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CIE3ME Microeconomics Exam Review (Theory of the Firm (Monopoly (Sources…

- - - - Industry made up of large number of firms
      - Firms are small compared industry (actions of one firm unlikely to have effect on competitors)
      - Firms produce slightly differentiated products
        
        Consumers may stay loyal to product, continue to buy if price goes up little (brand loyalty) → price makers b/c producers have element of independence when deciding price
        
        Downward sloping (relatively elastic b/c many slightly different substitutes) demand curve
        
        Producing to maximize profit @ MC=MR
      - No barriers to entry/exit
    - - MC=MR and AC less than selling price → abnormal profit
      - AC can be above price → economic loss
    - - Other firms attracted to industry if firms making short-run abnormal profits
        
        Take business away from existing firms → demand curve shifts leftwards
        
        Firms start to leave if firms making short-run losses
      - Whatever short-run situation, firms will make normal profits in long run (maximizing profits by producing where MC=MR and cost = price) → firms covering all costs, no incentive to leave industry; firms outside will not enter b/c they know their entrance will be detrimental to everyone
    - - Firms will produce at profit-maximizing level, not at where they are productively or allocatively efficient (both short- and long-run)
      - Inefficiency not due to firm's ability to restrict output and increase price; due to consumers' desires for variety (perfect competition gives homogeneous products, monopolistic competition gives consumers opportunity to make choices)
  - - - One firm producing product/firm IS the industry (really depends on how narrowly industry is defined)
      - Barriers to entry exist
        
        Allows abnormal profits in long run
    - - Economies of scale: average cost advantages as size increases (lower unit costs) → firm wishing to enter industry will have to start up in a small way
        
        Specialization
        
        Division of labour
        
        Bulk-buying
        
        Outside firms lack research and development, managerial economies, and promotional economies
      - Natural monopolies: only enough economies of scale available to support one firm
      - Legal barriers: firm may have legal right to be monopoly; patents give firm rights to be only producer for certain number of years after its invention
        
        gov't grants right to produce to single firm (e.g. natonalized industry such as postal service, banning other firms from entering that industry)
      - Brand loyalty: new firms put off from entering b/c they feel they are unable to produce product that will garner strong brand loyalty
      - Anti-competitive behaviour: restrictive practises; can lower price to loss-making price and should be able to sustain losses for longer than new entrants
    - - Abnormal profits in short run and effective barriers to entry
        
        Can also make abnormal profits in long run for as long as barriers to entry hold out
      - Little demand → no abnormal profits
        
        Losses in short-run: AC greater than AR at all quantities
        
        Closing down temporarily if not covering variable costs
        
        Continue production for time-being, plan ahead in long run to see whether changes can be made for normal profits to be made
        
        Close down firm; industry ceases to exist
      - Revenue maximization: produce where MR=0
    - - MC curve can be pushed down due to ability to achieve large economics of scale; curve below that of perfect competition → produce @ MC=MR, maximizing profits and producing greater quantity
      - High levels of R&D - abnormal profits used to fund this, in long run benefits consumers who would have better products and more choice
    - - No differences in cost → perfectly competitive market will produce at lower price and in greater quantity (MC=AR)
        
        If significant economies of scale do not exist, monopoly may restrict output/charge higher price than perfect competition
      - High profits considered unfair (by competitive firms/low incomes); can exercise anti-competitive behaviour → gov'ts have laws/policies to limit monopoly power
      - Productively/allocatively inefficient
  - - - Industry made up of many firms
      - Each firm small, incapable of having noticeable effect by altering output (cannot affect supply curve/price); price takers
      - Homogeneous products (no brand names, impossible to distinguish)
      - No barriers to entry/exit
      - Producers and consumers have perfect knowledge (prices, costs, workings of market, quality of products, availability)
    - - Short-run abnormal profits: AC less than AR
        
        Long-run normal profits: perfect knowledge + no barriers to entry → firms will enter market attracted by chance to make abnormal profits → industry supply curve shifts right causing price to fall → price-takers forced to take lower prices and their demand curves shift downwards → new entrants keep entering until no more abnormal profits (min. on AC = new MR)
      - Short-run losses: AC higher than price (still @ profit-maximizing level b/c any other output would create greater loss)
        
        Industries will start to leave → industry supply curve shifts left → price rises → price-takers take new price, shifting demand curves upwards until no more economic loss (min. of AC = new MR)
      - Long-run equilibrium: no incentive for firms to enter nor exit until there is change in industry demand/supply - if this happens, firms will make short-run adjustments until long-run equilibrium restored
    - - Short-run abnormal profits/losses: productive efficiency can't be achieved b/c profit-maximization point where MC=MR is being produced
      - Long-run: allocative efficiency AND productive efficiency achieved b/c lowest possible AC produced AND where MC=AR
  - - - Short-run: fixed factors of production except labour; long-run: planning, factors of production are variable except technology → back in short-run as soon as fixed factors are changed
      - Total/marginal/average product
        
        Total: total output using fixed/variable factors in given time period
        
        Average product = TP divided by number of units of variable factor employed
        
        Marginal product = change in total output divided by change in number of units of variable factors
      - Law of diminishing returns: as extra units of variable factor added to given quantity of fixed factor, output from each additional unit/output per unit will eventually diminish
      - Economic cost/opportunity cost
        
        Explicit costs: factors of production not owned by firm (price paid for them/alternative things that could have been bought)
        
        Implicit costs: opportunity cost involved in using factors that firm already owns
      - Short-run costs
        
        Total (average = total divided by quantity of output)
        
        Total fixed cost: fixed assets, present even with 0 output
        
        Total variable cost: variable factors
        
        Total cost = TFC + TVC
        
        Marginal cost: increase in total cost of producing extra unit of output **law of diminishing returns
      - Long-run costs: LRAC envelopes infinite number of SRAC curves that represent possible combinations of fixed/variable factors that could be used to produce different levels of output - as demand increases, firms can plan to decrease short-run costs by changing factors of production, leading to cheaper average costs)
        
        Boundary between unit cost levels that are attainable and unattainable
        
        Increasing returns to scale: When long-run unit costs falling as output increases
        
        Economies of scale
        
        Specialisation: management able to specialize in more specific areas → more efficient (rather than one manager for everything)
        
        Division of labour: able to break down production processes and reduce unit costs (e.g. assembly lines)
        
        Bulk buying: negotiate discounts w/ suppliers
        
        Financial economies: banks tend to charge lower interest rates to larger firms b/c there is less risk and they are more able to repay loans
        
        Transport economies: less delivery costs for bulk orders; own transport fleet which will cost less than paying other firms to transport their products
        
        Large machines: small firms need to hire use of equipment from other suppliers
        
        Promotional economies: promotion costs tend to not increase proportionally to output
        
        Constant returns to scale: given percentage increase in factors of production leads to same percentage increase in output
        
        Decreasing returns to scale: long-run average cost rising as output increases (increase in factors of production leads to smaller increase in output)
        
        Diseconomies of scale: increases in LRAC that come about when firm alters factors of production to increase output
        
        Control/communication problems: firm grows, management finds it harder to coordinate activities, leads to inefficiency, increases unit costs
        
        Loss of identity: workers feel as though what they do does not matter, lose a sense of belonging → less productivity → higher unit costs
        
        **in reality, economists have not yet found evidence of firm becoming so large that diseconomies of scale start to outweight economies of scale in long-run
    - - Shut-down price: level of price enabling firm to cover variable costs in short-run, if TR does not cover AVC, firm will shut down in short-run
      - Break-even price: price at which firm can make normal profit in long run
      - Profit-maximising: MC=MR
- - - - Tax to increase private costs, shift MPC curve upwards towards MSC **if tax not equal to external cost, it reduce area of DWL but not completely
        
        Difficulties
        
        Difficult to place value on tax
        
        Difficult to identify which firms are causing externality
        
        Producers may simply pay the tax and keep producing at same quantity
      - Ban firms from producing → may lead to job losses, non-consumption of whatever was being produced, cost of setting/policing standards may be greater than externality cost
      - Tradable permits for quotas