Please enable JavaScript.
Coggle requires JavaScript to display documents.
Chapter 7 (1) - Coggle Diagram
Chapter 7 (1)
Unit 3
Consider a firm that manufactures cars. This firm produces specialty cars and will turn out to be rather small, so we will call it Beautiful cars.
The owners/ shareholder would not be willing to invest in the firm if they could make better use of their money by investing and earning profits elsewhere. What they would receive per dollar is an opportunity cost, in this case called the opportunity cost of capital
-
The more cars produced, the higher the total cost will be.
-
The upper panel is the firms cost function, C (Q). We have worked out the average cost of a car, and how it changes with Q, the average cost curve (AC) is plotted in the lower panel.
Beautiful cars has decreasing average costs at a low levels of production: the AC curve slopes downward. At higher levels of production, average cost increases so the AC curve slopes upward
Marginal cost of producing a car, is the cost of producing one more car
Since marginal cost is the slope of the cost function and the cost curve gets steeper as Q increases, the graph of the marginal cost is an upward-sloping line. Beautiful cars has increasing marginal costs of car production. It is the rising marginal cost that eventually causes average costs to increase
-
You can see that the AC is downward sloping at values of Q where the AC is greater than the MC, and it is upward sloping where AC is less than MC. This is not coincidence: it happens whatever the shape of the total cost function
Unit 2
Why a large firm may be more profitable than a small firm is that the large firm produces its output at lower cost per unit. This may be possible for 2 reasons:
- Technological advantages: large-scale production often uses fewer inputs per unit of output
- Cost advantages: In larger firms fixed costs such as advertising have a smaller effect on the cost per unit. And they may be able to purchase their inputs at a lower cost because they have more bargaining power
Large firms are able to purchase their inputs on more favourable terms, because they have more bargaining power than small firms when negotiating with suppliers
Large size may benefit a firm in selling its products, not just in producing it. This occurs when people are more likely to buy a product or service if it already has a lot of users. These demand side benefits of scale are called network economies of scale.
Economists use the term economies of scale or increasing returns to describe the technological advantages of large scale production
- Economies of scale may result from specialization within the firm which allows employees to do the task they do best, and minimize training time by limiting the skill set that each worker needs.
- Economies of scale may also occur for purely engineering reasons
There are also built in diseconomies of scale.
- Think of the firms owners, managers, work supervisors and production workers. Suppose that each supervisor can direct 10 people while each manager can direct 10 supervisors.
- If the firm employs 10 production workers, then the owner can do the management and supervision.
- If it employs 100 production workers, it needs to add a layer of 10 supervisors
- If it grows to 1000 production workers, it will need to recruit another layer of supervision
- So increasing production workers requires more than a proportional increase in supervision and management. The only way the firm could increase all inputs proportionally would be to reduce the intensity of supervision, which is associated with losses in productivity
Cost per unit may fall as the firm produces more output, even if there are constant or even decreasing returns to scale. This happens if there is a fixed cost that doesnt depend on the number of units. An example of fixed costs would be:
- Cost of research and development
- Product design
- Marketing expenses such as advertising
- A firms attempt to gain favourable treatment by government bodies through lobbying, contributions to election campaigns, and public relations expenditure
Unit 6
Different method of finding the profit maximizing point without using isoprofit curves. Instead we use the marginal revenue curve. If Q cars are sold at a price P, revenue R is given by R = P x Q. The marginal revenue MR is the increase i revenue obtained by increasing the quantity from Q to Q + 1
-
-
The firm's revenue is the area of th rectangle drawn below the demand curve. When Q is increased from 20 to 21, the revenue changes for two reasons:
- An extra car is sold at the new price
-Since the new price is lower when Q = 21 there is also a loss of $80 on each of the other 20 cars.
- The marginal revenue is the net effect of these two changes
When P is high and Q is low, MR is high: the gain from selling one more car is much greater than the total loss on the small number of other cars. As we move down the demand curve P falls and Q rises so MR falls and eventually becomes negative
-
-
- So MR > MC, the firm could increase profit by raising Q
- If MR < MC, the marginal profit is negative. It would be better to decrease Q
-
In this case:
- When Q < 32, MR>MC, Marginal profit is positive so profit increases with Q
- When Q > 32, MR < MC marginal profit is negative, profit decreases with Q
- When Q = 32, MR = MC Profit reaches a maximum
Unit 5
-
-
At E, the profit maximizing point, MRT=MRS
The only feasible choices are the points on or below the demand curve, shown by the shaded area on the diagram. To maximize profit the firm should choose the tangency point E, which is on the highest possible isoprofit curve. The profit maximizing price and quantity are P = $5440 and Q = 32 and the corresponding profit is $63360
-
The firm maximizes profit at the tangency point where the slope of the demand curve is equal to the slope of the isoprofit curve, so that the two trade-offs are in balance:
- The demand curve is the feasible frontier and its slope is the marginal rate of transformation (MRT) of lower prices into greater quantity sold.
- The isoprofit curve is the indifference curve, and its slope is the marginal rate of substitution (MRS) in profit creation, between selling more and charging more
Unit 1
Firms producing differentiated products choose price and quantity to maximize their profits, taking into account the product demand curve and the cost function
The responsiveness of consumers to a price change is measured by the elasticity of demand, which affects the firms price and profit margin
The gains from trade are shared between consumers and firm owners, but prices above marginal cost cause market failure and deadweight loss
A firm's success depends on more than getting the price right. Product choice and ability to attract the customers, produce at lower cost and a t a higher quality than their competitors all matter. They also need to be able to recruit and retain employees who can make all these things happen
Keeping the price low, is one possible strategy for a firm seeking to maximize its profits: even though the profit on each item is small, the low price may attract so many customers that total profit is high
-
-
The demand for a product will depend on its price and the costs of production may depend on how many units are produced
To decide what price to charge, a firm needs information about demand: how much potential consumers are willing to pay for its product
-
If the price were $3 customers would demand 25 000 pounds of Apple cinnamon cheerios. For most products, the lower the price, the more customers wish to buy
Suppose that the unit cost (the cost of producing each pound) of Apple Cinnamon cheerios is $2. To maximize your profit, you should produce exactly the quantity you expect to sell, and no more. Then revenue, costs, and profit are given by:
- Total costs = unit cost x quantity = 2 x Q
- Total revenue = price x quantity = P x Q
- Profit = Total revenue - total costs = P x Q - 2 x Q
- Formula for profit = (P-2) x Q
-
The isoprofit curves are the firms indifference curves: the firm is indifferent between combinations of price and quantity that give you the same profit
Using this formula, you could calculate the profit for nay choice of price and quantity and draw the isoprofit curves
-
-
Your best strategy is to choose point E, you should produce 14 000 pounds of cereal, and sell it at a price of $4,40 per pound, making $34 000 profit.
The slope of the demand curve is the trade off you are constrained to make - your MRT, or the rate at which the demand curve allows you to transform quantity into price. You cannot raise the price without lowering the quantity, because fewer consumers will buy a more expensive product
The isoprofit curve is your indifference curve, and its slope at any point represents the trade off you are willing to make between P and Q - your MRS. You would be willing to substitute a high price for a lower quantity if you obtained the same profit
The graph in the lower panel is the profit function: it shows the profit you would achieve if you chose to produce a quantity Q and set the highest price that would enable you to sell the quantity according to the demand function
Unit 4
-
-
We do expect demand curves to slope downward: as the price rises, the quantity that consumers demand falls. This relationship between the price and quantity is sometimes known as the Law of Demand
If the price of a Beautiful car is high, demand will be low because the only consumers who will buy it are those who strongly prefer beautiful cars to all other makes. As the price falls, more consumers, who might otherwise have purchased a Ford or a Volvo will e attracted to a Beautiful Car
Then if we choose any price, say P = $3200 the graph shows the number of consumers whose WTP is greater than or equal to P. In this case, 60 consumers are willing to pay $3200 or more, so the demand for cars at a price of $3200 is 60
For beautiful cars imagine that there are 100 potential consumers who would each buy one beautiful car today, if the price were low enough. Each consumer has a Willingness to Pay (WTP) for a beautiful car, which depends on how much the customer personally values it. A customer will buy a car if the price is less than or equal to his WTP.
-
Suppose we line up the consumers up in order of WTP, with the highest first and plot the graph
- The firm's profit is the difference between its revenue (the price multiplied by quantity sold) and its total costs C (Q):
- Profit = total revenue - total costs = PQ - C (Q)
- This calculation gives us what is known as the economic profit. Remember the cost function includes the opportunity cost of capital (the payments that must be made to the owners to induce them to hold shares) which is referred to as normal profits
- Profit = Q (P-AC)
-
The lowest curve shows the zero-economic profit curve: combinations of price and quantity for which economic profit is equal to zero, because the price is just equal to the average cost at each quantity
- Isoprofit curves slope downward at points where P > MC - The profit margin is positive so the slope is negative
- Isoprofit curves slope upward at points where P < MC - The profit margin is negative so an increase in price is required to keep profit constant when quantity rises by 1
The difference between the price and the marginal cost is called the profit margin. At any point on an isoprofit curve the slope is given by:
- Slope of isoprofit curve = - (P - MC) / Q =- profit margin / quantity