts
Normative economics: what should
be
Value judgments, identify problems, and
prescribe solutions
Cannot be proved or disproved by the
52
facts alone
Why Economists Disagree
The difference of opinion may be
positive in nature
Facts are being disputed
The disagreement can be normative
Facts are not being disputed
When economists have different
values, they may arrive to different
conclusions
Disagreement - over goals and
53
values
Why Study Economics
To understand the world better
Global events and personal phenomena
To achieve social change
Understand the origins of social
problems
Design more effective solutions
54
Why Study Economics
To help prepare for other careers
A wide range of careers deal with
economic issues on many levels
To become an economist
Develop a body of knowledge that could
lead you to become an economist in the
future
55
The Methods of Economics
Use economic models to develop
economic theories
Economic models are built with
words, diagrams, and mathematical
statements
Economic models
Abstract representation of reality
Should be as simple as possible to
accomplish its purpose
56
ECONOMIC SECTORS
1. HOUSEHOLDS
2. BUSINESS FIRMS
3. GOVERNMENT/PUBLIC SECTOR
4. EXTERNAL SECTOR
ECONOMIC PROCESSES AND
ECONOMIC QUESTIONS
1. What is to be produced?
2. How much is to be produced?
3. How is it to be produced?
4. Who is to receive the goods/service
produced?
5. How should the system be adaptive
to change?
ECONOMIC GOOD vs FREE
GOOD
Free Goods and Services are those
that can be demanded without the
need for a monetary exchange
Exchange Goods are scarce, those
that demand monetary exchange
CIRCULAR FLOW OF GOOD AND
SERVICES
Circular flow in final goods and services model
illustrates how the transfer of goods and
services can be facilitated through the
linkages with the different sectors comprising
the economy.
- All sectors configure to maintain and sustain
exchange activity
- Observe how the economy can attain the
maxim that Total leakages must equal total
injections.
THE CIRCULAR FLOW in a TWO-
SECTOR MODEL
Economic Models: Assumptions and
Conclusions
62
The Three Step Process
Economists follow the same three-
step process to analyze almost any
economic problem:
The first two steps explain how
economists build an economic model
The last step explains how they use the
model.
63
Math, Jargon, and Other Concerns
Economic jargon
Special words that allow economists to
more precisely express themselves
Math
High school level algebra and geometry
We will covers some of the basic
math concepts that you will need
tomorrow
64
DEMAND
VS
DEMAND
THE LAW OF DEMAND
PRICE FALLS
Ceteris Paribus
PRICE RISES
METHODS OF DEMAND
ANALYSIS
DEMAND SCHEDULE - Information provided by a
demand schedule can be used to construct a demand
curve showing the price-quantity demanded
relationship in graphical form.
= -
Road Map
The Basic Decision-Making
Units
A firm is an organization that transforms
resources (inputs) into products
(outputs). Firms are the primary
producing units in a market economy.
An entrepreneur is a person who
organizes, manages, and assumes the
risks of a firm, taking a new idea or a
new product and turning it into a
successful business.
Households are the consuming units in
an economy.
The Circular Flow of Economic
Activity
A change in demand is
not the same as a change
in quantity demanded.
In this example, a higher
price causes lower
quantity demanded.
Changes in determinants
of demand, other than
price, cause a change in
demand, or a shift of the
entire demand curve, from
DA to DB.
A Change in Demand Versus a Change in
Quantity Demanded
Change in demand
(Shift of curve).
The Impact of a Change in
Income
Higher income Higher income
decreases the demand increases the demand
for an inferior good for a normal good
The Impact of a Change in the
Price of Related Goods
Demand for complement good
(ketchup) shifts left
A change in supply is
not the same as a
change in quantity
supplied.
In this example, a higher
price causes higher
quantity supplied, and
a move along the
demand curve.
In this example, changes in determinants of supply, other
than price, cause an increase in supply, or a shift of the
entire supply curve, from SA to SB.
A Change in Supply Versus
a Change in Quantity Supplied
Change in supply
(Shift of curve).
From Individual Supply
to Market Supply
The supply of a good or service can be
defined for an individual firm, or for a
group of firms that make up a market or
an industry.
Market supply is the sum of all the
quantities of a good or service supplied
per period by all the firms selling in the
market for that good or service.
Market Supply
As with market demand, market
supply is the horizontal summation
of individual firms supply curves.
Market Equilibrium
The operation of the market
depends on the interaction
between buyers and sellers.
An equilibrium is the
condition that exists when
quantity supplied and quantity
demanded are equal.
At equilibrium, there is no
tendency for the market price
to change.
Market Equilibrium
Only in
equilibrium is
quantity
supplied equal
At any price level
to quantity
other than P0, the
demanded.
wishes of buyers
and sellers do not
coincide.
Market Disequilibria
Excess demand, or
shortage, is the
condition that exists
when quantity
demanded exceeds
quantity supplied at
the current
When quantityprice.
demanded
exceeds quantity
supplied, price tends to
rise until equilibrium is
restored.
Market Disequilibria
Excess supply, or
surplus, is the
condition that exists
when quantity
supplied exceeds
quantity demanded at
the current price.
When quantity supplied
exceeds quantity
demanded, price tends to
fall until equilibrium is
restored.
Increases in Demand and
Supply
Qd2 y2 y1
Qd1 =
= --------------
-------------- y1 + y2
Qd1 +
Qd2 -------------
2
It will help the seller see how
consumers perceive goods he is
selling. Are they luxurious? Necessary?
Or Just Common?
Exercise
Georgina earns a monthly Every month, Tembong
salary of Php 5000 and earns Php5000 as a fish
she consumes Php1000 ball vendor. During this
worth of chicken per period, he also consumes
month. When her income Php100 worth of tuyo.
increased by When his income
Php2500/month, she increases by Php2500, he
started to consume began lessening his
Php2000 worth of chicken consumption of tuyo to
meat a month. Is Chriss Php50. From the given, is
demand for chicken tuyo normal, inferior, or
meat, normal, inferior, common good for
necessity or luxury? Tembong?
Consumer Behaviour
Product Concept
Selling Concept
Marketing
Concept
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The Production Concept
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The Product Concept
Myopia
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1-142
The Selling Concept
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Business Leaders Who
Understood Consumer Behaviour
Alfred Sloan, General Motors
Colonel Sanders, KFC
Ray Kroc, McDonalds
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Implementing the
Marketing Concept
Consumer Research
Segmentation
Targeting
Positioning
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Segmentation, Targeting, and
Positioning
Segmentation: process of
dividing the market into subsets
of consumers with common
needs or characteristics
Targeting: selecting one ore more
of the segments to pursue
Positioning: developing a distinct
image for the product in the
mind of the consumer
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Successful Positioning
Communicating the benefits of
the product, rather than its
features
Communicating a Unique Selling
Proposition for the product
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The Marketing Mix
Product
Price
Place
Promotion
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The Societal Marketing
Concept
All companies prosper when
society prospers.
Companies, as well as
individuals, would be better off
if social responsibility was an
integral component of every
marketing decision.
Requires all marketers adhere
to principles of social
responsibility.
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1-150
Digital Revolution in the Marketplace
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Digital Revolution in the
Marketplace - Continued
The exchange between consumers
and marketers has become more
interactive
May affect the way marketing is done
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Changes brought on by the digital
revolution
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Changes brought on by the digital revolution -
continued
Revamping distribution
systems
Direct distribution becomes more of
an option
Pricing methods may need to
be re-evaluated
Comparison shopping made easier
Consumer research methods
may change
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web-based
Why study consumer
behaviour?
Understanding consumer
behaviour will help you become
better marketers as it is the
foundation for
Segmenting markets
Positioning products
Developing an appropriate marketing
continued
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Why study consumer
behaviour?
Knowledge of consumer
behaviour is essential for non-
profit organizations
Non profits have different
customers to please
Donors, users, volunteers, general
public, government
continued
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Why study consumer
behaviour?
Public service initiatives have to
be based on an understanding of
consumer behaviour
Canadas largest advertiser is the
federal government
Most government initiatives (e.g.,
antismoking campaigns) need a
knowledge of consumer behaviour
to succeed
continued
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Why study consumer
behaviour?
Better understanding of our own
consumption behaviour
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Consumer Behavior and
Utility Maximization
4 Key Concepts
1. Understanding Utility: Total and
Marginal
2. Utility Maximization: Equalizing
Marginal Utility per Dollar (MU/PA =
MU/PB)
3. Individual and Market Demand Curves
4. Income and Substitution Effects
(review from unit two)
Introduction
The CONSUMER is essential to the
market. Understanding how the
consumer makes his/her purchasing
decisions is key.
1. Understanding Utility
Utility =
Satisfaction/Happiness/Pleasure one
gets from consuming a good.
Utility and usefulness are NOT
synonymous in economics.
Utility is difficult to quantify, as it
differs between people and situations
ie. A blanket to a person living in Arizona
vs. a person living in Minnesota.
Measured in utils (a personal
1. Understanding Utility
Total Utility (TU)
Total amount of satisfaction or pleasure
a person derives from consuming a
given quantity of that product
Marginal Utility (MU)
The extra satisfaction a consumer
derives from one additional unit of that
product.
In other words, the change in Total
Utility that results from the consumption
of one more unit
Law of Diminishing Marginal Utility
30
0 0
1 10
] 10 10
2 18
] 8
3 24 ] 6 0 1 2 3 4 5
Units Consumed Per Meal
6 7
] 4
6 30 ] 0 8
6
7 28 ] -2 4
2
0
-2 MU
1 2 3 4 5 6 7
Units Consumed Per Meal
2. Utility Maximization
Explains how consumers allocate their
money incomes among the many
goods and services available for
purchase
You will be faced with problems that
provide you with a consumers MU or
TU derived from purchasing 2 goods.
You will be expected to show how
many of each a rational consumer
would purchase.
Theory of Consumer Behavior
Numerical Example:
Find the Utility-Maximizing Combination of
A and B, if you have an Income of $10
(2) (3)
Product A: Product B:
Price = $1 Price = $2
(b) (b)
(a) Marginal (a) Marginal
(1) Marginal Utility Marginal Utility
Unit of Utility, Per Dollar Utility, Per Dollar
Product Utils (MU/Price) Utils (MU/Price)
First 10 10 24 12
Second 8 8 20 10
Third 7 7 18 9
Fourth 6 6 16 8
Fifth 5 5 12 6
Sixth 4 4 6 3
Seventh 3 3 4 2
Theory of Consumer
NumericalBehavior
Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(2) (3)
Product A: Product B:
Price = $1 Price = $2
(b) (b)
(a) Marginal (a) Marginal
(1) Marginal Utility Marginal Utility
Unit of Utility, Per Dollar Utility, Per Dollar
Product Utils (MU/Price) Utils (MU/Price)
First 10 10 24 12
Second 8 8 20 10
Third 7 7 18 9
Compare Marginal
Fourth 6 Utilities
6 16 8
Then Compare
Fifth 5 Per Dollar
5 - MU/Price
12 6
Choose the4Highest4
Sixth 6 3
Check Budget
Seventh 3 - Proceed
3 to Next
4 Item2
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(2) (3)
Product A: Product B:
Price = $1 Price = $2
(b) (b)
(a) Marginal (a) Marginal
(1) Marginal Utility Marginal Utility
Unit of Utility, Per Dollar Utility, Per Dollar
Product Utils (MU/Price) Utils (MU/Price)
First 10 10 24 12
Second 8 8 20 10
Third 7 7 18 9
Again,
Fourth Compare
6 Per6 Dollar - 16
MU/Price8
Choose
Fifth the5Highest5 12 6
Buy
Sixth One of 4Each Budget
4 Has6 $5 Left
3
Proceed
Seventh to 3Next Item
3 4 2
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(2) (3)
Product A: Product B:
Price = $1 Price = $2
(b) (b)
(a) Marginal (a) Marginal
(1) Marginal Utility Marginal Utility
Unit of Utility, Per Dollar Utility, Per Dollar
Product Utils (MU/Price) Utils (MU/Price)
First 10 10 24 12
Second 8 8 20 10
Third 7 7 18 9
Fourth 6 6 16 8
Again,
Fifth Compare
5 Per5 Dollar - 12
MU/Price6
Buy
Sixth One More
4 B Budget
4 Has6 $3 Left
3
Proceed
Seventh to 3Next Item
3 4 2
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(2) (3)
Product A: Product B:
Price = $1 Price = $2
(b) (b)
(a) Marginal (a) Marginal
(1) Marginal Utility Marginal Utility
Unit of Utility, Per Dollar Utility, Per Dollar
Product Utils (MU/Price) Utils (MU/Price)
First 10 10 24 12
Second 8 8 20 10
Third 7 7 18 9
Fourth 6 6 16 8
Fifth 5 5 12 6
Again,
Sixth Compare
4 Per4 Dollar - MU/Price
6 3
Buy One of 3Each 3Budget Exhausted
Seventh 4 2
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(2) (3)
Product A: Product B:
Price = $1 Price = $2
(b) (b)
(a) Marginal (a) Marginal
(1) Marginal Utility Marginal Utility
Unit of Utility, Per Dollar Utility, Per Dollar
Product Utils (MU/Price) Utils (MU/Price)
First 10 10 24 12
Second 8 8 20 10
Third 7 7 18 9
Fourth 6 6 16 8
Fifth 5 5 12 6
Final Result At These Prices,
Sixth 4 4 6 3
Purchase 2 of Item A and 4 of B
Seventh 3 3 4 2
Theory of Consumer Behavior
Algebraic Restatement:
MU of Product A MU of Product B
Price of A
= Price of B
8 Utils 16 Utils
$1
= $2
Unit MU Unit MU
1 20 1 30
2 10 2 20
3 6 3 15
4 3 4 5
5 1 5 -5
Two-Good Practice Problem
Given TU, and an income/budget
constraint of $9 find the Utility-
Maximizing Combination of A and B
(2) (3)
Product A: Product B:
Price = $2 Price = $1
Unit TU Unit TU
1 22 1 10
2 32 2 16
3 40 3 20
4 46 4 22
5 48 5 20
The Problem with Utils
Answer the following problem:
If Henry derives 5 utils from the 1st
candy bar, 3 utils from the 2nd candy
bar, 0 utils from the 3rd candy bar,
and -5 utils from the 4th candy bar
How many candy bars should Henry
consume if each candy bar
Is absolutely free (MC = 0)
Costs $2
Costs $4
From Utils to Benefit
Because Utils cannot be compared
between people, and cannot be
compared to dollars economists
must measure satisfaction in Benefit.
Benefit is the same concept as utility, but
it is measured in dollars (according to the
consumers WILLINGNESS TO PAY.
Total Benefit ($), Marginal Benefit ($)
Golden Rule of Consumption
A rational consumer will continue to
purchase until
MB = MC
To consume one more would mean your
marginal cost is greater than your
marginal benefit
3. Individual and Market Demand
Curves
Start with an individual consumer
maybe you, maybe me, but could be
anyone
Derive demand curve for that
individual
focus on marginal utility or marginal
benefit
Add up demand curves for many such
individuals to get market demand
curve
Assumption about consumer behavior
General economic
principle
People When applied to
make purposeful the behavior of
choices consumers
with limited People
resources maximize utility
subject to a
budget constraint
3. Individual and Market Demand
Curves
Consider all consumers in the market
Add up quantity demanded by all
individuals at each price to get market
demand
Add horizontally to create market
demand curve
05_06 PRICE PRICE
(DOLLARS) (DOLLARS)
5 5
4 4
3
Pete's
3
Ann's
2 demand 2 demand
curve curve
1 1
0 1 2 3 4 5 0 1 2 3 4 5
QUANTITY DEMANDED QUANTITY DEMANDED
BY PETE (POUNDS) BY ANN (POUNDS)
PRICE
(DOLLARS)
2 Market
demand
1 curve
0 1 2 3 4 5 6 7 8 9 10
QUANTITY DEMANDED
IN MARKET (POUNDS)
4. Substitution and Income
Effects
This topic on the AP Course Outline
was already covered in unit 2.
To review, just remember that both of
these effects help to explain why the
demand curve slopes downward.
Review Questions Utility
Which of the following factors contributes to a
downward-sloping demand curve?
I. The income effect
II. The substitution effect
III. Diminishing marginal utility
A. I only
B. III only
C. I and II only
D. II and III only
E. I, II, and III
Review Questions Utility
Price of Product B
Price Per Quantity
Unit of B Demanded
$2 4
1 6 1
Income Effects DB
Substitution Effects0 4 6
Quantity Demanded of B
Four Market Structures
The focus of this lecture is the four market structures. Students will learn the
characteristics of pure competition, pure monopoly, monopolistic competition, and
oligopoly.
OBJECTIVES
1. Identify various market structures and their characteristics.
2. Be able to categorize firms into four market structures.
3. Describe the effects of imperfect competition upon the market and the firm.
4. Understand the pricing structure of the four structures.
TOPICS
Please read all the following topics.
PERFECT COMPETITION
PERFECT COMPETITION CONT.
PERFECT COMPETITION EXAMPLE
PURE MONOPOLY
MONOPOLY EXAMPLE
PRICE DISCRIMINATION
MONOPOLISTIC COMPETITION
OLIGOPOLY
TECHNOLOGICAL DEVELOPMENT
ECONOMIC EFFICIENCY
Perfect Competition
Pure or perfect competition is rare in the real world, but the model is important
because it helps analyze industries with characteristics similar to pure competition.
This model provides a context in which to apply revenue and cost concepts
developed in the previous lecture. Examples of this model are stock market and
agricultural industries.
Characteristics
1. Many sellers: there are enough so that a single sellers decision has no impact
on market price.
2. Homogenous or standardized products: each sellers product is identical to its
competitors.
3. Firms are price takers: individual firms must accept the market price and can
exert no influence on price.
4. Free entry and exit: no significant barriers prevent firms from entering or leaving
the industry.
Demand
The individual firm will view its demand as perfectly elastic. A perfectly elastic
demand curve is a horizontal line at the price. The demand curve for the industry is
not perfectly elastic, it only appears that way to the individual firms, since they
must take the market price no matter what quantity they produce. Therefore, the
firms demand curve is a horizontal line at the market price.
Marginal revenue (MR) is the increase in total revenue resulting from a one-unit
Profit-Maximizing Output
Short Run Analysis
In the short run, the firm has fixed resources and maximizes profit or minimizes loss by adjusting
output. Firms should produce if the difference between total revenue and total cost is profitable (EP
>0), or if the loss is less than the fixed cost (EP>- FC). The firm should not produce, but should shut
down in the short run if its loss exceeds its fixed costs. By shutting down, its loss will just equal
those fixed costs. Fixed cost in real life would be rent of the office, business license fees, equipment
lease, etc. These cost would have to be paid with or without any output. Therefore, fixed cost would
be the loss of shut down at any time. If by producing one unit of output, this loss could be lowered,
then this unit should be produced to minimize the loss. However, if by producing one unit of output,
this loss would be higher , then this unit should not be produced. The firm should shut down, just
pay for the fixed cost.
If EP< - FC firm should shut down. Then its lost will be the Fixed cost. EP = - FC. In order for EP < -
FC, market price, P, must be lower than the minimum AVC.
If EP> - FC, firm should produce. That is when market price is greater than minimum AVC.
Marginal revenue and marginal cost (MC) are compared to decide the profit-maximizing output.
If MR > MC, then the firm should continue to produce.
If MR = MC, then the firm should stop producing the additional unit. As the additional units MC
would be higher according to law of diminishing returns, MR would be less than MC; that is, the firm
would loss profit by producing additional units. Therefore, this is the profit maximizing output level.
If MR < MC, then the firm should lower its output.
In conclusion:
The shutdown point is the level of output and price at which the firm just covers its total variable
cost. If the MR of the product is less than the minimum average variable cost (min AVC), the firm
will shut down because this action minimizes the firms loss. In this case, the firms economic loss
equals its total fixed costs. If MR < min AVC, then each additional unit produced would increase the
loss. For pure competition, MR is equal to price as the firm is facing a perfectly elastic demand.
Therefore, for short run, if Price < min AVC, then the firm should shut down. If Price > min AVC,
then the firm should produce. Price and MC are compared to find the profit maximizing or loss
minimizing output level. The supply curve of the pure competition firms would be the portion of the
Perfect Competition Cont.
Following the rules discussed in the previous section. Here is an example.
If market price is 50 which is less than min AVC, the firm would loss $5 more by producing each
unit. If the firm produces one unit, its total loss would be $5 plus $100 fixed cost. If the firm decides
to shut down, its loss would be only $100 as the firm does not need to pay for the variable cost.
Shut down would be the loss minimization strategy.
If the market price is 60, the firm would lose $5 less by producing each unit. If the firm produces
one unit, its total cost would be fixed cost less $5, which is $95. The firm is better off by producing,
not shutting down. When the market price is higher than the minimum AVC, MR and MC should be
compared to find out the optimal level of output.
In long run, if economic profits are earned, firms enter the industry, which increases the market
supply, causing the product price to go down. Until zero economic profits are earned, then the
supply will be steady. If losses are incurred in the short run, firms will leave the industry which
decreases the market supply, causing the product price to rise until losses disappear. This model is
Efficiency Analysis
1. Productive efficiency: occurs where P= min ATC. Perfect
competitive firms will achieve productive efficiency as firms must
use the least-cost technology or they won't survive.
1 60 45 105 45
2 30 42.5 72.5 40
3 20 40 60 35
4 15 37.5 52.5 30
5 12 37 49 35
6 10 37.5 47.5 40
7 8.57 38.57 47.14 45
8 7.5 40.63 48.13 55
9 6.67 43.33 50 65
10 6 46.5 52.5 75
Characteristics
1. A single seller: the firm and industry are synonymous.
2. Unique product: no close substitutes for the firms product.
3. The firm is the price maker: the firm has considerable control over the price because it can
control the quantity supplied.
4. Entry or exit is blocked.
Barriers to Entry
Economies of scale is the major barrier. This occurs where the lowest unit cost and, therefore, low
unit prices for consumers depend on the existence of a small number of large firms, or in the case
of monopoly, only one firm. Because a very large firm with a large market share is most efficient,
new firms cannot afford to start up in industries with economies of scale. Public utilities are known
as natural monopolies because they have economies of scale in the extreme case. More than one
firm would be inefficient because the maze of pipes or wires that would result if there were
competition among water companies or cable companies. Legal barriers also exist in the form of
patents and licenses, such as radio and TV stations. Ownership or control of essential resources is
another barrier to entry, such as the professional sports leagues that control player contracts and
leases on major city stadiums. It has to be noted that barrier is rarely complete. Think about the
telephone companies a couple decades ago; there was no substitute for the telephone. Nowadays,
cellular phones are very popular. It creates a substitute for your house phone, causing the
traditional telephone companies to lose their monopoly position.
Demand Curve
Monopoly demand is the industry or market demand and is therefore downward sloping. Price will
exceed marginal revenue because the monopolist must lower price to boost sales and cannot price
discriminate in most cases. The added revenue will be the price of the last unit less the sum of the
Profit Maximizing Output & Efficiency
Profit Maximizing Output:
The MR = MC rule will still tell the monopolist the profit maximizing output. The monopolist
cannot charge the highest price possible, it will maximize profit where TR minus TC is the greatest.
This depends on quantity sold as well as on price.
The monopolist can charge the price that consumers will pay for that output level. Therefore, the
price is on the demand curve. Losses can occur in monopoly, although the monopolist will not
persistently operate at loss in the long run.
Monopolies will sell at a smaller output and charge a higher price than would pure competitive
producers selling in the same market.
Income distribution is more unequal than it would be under a more competitive situation, unless
the government regulates the monopoly and prevents monopoly profits. If a monopoly creates
substantial economic inefficiency and appears to be long-lasting, antitrust laws could be used to
break up the monopoly.
Efficiency:
1. Productive efficiency: occurs where P= min ATC. Monopoly firms will not achieve productive
efficiency as firms will produce at an output which is less than the output of min ATC. X-inefficiency
may occur since there is no competitive pressure to produce at the minimum possible costs.
2. Allocative efficiency: occurs where P = MC. This efficiency is not achieved because price( what
product is worth to consumers) is above MC (opportunity cost of product).
It is possible that monopoly is more efficient than many small firms. Economies of scale (natural
monopoly) may make monopoly the most efficient market model in some industries. However, X-
inefficiency and rent-seeking cost (lobbying, legal fees, etc.) can entail substantial costs, causing
inefficiency.
An Example
In this example, the cost function is the same as the TP or Q AFC AVC ATC MC
one used in the perfect competition example. You can
see from the following analysis that the output level 0
and market price are different in monopoly . The output 1 60 45 105 45
level is lower than output of the perfect competitive 2 30 42.5 72.5 40
firm; and price is higher than the price of perfect 3 20 40 60 35
competitive firm. 4 15 37.5 52.5 30
5 12 37 49 35
6 10 37.5 47.5 40
7 8.57 38.57 47.14 45
8 7.5 40.63 48.13 55
9 6.67 43.33 50 65
10 6 46.5 52.5 75
Pd Qd TR MR EP
115 0 0 0
Characteristics
1. A lot of firms: each has a small percentage of the total market.
2. Differentiated products: variety of the product makes this model
different from pure competition model. Product differentiated in style,
brand name, location, advertisement, packaging, pricing strategies,
etc.
3. Easy entry or exit.
Demand Curve
The firms demand curve is highly elastic, but not perfectly elastic. It
is more elastic than the monopolys demand curve because the seller
has many rivals producing close substitutes; it is less elastic than
pure competition, because the sellers product is differentiated from
its rivals.
Profit - Maximizing Output
The MR = MC rule will give the firms the profit maximizing output. The price they
charge would be on the demand curve.
In the long run, the situation will tend to be breaking even for firms. Firms can enter
the industry easily and will if the existing firms are making an economic profit. As
firms enter the industry, the demand curve facing by an individual firm shift down, as
buyers shift some demand to new firms until the firm just breaks even. If the demand
shifts below the break-even point, some firms will leave the industry in the long run.
Price exceeds marginal cost in the long run, suggesting that society values additional
units which are not being produced. Average costs may also be higher than under
pure competition, due to advertising cost involved to attract customers from
competitors. The various types, styles, brands and quality of products offers
consumers choices. However, economic inefficiency is the result. The excess capacity
(producing at the quantity that a firm produces is less than the quantity at which ATC
is a minimum) exists in this industry.
Oligopoly
Oligopoly exits where few large firms producing a homogeneous or
differentiated product dominate a market. Examples are automobile
and gasoline industries.
Characteristics
1. Few large firms: each must consider its rivals reactions in
response to its decisions about prices, output, and advertising.
2. Standardized or differentiated products.
3. Entry is hard: economies of scale, huge capital investment may
be the barriers to enter.
Demand Curve
Facing competition or in tacit collusion, oligopolies believe that
rivals will match any price cuts and not follow their price rise. Firms
view their demands as inelastic for price cuts, and elastic for price
rise. Firms face kinked demand curves. This analysis explains the
fact that prices tend to be inflexible in some oligopolistic industries.
Efficiency & Advertisement
1. Productive efficiency: occurs where P= min ATC.
The Organization of Petroleum Exporting Countries (OPEC) is a cartel. The eleven countries
agreed on the output amount and working together to control the worlds crude oil supply. In US,
anti-trust law has set up guidelines for corporations to follow to avoid collusion of large firms in
Technological Development
Technological advance is a three-step process that shifts the economys production
possibilities curve outward enabling more production of goods and services.
1. Invention: is the discovery of a product or process and the proof that it will work.
2. Innovation: is the first successful commercial introduction of a new product, the
first use of a new method, or the creation of a new form of business enterprise.
3. Diffusion: is the spread of innovation through imitation or copying.
Many projects may be affordable but not worthwhile because the marginal benefit is
less than marginal cost. Often the R&D spending decision is complex because the
estimation of future benefits is highly uncertain while costs are immediate and
more clear-cut.
The Role of Market
Structure
1. Pure competition: the small size of competitive firms and the fact hat
they earn zero economic profit in the long run leads to serious questions as
to whether such producers can finance substantial R&D programs. The
firms in this market structure would spend no significant amount. However,
firms of the same industry may gather their resources and develop R&D
programs.
1. Allocative efficiency means that resources are used for producing the combination of goods
and services most wanted by society. For example, producing computers with word processors
rather than producing manual typewriters.
2. Productive efficiency means that least costly production techniques are used to produce
wanted goods and services.
Full efficiency means producing the "right" (Allocative efficiency) amount in the "right
"way (productive efficiency).
Pure competition:
Productive efficiency occurs where price is equal to minimum average total cost (min ATC); at
this point firms must use the lease-cost technology or they wont survive.
Under pure competition, this outcome will be achieved, as the long run equilibrium price of pure
competitive firms would be at the min ATC.
Allocative efficiency occurs where price is equal to marginal cost ( P=MC), because price is
societys measure of relative worth of a product at the margin or its marginal benefit. And the
marginal cost of producing product X measures the relative worth of the other goods that the
resources used in producing an extra unit of X could otherwise have produced. In short, price
measures the benefit that society gets from additional units of good X, and the marginal cost of
this unit of X measures the sacrifice or cost to society of other goods given up to produce more
of X.
Efficiency Cont.
Non-perfect competition:
Price of non-perfect competitive firms will exceed marginal cost, because price exceeds marginal
revenue and the firms produce where marginal revenue (MR) and marginal cost are equal. Then the
firms can charge the price that consumers will pay for that output level. Allocative efficiency is not
achieved because price (what product is worth to consumers) is above marginal cost (opportunity
cost of product). Ideally, output should expand to a level where P=MC, but this will occur only under
pure competitive conditions where P = MR. Productive efficiency is not achieved because the firms
output is less than the output at which average total cost is minimum.
Economies of scale (natural monopoly) may make monopoly the most efficient market model in
some industries. X-inefficiency, the inefficiency that occurs in the absence of fear of entry and
rivalry, may occur in monopoly since there is no competitive pressure to produce at the minimum
possible costs. Rent-seeking behavior often occurs as monopolies seek to acquire or maintain
government granted monopoly privileges. Such rent-seeking may entail substantial cost (lobbying,
legal fees, public relations advertising etc.) which are inefficient.
There are several policy options available when monopoly creates substantial economic
inefficiency:
1. Antitrust laws could be used to break up the monopoly if the monopolys inefficiency appears to
be long-lasting.
2. Society may choose to regulate its prices and operations if it is a natural monopoly.
3. Society may simply ignore it if the monopoly appears to be short-lived because of changing
conditions or technology.
TPL output
APL = Efficiency of Production of Good X
L = input =
labour L TPL APL MPL
Notice that the APL increases as the first
three units of labour are added to the
0 0 0 --
fixed inputs of K and R. The maximum 1 4 4 4
efficiency of Labour or maximum APL , given 2 10 5 6
our technology, plant and natural
resources is with the third worker. 3 20 6.67 10
4 25 6.25 5
As additional units of labour are added 5 29 5.8 4
beyond the third worker the 3
6 32 5.3
output per worker [APL ] declines.
7 34 4.87 2
8 35 4.37 1
9 35 3.89 0
..
rate; it is convex from below.
. .
0 0
TPL
Output, QX
.
1 4
35
.
Maximum
2 10
30 output
.
3 20
25
After some point it 4 25
20 then increases at a
.
decreasing rate and 5 29
15
reaches a maximum
.
6 32
10 level of output,
.
7 34
5 and declines
8 35
1 2 3 4 5 6 7 8 9 9 35
Labour
. .
29 5 5.8
. ..
8
.
32 6 5.3
6
4 . .. 34
35
7
8
4.87
4.37
2
. 1 2 3 4 5 6 7 8 9
APL 35 9 3.89
Labour
.
.
35 TPL
.
.
The APL is the
.
.
30 slope of a Graphically the relationship
between APL and TPL can be shown:
.
ray from
25 M
the origin 5 1 unit of L produces 4Q,APL is 4/1 = 4 or the
20 to the =
n slope of line 0H.
TPL . u H
.
15 e/r 2 units of L produces 10Q,
ris =
4
10 u n APL is 10/2 = 5 or the slope of line 0M.
r
.
e /
ris 3 units of L produces 20Q,
APL
5
4
0 .1 2 3 4 5
APL is 20/3 = 6.67 or the slope of line 0Z.
.
10
.
Labour APL is 25/4 = 6.25 or
. .. .
8 the slope of line 0W.
6
9
slope is tangent to the TP.
.
.
35 TPL
.
.
Given TPL , the APL was
.
30
calculated and graphed.
.
25 MPL was calculated as L MP
APLL TPL
20 the change in TPL given a
change in L.
0 --
0 0
.
4-0
15 The first unit of labour added 1 44 4
4 units of output.
10 2 65 10
.
Between the 1st and 2cd units
. .
5 of labour, Q increases by 6. 3 10
6.67 20
4
0 4 5
6.25 25
APL 1 2 3 4 5 6 87 9
.
10 5 4
5.8 29
.
Labour
.
Note: Where MPL = APL, APL
.. .
8 3 32
.
6 5.3
. .. . ..
is a maximum.
..
MPL = APL
6 7 2
4.87 34
4 8 1
4.37 35
2
. . .
APL 9 0
3.89
MPL Remember: MP is graphed
35
Fall 97
1 2 3 4 5 Principles
6 7 8 9 at between unitsSlide
of Microeconomics
of L.
-- 233
Labour
Output, QX
Z
.
.
35 TPL
.
.
.
30 Useful things to notice:
1. MPL is the slope of TPL.
.
25
2. When TPL increases at an increasing
20 rate, MPL increases. At the inflection
.
point in the TPL , MPL is a maximum.
15
When TPL increases at a decreasing rate,
10
.
MPL is decreasing.
. .
3. The APL is a maximum when:
5
4 a. MPL = APL ,
0 b. the slope of the
APL 1 2 3 4 5 6 7 8 ray9 from origin is tangent to
.
10
.
Labour
.
TPL .
.. .
8
.. . .
.. . ..
4. When MPL > APL the APL is increasing.
6 When MPL < APL the APL is decreasing
4 5. When MPL is 0, the
2
. . .
APL
MPL
slope of TPL is 0, and TP
is a maximum.
Fall 97
1 2 3 4 5 Principles
6 7 8 9
of Microeconomics Slide -- 234
Labour
Summary: TPL , MPL and APL
0 5 0 0 0 = ? AP is a maximum
L= 1 TPL = 8 when L = 4.
1 5 8 8TP8.0 8 1 = 8
L= 1 L = 15
2 5 23 15TP11.5 23 2 = 11.5Note that MP is
L= 1 L = 19
3 5 42 19 14.0 42 3 = 14 15 between 3rd & 4th
L= 1 TPL = 15
4 5 57 15TP14.25 574 = 14.25 units of L, it is 10
L= 1 = 10
67 5 = 13.4 between 4th & 5th,
L
5 5 67 10TP13.4
= 7
L= 1 L so it equals
6 5 74 7 12.33 AP = 14.25 at L=4.
7 5 79 5 11.28
8 5 82 3 10.25 To calculate MP:
1 9.22
9 5 83
TPL
10 5 82 -1 8.2 MP =
L
L
0 x $4 =
5 0 0
$30 + $ 0
--
1 x $4 =
5 8 8 8 =$30
$30 + $ 4
2 x $4 =
5 23 11.5 15 $30 =$34
+ $ 8=$38
3 x $4 =
5 42 14 19
$30 + $12=$42
4 x $4 =
5 57 14.25 15
$30 + $16=$46
5 x $4 =
5 67 13.4 10
$30 + $20=$50
6 5 74 12.33 7 $30 + $24=$54
7 5 79 11.28 5
$30 + $28=$58
8 5 82 10.25 3
$30 + $32=$62
9 5 83 9.22 1 $30 + $36=$66
10 5 82 8.2 -1 $30 + $40=$70
0 5 0 0 --
$0 $30
$30
1 5 8 8 8 $4 $34 $3.75 $ .50 $4.25
$30
2 5 23 11.5 15 $30 $8 $38 $1.30 $ .35 $1.65
3 5 42 14 19 $30 $12 $42 $ .71 $ .29 $1.00
4 5 57 14.25 15 $46 $ .53 $ .28 $.81
$30 $16
5 5 67 13.4 10 $50 $ .45 $ .30 $.75
$30 $20
6 5 74 12.33 7 $54 $ . $ .32 $.729
$30 $24
7 5 79 11.28 5 41
$30 $28 $58 $ .38 $ .35 $.734
8 5 82 10.25 3 $62 $ .37 $ .39 $.76
$30 $32
9 5 83 9.22 1 $30 $66 $ .36 $ .43 $.79
$36
10 5 82 8.2 -1 $70 $ .37 $ .49 $.86
$30 $40
0 5 0 0 -- $30
$30 $0
1 5 8 8 8 $4 $34 $3.75 $ .50 $4.25
$30
2 5 23 11.5 15 $8 $38 $1.30 $ .35 $1.65
$30
3 5 42 14 19 $12 $42 $ .71 $ .29 $1.00
$30
4 5 57 14.25 15 $46 $ .53 $ .28 $.81
$30 $16
5 5 67 13.4 10 $50 $ .45 $ .30 $.75
$30 $20
6 5 74 12.33 7 $54 $ . $ .32 $.729
$30 $24
7 5 79 11.28 5 41
$30 $28 $58 $ .38 $ .35 $.734
8 5 82 10.25 3 $62 $ .37 $ .39 $.76
$30 $32
9 5 83 9.22 1 $30 $66 $ .36 $ .43 $.79
$36
10 5 82 8.2 -1 $70 $ .37 $ .49 $.86
$30 $40
APL APL
MPL MPL
L1 L2 L3 L The maximum of the AP is consistent with
the minimum of the AVC.
1 xP $
MC = L
MC
MPL
MP
APL
AVC
AVC = 1 xP
L
AP AVC
Q
APL x L2
ATC
AVC
ATC* MC will intersect the ATC
R
at the minimum of the ATC.
AVC* TC = ATC* x Q** J
The vertical distance between
TVC = AVC* x Q* ATC and AVC at any output is
the AFC. At Q** AFC is RJ.
Q* Q** Q
At Q* output, the AVC is at a minimum AVC* [also max of APL].
At Q** the ATC is at a MINIMUM.