Introduction to Agricultural Economics - PowerPoint Presentation

Slide1

Introduction to Agricultural Economics

SAB – 101

T-R: 9.30 am – 10.45 am

Fall 2016

Instructor:

Sankalp

Sharma

Email: Ssharma3@unl.edu

Slide2

Who am I?

Slide3

A word on my teaching philosophy

Slide4

About this class

In class expectation

Out of class expectation

Book

Homework

Grading

Slide5

In-class Expectation

Key to learning:

interaction

Review previous class’ notes before class (same file will be updated)

Attend all classes (cannot emphasize enough)

Ask questions…

But don’t be a troll!

No cellphones or laptops during the class !!

Slide6

Out-of-class Expectation

No gains without practice.

Reading not enough, you must practice problems.

Form groups to practice.

Understand concept, memorization won’t help you.

Slide7

Book

Introduction to Agricultural Economics 4

th

edition

(

Penson

et al.)

Buy used copy from Amazon for $11

Slide8

Homework

Frequently assigned.

Usually only one question.

A random student will be asked to solve the HW on the board.

Slide9

Grading

Exams will be long and difficult.

Everything taught in class is fair game.

But grading will be easy.

40% midterm, 40% final, 20% HW, (bonus: 20% class interaction)

Slide10

Questions?

Slide11

What is Economics?

Problem

Resources Required

Solution

Slide12

What is Economics?

Solutions often compromised due to several moving parts.

One solution might be agreeable to a certain group, but not to a different one.

Eg

: Difficult to make policymaking decisions.

Best possible solutions rarely achievable.

Slide13

Economics: How the world works

Consumer preferences

Creates Demand

Equilibrium: create price for a quantity

Producer wants profit

Create Supply

Slide14

- No, not always

Producers often influence our preferences.

Eg

: Let’s say a new product Apple Inc. comes out with.

Does the previous chart hold true always?

Consumer preferences

Producer wants profit

Slide15

Why is Economics Useful in Agriculture

- Several problems both on the consumer side and producer side.

- Cost-benefit analysis.

- Think of farm/crop insurance subsidies and the need for them.

Slide16

So let’s begin…

Slide17

Theory of Consumer Behavior

In the book: chapter 3, part 2: Understanding Consumer behavior.

Slide18

What is utility?

Slide19

What is utility?



It is a set of preferences.

Slide20

What does a typical utility function (U) look like?

U(.)

Food, wealth, health, etc.

Slide21

What does “my” utility function look like?

U(.)

Food, travel, health, swimming, relationship with significant other,

Game of Thrones

Slide22

Goods

Each item in the box is defined as a “Good”

Slide23

Utility: The higher the better

Slide24

What do we require to make our utility higher?

Answer: Resources

Slide25

What kind of resources?

What do I mean by a resource?

Provide some examples of resources needed for the following “goods”:

Food.

Travel.

Running.

Swimming.

Slide26

Resource for our purposes: Money

We only focus on money in this class.

Most things besides “time” can be bought through money.

Slide27

Utility: In-depth

In real life difficult to measure someone’s level of utility

Think of water (measured in gallons)

But how does one measure somebody’s satisfaction level.

For

eg

: you eat two cups of ice-cream, can you tell me how “happy you are” vs. when you have three cups?

Slide28

Utils

Is the scale used to measure utility. (For

eg

: a scale of 1 to 10)

It is an arbitrary scale

No real-life meaning.

Still useful to get a sense of someone’s level of utility.

Slide29

Utils

: No real life interpretation without context

- For

eg

: Let’s say Papa Johns comes up with a new Pizza.

Most likely, you will tell your friend how many slices you ate and whether you liked it or not.

… and not whether you received 7

utils

or 10

utils

from it.

Slide30

Utility: Mathematical Representation

Suppose there are two types of pizzas:

Papa Johns and Dominoes.

Utility value =

(quantity of papa johns pizzas)

(quantity of Dominoes pizzas)

A different utility value:

*Utility value

=

(quantity of papa johns pizzas)

(quantity of Dominoes pizzas)

*Above equation known as a: utility function as well.

 

Slide31

Question: Utility value/utils

Ronald (Ron)

Weasley

is a student at Hogwarts, he likes two types of drinks:

Butterbeer

and Pumpkin juice

His utility function is:

Utility =

He is able to acquire

2

glasses of

butterbeer

and

3

glasses of pumpkin juice.

What is his utility value?

 

Slide32

Solution

Slide33

Solution

Ron’s utility =

 

Slide34

Another Example:

Ron’s friend Dean Thomas also goes to Hogwarts and has the following utility function:

Dean’s Utility =

He is able to acquire 1 glass of

butterbeer

and 4 glasses of pumpkin juice

What is Dean’s utility?

Who was able to acquire a higher utility level?

 

Slide35

Solution

Slide36

Dean’s utility =

..and who reached a higher utility level?

Ron!

 

Solution

Slide37

What does a utility curve look like graphically?

See book (chapter 3)

Butterbeers

per units of time

Slide38

Marginal utility (MU)

“Marginal”

 English definition: adj. “very narrow / slight/minor importance.

“Marginal”  Economics definition: “change”

Marginal utility

: Change in utility as more of a “good” is consumed.

Slide39

Marginal utility

How to find MU?

Formula



represents an “increase”.

Typically

in the denominator represents an “increase” by 1.

 

Slide40

Can you think of a good that decreases utility?

Slide41

Marginal Utility

Two components in the formula: change in numerator (

and change in denominator (

 

Slide42

Question: Marginal Utility

Let’s return to our previous examples of Ron and Dean’s utility:

Suppose now Ron is able to consume

3

glasses of

butterbeer

instead of

2

. (His consumption of pumpkin juice remains the same).

What is his marginal utility?

Slide43

Solution

What is Ron’s change in utility from drinking one more glass of

butterbeer

?

We have already calculated Ron’s utility at 2

butterbeers

, which was:

36

*

 means marginal utility of

butterbeers

 

Slide44

Solution

What is Ron’s new utility?

Recall that Ron’s utility function is:

Previously Ron was drinking 2 glasses of

butterbeer

, therefore his utility was:

Now, he drinks

3

glasses, therefore his new utility is:

 

Slide45

Solution

-Therefore Ron’s change in utility is:

= 81 – 36 = 45

 

Slide46

Question: Dean Thomas’s MU

Lets suppose dean also gets an

extra

glass of

butterbeer

. Recall that he was originally consuming:

1

glass of

butterbeer

and

4

glasses of pumpkin juice.

… and his utility function is given by:

Dean’s Utility =

Find Dean’s marginal utility of

butterbeer

?

 

Slide47

Homework 1: Marginal utility of pumpkin juice

In the previous two examples, suppose instead of

Butterbeer

, both Ron and Dean receive an additional glass of pumpkin juice. Find both Ron and Dean’s marginal utility of pumpkin juice.

Slide48

Law of Diminishing Marginal Utility

Draco Malfoy is also Ron’s friend. His utility function is given by:

Let’s say he is initially able to consume, 1 glass of

butterbeer

and 1 glass of pumpkin juice.

Subsequently, he consumes:

2

glasses of

butterbeer

, while his pumpkin juice consumption remains the same.

3

glasses of

butterbeer

, while his pumpkin juice consumption remains the same.

Find his utility level at each of the three levels, tell me his MU of

buttebeer

after each increase of

butterbeer

consumption.

 

Slide49

Hint:

 

Slide50

Solution?

Slide51

Indifference Curves

Again, let’s return to our

butterbeer

and pumpkin juice example.

In our initial

eg

: Ron was consuming 2 glasses of

butterbeer

and 3 glasses of pumpkin juice.

(2,3) is referred to as a consumption bundle.

That “consumption bundle” got him to a utility level of 36.

Slide52

Indifference Curves

- Can you think of a different consumption bundle, which gives Ron the same utility?

You need to find a different combination of

butterbeer

and pumpkin juice consumption which gives Ron the same utility amount?

Can you find two such combinations?

Slide53

Indifference curves: Graphical representation

2

Butterbeer

Pumpkin juice

3

1

6

Utility level = 36

A

B

A and B are two consumption bundles, which give the same utility level.

Slide54

Solution?

(?,?)

(?,?)

Slide55

Solution

(3,2)

(1,6)

Slide56

Marginal Rate of Substitution

Ron “substitutes” pumpkin juice for

butterbeer

to maintain the same level of utility.

MRS (of pumpkin juice for

butterbeer

) =

Interpretation of the above formula: MRS represents the number of glasses of

butterbeer

Ron is willing to give up to consume an additional glass of pumpkin juice.

 

Slide57

What does this imply?

Butterbeer

more valuable for his utility.

Ron wants 3 glasses of pumpkin juice in exchange for giving up only a single glass of

butterbeer

.

Slide58

Budget Constraint

Thus far we have been assuming that Ron, Dean and Draco have just been able to acquire the drinks that increase their utility.

We know for a fact that nothing in the real world comes without a price.

The budget constraint is given by:

 

Slide59

Let’s return to Ron’s example

Let price of a single glass of

butterbeer

be $5 and a single glass of pumpkin juice be $4.

Given that Ron consumes 2 glasses of

butterbeer

and 3 glasses of pumpkin juice. How much Income does he need to satisfy his utility?

Slide60

Solution?

Slide61

Solution

-

Therefore, Income needed:

 

Slide62

Budget constraint: Graphical explanation

- So we just found how much money it would take to buy 2 glasses of

butterbeer

and 3 glasses of pumpkin juice = $22.

Suppose we now have 100 bucks and the prices of

butterbeer

and pumpkin juice remain the same. How would you graph the curve?

Slide63

Budget constraint: Graphical explanation

Equation to graph?

- 5*y+4*x=100

Y



butterbeer

x  pumpkin juice

y

x

25

20

Slide64

What happens when price of butterbeer

changes?

Slide65

What happens when price of pumpkin juice changes?

Slide66

What happens when price of both changes?

Slide67

What happens when income increases?

Slide68

What happens when income decreases?

Slide69

Midterm

October 31

st

2016

Material Covered up to that date will be in the exam.

Slide70

Consumer Equilibrium and Market Demand

- Chapter 4, in

Introduction to

Agricultutal

Economics,

Penson

et al.

Slide71

Consumer Equilibrium

So now we know what an individual’s utility is.

And we know their budget.

Can we then find the “consumption bundle” that maximizes their utility.

“Equilibrium” definition: A state of balance. Or a steady state.

“Equilibrium” economics definition: When the no-one has any incentive to deviate from the current consumption, all things being constant.

Slide72

Things you need to find the “best” consumption bundle:

Price of goods

Utility function

Budget

Find Marginal Rate of Substitution:

Find consumer equilibrium

Slide73

What does consumer equilibrium mean?

It is simply:

“consumer equilibrium”

 is the “

demand

” for a particular good.

At equilibrium the consumer identifies the “quantity” of a good, which he wants to buy at a given price.

Slide74

What is demand?

A

demand curve

is a schedule that shows, holding all other factors constant, the inverse or opposite relationship between the price of a good and the amount/quantity of good consumed.

3

2

1

2

4

6

Price

Quantity of a good

Demand curve

Slide75

The relationship that matters

 pumpkin juice



butterbeer

Goal  Find the point on the line that maximizes utility.

 

Slide76

Graphical representation

2

Butterbeer

Pumpkin juice

3

1

6

Utility level = 36

A

B

A and B are two consumption bundles, which give the same utility level.

For the

blue

budget constraint, utility is maximized at A

For the

orange

budget constraint,

utility is maximized at B.

Slide77

Changes in Equilibrium

As stated previously:

-Changes in income or price of goods, would lead to a change in consumer demand for goods and services.

-This assumes that every other factor remains constant.

Slide78

Example: Changes in Equilibrium

Albus

Dumbledore likes Cauldron Cakes and Treacle tarts at

Hogsmeade

village.

Price of cauldron cake: $2

Price of treacle tart: $3

His equilibrium consumption is at: 3 cauldron cakes and 2 treacle tarts.

Slide79

Graph his indifference curve, point of consumption and budget constraint.

Slide80

Now assume that price of cauldron cake decreases by 1

Two things happen:

Since Cauldron cake is cheaper,

Albus

wants to “substitute” cauldron cakes for treacle tart. This is called the

substitution effect

But his effective income also went up because one of the goods (cauldron cake) is cheaper. So he could consumer more of both goods. This is called the “income effect”.

Slide81

Graphical representation: Equilibrium change

 

B

C

 

A

 

 

is the original treacle tart consumption.

is the “original” cauldron cake consumption.

A

 original consumer equilibrium

B  “substitution” move

C  final equilibrium

is the new treacle tart consumption.

is the new cauldron cake consumption.

 

Treacle tart

Cauldron cake

Substitution effect

Income effect

Slide82

Drawing graphs for substitution and income effects: Steps

- Draw original budget constraint. Mark point of “consumer equilibrium”

Once price changes, draw new budget constraint. Identify new “consumer equilibrium”.

Identify substitution effect. It is the movement on the original indifference curve

Draw parallel hyphenated budget constraint to the new budget constraint, on the original indifference curve. (shown in graph)

Identify income effect. It is the distance between the hyphenated constraint and the new budget constraint.

** Strongly recommend reading the book!!

Slide83

Question: draw graph for new equilibrium when, price of cauldron cake increases by 1.

Slide84

What would happen if income increased to 50?

- How do the substitution and income effects work then?

Slide85

Homework 3: Draw graph for when the price of treacle tart decreases by 1?

Slide86

Solution?

Slide87

Market Demand

- The horizontal sum of individual demands is called the “market demand”.

Albus

Cornelius

+

=

Market

Price

Qty

Qty

Aggregated quantity

Slide88

Consumer Surplus

Is the difference between the maximum price consumers are willing to pay and the actual price they actually pay.

CS

Price

Qty

10

2

5

Slide89

Important disclaimer:

-

CS

Price

10

2

5

This here is a demand curve, not a budget constraint!

Remember budget constraint comes into play when both axis have two goods.

The demand curve explains the relationship between price and quantity of an individual good.

Slide90

How do we find the “consumer surplus”?

Basically find the area of the triangle.

…and what’s the formula?

Area of triangle =

 

Slide91

Question: Find the CS for the following problem

CS

Price

20

4

7

Slide92

Question: Find the CS for the following problem

CS

Price

20

4

7

Slide93

Solution?

Slide94

Measurement and Interpretations of Elasticities

In the book:

Chapter 5 (please review book carefully)

Slide95

The story so far:

We have learned about utility.

From there we get the demand for a good we desire.

When a group of people have separate demand curves, aggregating them gives us the

market demand

.

What is left is the degree of responsiveness to change in prices and incomes.

Slide96

This degree of responsiveness is known as an

elasticity.

Very Elastic

Less Elastic

Price

Price

Quantity

Quantity

Slide97

Definitions:

Own price elasticity of demand

or

just the

price elasticity of demand

is the measure of responsiveness of quantity demanded of good X to a change in the price of good X.

Income elasticity of demand

is the measure of responsiveness of quantity demanded of good X to a change in the income.

Cross price elasticity of demand

is the measure of responsiveness of quantity demanded of good Y to a change in the price of good X.

Slide98

Own Price Elasticity of Demand

How do you find it?

 

Slide99

Own Price Elasticity of Demand

How do you find it?

 

change

response

Response in quantity

Change in price

Slide100

Own price elasticity: Specifics

Numerator:

Denominator:

 

Slide101

Own Price Elasticity: Example

Anakin Skywalker is a Pizza enthusiast. His price and quantity movements are described in the table below.

Find his own price elasticity of demand?

4

3

2

1

Slices per day

$ per unit

1

2

3

4

5

6

Pizza demand curve

Price

Quantity

$3

3 slices

$2

5 slices

Slide102

Solution

Put in the formula:

 

Slide103

Own Price Elasticity: Another Question

Luke Skywalker is a Burger enthusiast. His price and quantity movements are described in the table below.

Find his own price elasticity of demand?

4

3

2

1

Slices per day

$ per unit

1

2

3

4

5

6

Pizza demand curve

Price

Quantity

$3

3 slices

$2

4 slices

Slide104

Solution?

Slide105

Income elasticity of Demand

-Same idea as before. Now we find, measure of responsiveness of quantity demanded of good X to a change in the income.

Original demand

new demand

$ per unit

Units of X

 

 

Price

Slide106

Income elasticity of Demand

How do you find it?

 

change

response

Response in quantity

Change in income

Slide107

Question: Income Elasticity of Demand

Darth Sidious likes owning lightsabers. When his income is $100 his demand for lightsabers is 20. His income rises by 100% a year later. He now demands 40 lightsabers. Find his elasticity of demand?

Slide108

Cross Price Elasticity of Demand

Cross price elasticity of demand

is the measure of responsiveness of quantity demanded of good Y to a change in the price of good X.

How do you find it?

 

Slide109

Cross-Price Elasticities

If the elasticity is:

Positive: The goods are substitutes

Negative: The goods are complements

Zero: The goods are independent.

Slide110

Homework 3: Cross Price Elasticity of Demand

Nathan Drake likes to eat two types of cookies: Choco-chip and Peanut Butter cookies. He was consuming 4

choco

-chip cookies and 5 peanut butter cookies. The price of

choco

-chip cookies went up by 20%, which resulted in him

decreasing

his

choco

-chip cookie consumption by 25% and

increasing

peanut butter cookie consumption by 20%.

Find Nathan’s own-price elasticity of demand and cross-price of elasticity of demand.

Are

choco

-chip cookies: complements? Substitutes or independent?

Slide111

Solution?

Slide112

Introduction to Production and Resource Use

- Thus far we have talked about:

Consumers and their utility.

The

demand

that emerges from that utility.

We now transition into how that demand gets translated into an actual product through resource use.

Slide113

Inputs, Production and Costs

Classification of inputs and how they are used in production.

The production function.

Total costs, average costs and marginal costs.

Marginal and Average Revenue.

Slide114

But first we start with

Perfect Competition

What is perfect competition?

“the situation prevailing in a market in which buyers and sellers are so numerous and well informed that all elements of monopoly are absent and the market price of a commodity is beyond the control of individual buyers and sellers.”

**The farm sector comes closer than any other sector of the economy to satisfying the conditions of perfect equilibrium.

Slide115

Conditions for Perfect Equilibrium

The products sold in the market are homogenous. Buyers in the market choose from a number of sellers.

Any business can enter the market, without barriers.

No single seller has a disproportionate influence on price. (That is

imperfect competition

, which we will get to later.

**Everything we talk about from here on out assumes the conditions for perfect equilibrium. Keep that in the back of your mind.

Slide116

Inputs

- You are a supplier of wheat. You have to make wheat? What do you require?

Slide117

Inputs

- You are a supplier of wheat. You have to make wheat? What do you require?

Land

Labor

Capital

Management

Slide118

The Production Function

A production function characterizes the relationship between the use of inputs and the level of output.

Say

, there could be more.

is measured in physical quantity. For example: Bushels of wheat and Gallons of milk.

 

Slide119

Total Physical Product Curve

“Shows the relationship between output and one input, while holding other inputs fixed.

output

TPP curve

Daily labor use

Slide120

Marginal Physical Product

“Explains how output changes as an input is changed (increase/decrease).

Formula

The MPP measures the rate of change in output in response to a change in use of labor.

When TPP is

decreasing

MPP is

negative

.

 

Slide121

Average Physical Product

Is defined exactly as the words say. APP is capturing average output per input use, holding all other inputs constant.

For example: output per hour of labor spent.

APP =

 

Slide122

Let’s start with an example

-

1

2

3

4

Daily labor use

Daily output level

MPP

APP

10

1

16

2

20

4.8

22

6.5

26

8.1

32

9.6

40

10.8

50

11.6

62

12.0

72

11.7

MPP =

 

Slide123

Let’s start with an example

-

1

2

3

4

Daily labor use

Daily output level

MPP

APP: (2) / (1)

10

1

0.1

16

3

0.33

0.19

20

4.8

0.45

0.24

22

6.5

0.85

0.30

26

8.1

0.40

0.3

32

9.6

0.25

0.30

40

10.8

0.15

0.27

50

11.6

0.08

0.23

62

12.0

0.02

0.19

72

11.7

-0.02

0.15

1

2

3

4

Daily labor use

Daily output level

APP: (2) / (1)10

10.11630.330.19204.80.450.24

226.50.850.30268.10.40

0.3329.60.250.304010.80.150.275011.60.08

0.236212.00.020.197211.7-0.020.15

Slide124

Relation between MPP and APP

If MPP is above the APP, the APP must be rising.

If MPP is below the APP, the APP must be falling.

The MPP cuts the APP from above, at the point where APP is at its maximum.

APP

MPP

MPP/APP

Labor Use

Slide125

Homework 4:

Calculate the MPP and APP for the following table:

1

2

3

4

Daily labor use

Daily output level

MPP

APP

1

10

?

2

15

?

?

3

45

?

?

4

60

?

?

5

55

?

?

Graph the MPP/APP curves?

Slide126

Summary of production strategy

If MPP is rising, it makes sense to increase input use.

If MPP is falling, irrational to increase input use, since both Average output and marginal output are declining.

- In some cases average output might flat line, in that case maintaining inputs is ideal.

Slide127

Costs

We talked about this: as resources in the very first lecture.

Broadly categorized into two categories:

Short-run: there are both fixed and variable costs.

Long-run: there are no fixed costs.

For example: once you bought equipment, it would be considered a fixed cost for at least a season (short-run). Since you have no choice but to use it.

Slide128

Short-Run Costs

Short-run Costs:

-Total Variable cost (TVC). (

Egs

of variables costs?)

-Total Fixed cost (TFC).

TC = TFC + TVC

Slide129

Graphically understanding: TFC & TVC

Fixed cost (TFC) creates a flat line along the x-axis.

Variable cost (TVC), rises with input use.

Therefore, TFC is also rises along with the TVC

1

3

4.8

6.5

8.1

9.6

10.8

11.6

100

200

300

400

500

Total Cost

Total variable Cost

Total fixed Cost

Dollars

Output

Slide130

Average Total Cost

- Average total cost (ATC): is the cost per unit of output.

Formula: ATC =

This formula can be split into two parts, just like the cost function

Formula: AFC =

Formula AVC =

 

Slide131

Understanding the nature of costs

Terms to keep in mind

ATC

AFC

AVC

AFC declines with production, because cost is fixed cost never changes.

AVC decline

upto

a certain point in the output, but rise when output expands further.

Slide132

Average Variable cost & the APP curve

Both curves are basically mirror images.

The maximum APP in the example shown is at 0.31 and is attained when daily labor is 26 hours.

The AVC is at it’s lowest point then. (Graph: next slide)

- When output per unit of labor rises, AVC must necessarily decline.

Slide133

Short-Run Cost Schedule

Total

ouput

TFC

AFC

TVC

AVC

TC

MC

ATC

1

100

?

50

3

100

?

80

4.8

100

?

100

6.5

100

?

110

8.1

100

?

130

9.6

100

?

160

10.8

100

?

200

11.6

100

?

250

12.0

100

?

310

11.7

100

?

380

AFC = TFC/output

Slide134

Short-Run Cost Schedule

Total

ouput

TFC

AFC

(2)/(1)

TVC

AVC

(4)/(1)

TC

(2)+(4)

MC

ATC

(3)+(5)

1

100

100

50

50.00

150

150

3

100

33.3

80

26.67

180

60

4.8

100

20.83

100

20.83

200

41

6.5

100

15.38

110

16.92

210

32.31

8.1

100

12.35

130

16.05

230

28.40

9.6

100

10.42

160

16.67

26027.08

10.81009.2620018.5230027.7811.61008.6225021.5535030.17

12.01008.3331025.8341034.1711.7100

8.5538032.4848041.03

Slide135

Marginal Cost (MC)

Defined as: the change in firm’s total costs as output changes.

The most important cost.

Both in terms of money and time.

Formula

 MC=

Also think in terms of time: For instance the marginal cost of money.

You spent tens of hours trying to learn a skill and were able/unable to.

For example: An Olympic swimmer, who trains for years (

thinktime

as a cost/resource) and is unable to win a medal.

 

Slide136

Returning to our Short-run Cost Schedule

MC is:

Total

ouput

TFC

AFC

(2)/(1)

TVC

AVC

(4)/(1)

TC

(2)+(4)

MC

ATC

(3)+(5)

1

100

100

50

50.00

150

150

3

100

33.3

80

26.67

180

?

60

4.8

100

20.83

100

20.83

200

?

41

6.5

100

15.38

110

16.92

210

?

32.31

8.1

100

12.35

130

16.05

230

?

28.40

9.610010.42160

16.67260?27.0810.81009.2620018.52300?27.7811.61008.62250

21.55350?30.1712.01008.3331025.83410?34.17

11.71008.5538032.48480?

41.03

Slide137

Returning to our Short-run Cost Schedule

What is the MC here?:

Total

ouput

TFC

AFC

(2)/(1)

TVC

AVC

(4)/(1)

TC

(2)+(4)

MC

ATC

(3)+(5)

1

100

100

50

50.00

150

150

3

100

33.3

80

26.67

180

15.00

60

4.8

100

20.83

100

20.83

200

11.11

41

6.5

100

15.38

110

16.92

210

5.88

32.31

8.1

100

12.35

130

16.05

230

12.50

28.40

9.610010.4216016.67

26020.0027.0810.81009.2620018.5230033.3327.7811.61008.6225021.55

35062.5030.1712.01008.3331025.83410150.034.17

11.71008.5538032.48480N/A41.03

Slide138

Understanding the MC curve?

Why is there an N/A in the table?

Well you will notice that output in fact declines in the last cell.

Can’t have a negative MC.

Slide139

Graph: Marginal & Average Cost

3

4.8

6.5

8.1

9.6

10.8

11.6

10

20

30

40

50

60

MC

ATC

AVC

AFC

Dollars

Output

Slide140

Graph: Observations

ATC starts out so high.

But AVC pulls it down, before ATC starts to rise again through rising AVC.

As an example: Think initial farm investment.

Slide141

Question: Calculate Marginal Cost

Output

Total Cost

MC

1

21

3

51

?

5

71

?

8

81

?

13

101

?

21

131

?

23

171

?

19

211

?

Slide142

Understanding Revenue: Short-Run Decision-making

- Total Revenue = Output price

Output

Marginal Revenue

: Is the change in revenue by producing more output.

Formula

 marginal revenue =

 

Slide143

How much should a firm/company produce?

Easily one of the most important decisions for the firm.

Produce too much, while incurring a higher cost. Only to see consumers not buying your product.

A business should never increase the use of an input if marginal cost exceeds marginal revenue.

Slide144

How much should a firm produce?

- Produce at the point, where:

Intuition: The equation above is

the point at which the marginal revenue from the sale of another unit of output equals the marginal cost of producing that output.

Economic Profit

from production is maximized when the firm operates where

marginal cost is equal to marginal revenue.

 

Slide145

In Perfect Competition…

In perfect equilibrium:

marginal revenue is the output price.

Consider the following table:

Total

ouput

Output Price

Total Revenue

TC

Economic Profit

TC

(2)+(4)

MC

Marginal

Revenue

1

45

?

150

?

150

3

45

?

180

?

180

?

?

4.8

45

?

200

?

200

?

?

6.5

45

?

210

?

210

?

?

8.1

45

?

230

?

230

?

?

9.6

45

?260?260??10.845?300?300?

?11.645?350?350??12.0

45?410?410??

11.745?480?480??

Slide146

In Perfect Competition…

In perfect equilibrium: marginal revenue is the

output price

.

Consider the following table:

Total output

Output Price

Total Revenue

TC

Economic Profit

TC

(2)+(4)

MC

Marginal

Revenue

1

45

45

150

-105

150

3

45

135

180

-45.00

180

15

45

4.8

45

216

200

16.00

200

11.11

45

6.5

45

292

210

82.50

210

5.88

45

8.1

45

364

230

134.50

230

12.5

45

9.6

45

432260172.0026020.004510.845486300186.00300

33.334511.645522350172.0035062.5045

12.045540410130.00410150.00

4511.74552648046.50480N/AN/A

Slide147

A few observations

The marginal revenue curve is flat, notice again that marginal revenue curve is the output price.

The flatness suggests that the firm/business is a price taker.

The business is small enough to not have a perceptible impact on the market price.

Bottomline

: Average Revenue = Marginal Revenue = Output price.

The profit maximizing level of output is found at the point, where the marginal revenue curve intersects with the marginal cost curve.

Slide148

Graphical Analysis:

3

4.8

6.5

8.1

9.6

10.8

11.6

10

20

30

40

50

60

MC

ATC

AVC

Dollars

70

1

MR

Output

Produce at this output level

Breakeven point: Average Revenue = Average Total Cost

Shut down point

Economic Profit

0,0

Slide149

Summary of Analysis

If marginal revenue (same as average revenue/output price) falls to where the ATC is then: the firm’s average total costs will be the same as the average revenue. Can still produce, by “breaking even”.

If MR/AR/Price were to fall further, where it is just tangent to the AVC, then production must

shutdown.

Firm can no longer afford to remain in production.

Shaded area is the economic profit.

Slide150

Level of Resource Use

We have just determined what the

profit-maximizing level

of output should be.

So how to find the optimal input use level?

- Compare profit-maximizing output level to actual input use.

Slide151

Let’s return to the very first table

1

2

3

4

Daily labor use

Daily output level

MPP

APP: (2) / (1)

10

1

0.1

16

3

0.33

0.19

20

4.8

0.45

0.24

22

6.5

0.85

0.30

26

8.1

0.40

0.3

32

9.6

0.25

0.30

40

10.8

0.15

0.27

50

11.6

0.08

0.23

62

12.0

0.02

0.19

72

11.7

-0.02

0.15

1

2

3

4

Daily labor use

Daily output level

APP: (2) / (1)

1010.1163

0.330.19204.80.450.24226.50.850.30

268.10.400.3329.60.25

0.304010.80.150.275011.60.080.236212.00.020.1972

11.7-0.020.15

Slide152

But there is another way

Profit-maximizing input demand:

Marginal Benefit from input use =

= Marginal Value Product (MVP).

We were using Labor initially so,

Marginal Value product for Labor =

 

Slide153

MPP vs MB

Slide154

Profit-maximizing level of input

Occurs when,

Here, if additional labor were applied the marginal cost would exceed the marginal benefit of labor use.

Which would no longer be the profit-maximizing point.

 

Slide155

Marginal Value Product Example

-

Use of Labor

MPP

MVP

($45 price)

Wage

Marginal Net Benefit

Cumulative Net Benefit

10

16

0.33

?

5.00

?

?

20

0.45

?

5.00

?

?

22

0.85

?

5.00

?

?

26

0.40

?

5.00

?

?

32

0.25

?

5.00

?

?

40

0.15

?

5.00

?

?

50

0.08

?

5.00

?

?

62

0.03

?

5.00??76

-0.02?---

Slide156

Marginal Value Product Example

-

Use of Labor

MPP

MVP

Wage

Marginal Net Benefit

(3) / (4)

Cumulative Net Benefit

10

16

0.33

14.85

5.00

9.85

9.85

20

0.45

20.25

5.00

15.25

25.10

22

0.85

38.25

5.00

33.25

58.35

26

0.40

18.00

5.00

13.00

71.35

32

0.25

11.25

5.00

6.25

77.60

40

0.15

6.75

5.00

1.75

79.35

50

0.08

3.60

5.00

-1.40

77.95

62

0.03

1.35

5.00-3.6574.3076-0.02-0.90--

-

Slide157

Conclusion

Because the MVP is nothing but the MPP multiplied by a fixed price. The slope of the MVP mirrors that of the MPP.

If you fix output price as 1, then we can also say:

 

Slide158

Homework 5:

Draw a graph/s for all the curves.

1

2

3

4

5

6

7

Daily labor use

Daily output level

MPP

MVP

($5 price)

Wage rate

Marginal

Net Benefit

Cumulative Net Benefit

1

10

3

?

2

15

?

?

3

?

?

3

30

?

?

3

?

?

4

47

?

?

3

?

?

5

60

?

?

?

?

?

6

65

?

?

???755??-?

Slide159

Midterm Reminder

As previously discussed. Midterm is on the 31

st

of October

Questions from material in Chapters 3 through 7 will be asked in the exam.

Mix of multiple choice and fill in the blanks questions.

Won’t be required to draw graphs.

Some questions will have a special answer choice: “Unsure, explanation below”. Good way to get extra credit.

All the questions will come from material covered in the notes.

You don’t have to worry about anything not in the notes.

Slide160

General Advice About the Midterm

Slide161

Economics of Input and Product Substitution

Chapter 7: In the book.

Slide162

Understanding interaction of inputs

In the previous chapter, we focused on varying use of one input.

The purpose was to understand:

Important production concepts.

Their relationship to the cost of production.

And the profit-maximizing level of output.

We now expand this discussion to include

two inputs

and input substitution.

The purpose of this chapter is to explain the economics of input substitution in the short-run and long-run.

Slide163

Isoquant

A curve that reflects the combination of two inputs that result in a particular level of output is called an

isoquant

.

Along the isoquant, an infinite number of combinations of two inputs (say labor and capital) give the same level of output.

As the quantity of labor increases less capital is necessary to produce a given level of output.

Slide164

Graphical comparison of Isoquants and

Isoutility

.

- Notice the similarities.

 

 

butterbeer

Pumpkin juice

=10

 

=20

 

capital

labor

isoutility

isoquant

Slide165

Isoquants Continued

A higher level of isoquant implies a higher output.

Question:

Would a producer always want to increase his/her output?

Slide166

Isoquants Continued

A higher level of isoquant implies a higher output.

Question:

Would a producer always want to increase his/her output?

Answer:

No. Recall that the goal of the producer is profit-maximize, excess production only increases his marginal cost.

And as mentioned in the previous chapter if marginal cost > marginal revenue, then the producer should not use any more inputs.

Slide167

Marginal Rate of Technical Substitution (MRTS)

Recall earlier, when we were talking about utility, we talked about marginal rate of substitution.

That was defined as the rate at which a consumer would give up consumption of one good for the other, such that his utility remains the same.

-RTS is the exact same idea: how much would a producer s

ubstitute one input for the other

to maintain the

same level of output

.

Slide168

Mathematical representation

Formula,

- Therefore, the MRTS (capital for labor) is nothing but the ratio of

The above equation indicates the change in labor must be compensated by changes in capital to keep the output at the same level.

 

Slide169

MRTS: Further explained

When labor is

substituted

for capital along an isoquant, the MRTS of capital for labor falls.

Just like MRS (in utility theory), a declining MRTS is the consequence of the law of diminishing marginal returns.

Recall that after some point as you increase labor the MPP falls.

Also keep in mind that while having any combination of inputs on an isoquant is going to keep the output at the same level,

there is only a certain region of input choices, which maximize profit.

Eg

: Think of a producer trying to decide between two types of fertilizers.

Slide170

MRTS: Extreme Cases

Substitute inputs at the extreme can be either

perfect substitutes

or

perfect complements

.

The isoquants we have seen in the graph, can be called imperfect substitutes.

Slide171

Understanding Min and Max functions:

For a perfect complement:

“Min” here stands for minimum function

 “Max” stands for maximum function

 

Slide172

“Min” function continued

For example. Suppose an engine requires 1 part of two different inputs. You have 10 parts of the first input and 12 parts of the second.

How many engines can you make?

Having two additional parts of the second input is a waste because you can’t use them.

You can think of other examples in agriculture.

 

Slide173

The Iso

-Cost line

Again, the same idea as before: just like a consumer’s budget constraint: An

Iso

-cost line is nothing but a producer’s budget constraint.

For example:

 

Slide174

Slide175

Slide176

Slope of the given budget line is?

Always remember, to find the slope of any equation convert it to the form:

Y

 value to put on the vertical axis.

X value to put on the horizontal axis.

b slope of the line.

A the intercept.

 

Slide177

Graph of Iso

-Cost line

capital

labor

5

10

15

20

50

100

150

200

Slide178

If the budget doubles then?

capital

labor

5

10

15

20

50

100

150

200

Slide179

If budget doubles then?

capital

labor

5

10

15

20

50

100

150

200

Slide180

If the budget halves then?

capital

labor

5

10

15

20

50

100

150

200

Slide181

Draw graphs for when wage rate decreases to $5

Slide182

Homework 6: Isoquant &

Isocost

Question: Suppose there is a pumpkin juice producer, the wage rate for employed labor is $10 an hour and the cost of capital is $100. Based on this information, answer the following questions.

Let’s say the hourly budget is: $1000. Draw

iso

-cost line.

What is the least cost level of capital and labor this business should utilize when packaging 1000 cases of pumpkin juice? How did you arrive at this answer?

How much does it cost his business to package 1000 cases of pumpkin juice?

If the firm can sell the juice for $50 per case, what is the profit?

Slide183

Slide184

Slide185

Least-cost use of inputs for a given output

Two input decisions, a business faces in the short-run that pertain to input use:

First is the least cost combination of inputs to produce a given level of output.

Second is the least cost combination of inputs to produce a given a level of budget.

Slide186

Short-run Least Cost Input Use

The business wants to produce a given level of output and wants to do so at the lowest possible cost.

Graphically: this is the point where the

iso

-cost line is just tangent

ot

the isoquant curve.

Notice again the analogous nature of this setup and the one in consumer theory.

Slide187

Graphical comparison

 

 

butterbeer

Pumpkin juice

=10

 

=20

 

Capital

Labor

isoutility

isoquant

Consumer

Producer

Consumer’s budget constraint

producer’s

iso

-cost

G

H

Slide188

Relation between MRTS and input price ratio

The slopes at the point where the

Iso

-cost line touches the isoquant are the same. (Point G or H) in the previous slide.

At this point the MRTS of capital for labor (

is equal to the input price ratio.

Mathematically,

 

Slide189

Notice again the parallel with consumer theory

Consumer theory

Producer theory

MRS

=

 

 

Slide190

Long-Run Expansion of Input use

Thus far we have talked about short-run input use decisions.

Some costs are

fixed

, others are

variable

in the short-

tun

In the long-run,

all costs are variable.

Slide191

Long-Run Average Costs (LAC)

Recall that:

However, we were talking about that ATC in the “short-run”. Think perhaps of costs of a farmer for 1 season.

A typical short-run average cost curve can be graphically expressed as:

 

SAC

Cost per unit

output

Slide192

The presence of the fixed cost gives the SAC its u-shape.

Consider the following SAC curves:

The average costs represents the sizes of three business: A, B and C.

A is the smallest with costs represented by:

B is larger, with average cost curve as:

C is largest, with curve being:

The values OA, OB and OC on the horizontal axis depict the least cost output level.

 

 

Cost per unit

output

 

 

A

B

C

O

Slide193

- If the business decides it wants to get bigger from A to C, it can produce at OC instead of OA.

The point of the previous slide is to show, how the “long-run” average cost evolves as business alter their sizes.

The long-run average cost curve

, illustrates to the business how varying its size will effect the business’s economic efficiency.

Slide194

LAC: Definition & Graph

Is comprised of points on a series of short-run average cost curves.

The idea is to determine the profitability of different sizes of operations.

Since the business eventually desires

to expand.

Graph:

LAC

Cost per unit

output

Slide195

Returns to Size

Constant returns to size

(CRS): An increase in output caused by an exactly proportional increase in inputs. For example:

doubling

inputs causes output to

double.

Increasing returns to size

(CRS): An increase in output more than proportional increase in inputs. For example:

doubling

inputs causes output to

triple.

Decreasing returns to size

(CRS): An increase in output more than proportional increase in inputs. For example:

doubling

inputs causes output to

triple.

Slide196

Slide197

Production Possibilities Frontier

Thus far we have examined issues associated with the combination of inputs used by a business.

We focused on the degree to which one input could be substituted for another to producer a given level of output.

It is also important to understand the substitution among the different products the business can produce.

Slide198

Production Possibilities Frontier

Chapter 6 introduced the concept of technical efficiency by indicating the minimal of hours required to produce given levels of output.

Technical Efficiency: “

maximum output possible from the given level of inputs”.

Production Possibilities Frontier:

Illustrates the maximum output for different combinations of two products a firm can produce.

Slide199

An Example:

A company has an option of canning either all fruit, all vegetables or some combination of these two products:

The company has a fixed canning capacity.

Slide200

Marginal Rate of Transformation (MRT)

Represents the rate at which the canning of fruit must contract (expand) for a one-case increase (decrease).

 

Slide201

Cases of Canned Fruit

Cases of Canned Vegetables

Marginal Rate of Transformation

135,000

0

128,000

10,000

?

119,000

20,000

?

108,000

30,000

?

95,000

40,000

?

80,000

50,000

?

63,000

60,000

?

44,000

70,000

?

23,000

80,000

?

0

90,000

?

Marginal Rate of Transformation (MRT)

Slide202

Cases of Canned Fruit

Cases of Canned Vegetables

Marginal Rate of Transformation

135,000

0

128,000

10,000

-0.7

119,000

20,000

-0.9

108,000

30,000

-1.1

95,000

40,000

-1.3

80,000

50,000

-1.5

63,000

60,000

-1.7

44,000

70,000

-1.9

23,000

80,000

-2.1

0

90,000

-2.3

Cases of Canned Fruit

Cases of Canned Vegetables

135,000

0

128,000

10,000

-0.7

119,000

20,000

-0.9

108,000

30,000

-1.1

95,000

40,000

-1.3

80,000

50,000

-1.5

63,000

60,000

-1.7

44,00070,000-1.923,00080,000-2.10

90,000-2.3Marginal Rate of Transformation (MRT)

Slide203

PPF: Graph

20

40

60

80

100

120

140

0

20

40

60

80

100

120

140

Canned vegetables

Canned fruit

The end points indicate specialization in either canning fruit or canning vegetables.

Any point on the line would result in the canning of some of both commodities with the

same inputs

PPF curve

Slide204

Profit-Maximizing Combination of Products

The ISO-Revenue line is:

Slope of this line is?

 

Slide205

Profit-Maximizing Combination of Products

The ISO-Revenue line is:

Slope of this line is?

 

Slide206

Another way to remember the slope

Slide207

Profit-Maximizing Combination of Products

The profit maximizing business seeks to maximize the revenue for the least cost combination of inputs.

The business wants to determine the point where the MRT equals the relative prices of the products being sold.

 

Slide208

Let’s return to the table

Cases of Canned Fruit

Cases of Canned Vegetables

Revenue

: price fruit: $33.33, price vegetables:

Marginal Rate of Transformation

Slope

135,000

0

?

128,000

10,000

?

-0.7

?

119,000

20,000

?

-0.9

?

108,000

30,000

?

-1.1

?

95,000

40,000

?

-1.3

?

80,000

50,000

?

-1.5

?

63,000

60,000

?

-1.7

?

44,000

70,000

?

-1.9

?

23,000

80,000

?

-2.1

?

0

90,000

?

-2.3

?

Cases of Canned Fruit

Cases of Canned Vegetables

Revenue

: price fruit: $33.33, price vegetables:

Slope

135,000

0

?

128,000

10,000

?

-0.7

?

119,000

20,000

?

-0.9

?

108,000

30,000

?

-1.1

?

95,000

40,000

?

-1.3

?

80,000

50,000

?

-1.5

?

63,000

60,000

?

-1.7

?

44,000

70,000

?

-1.9

?

23,000

80,000

?

-2.1

?

0

90,000

?

-2.3

?

Slide209

Let’s return to the table

Cases of Canned Fruit

Cases of Canned Vegetables

Revenue

: price fruit: $33.33, price vegetables: $25

Marginal Rate of Transformation

Slope

135,000

0

4,449,550

128,000

10,000

4,516,240

-0.7

0.75

119,000

20,000

4,446,270

-0.9

0.75

108,000

30,000

4,349,640

-1.1

0.75

95,000

40,000

4,166,350

-1.3

0.75

80,000

50,000

3,916,400

-1.5

0.75

63,000

60,000

3,599,790

-1.7

0.75

44,000

70,000

3,216,520

-1.9

0.75

23,000

80,000

2,766,590

-2.1

0.75

0

90,000

2,250,000

-2.3

0.75

Cases of Canned Fruit

Cases of Canned Vegetables

Revenue

: price fruit: $33.33, price vegetables: $25

Slope

135,000

0

4,449,550

128,000

10,000

4,516,240

-0.7

0.75

119,000

20,000

4,446,270

-0.9

0.75

108,000

30,000

4,349,640

-1.1

0.75

95,000

40,000

4,166,350

-1.3

0.75

80,000

50,000

3,916,400

-1.5

0.75

63,000

60,000

3,599,790

-1.7

0.75

44,000

70,000

3,216,520

-1.9

0.75

23,000

80,000

2,766,590

-2.1

0.75

0

90,000

2,250,000

-2.3

0.75

Slide210

Solution?

Where is the profit maximizing point?

Slide211

Understanding it Graphically

-

20

40

60

80

100

120

140

0

20

40

60

80

100

120

140

Canned fruit

PPF curve

Iso

-Revenue Line

Canned vegetables

Slide212

What happens when price of fruit decreases to $25?

-

20

40

60

80

100

120

140

0

20

40

60

80

100

120

140

Canned fruit

PPF curve

Iso

-Revenue Line

Canned vegetables (value in 1000s)

Find new slope?

Draw the profit maximizing point on the graph?

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Market Equilibrium in Perfect Competition

Thus far we have discussed individual demand and market demand

This represents only 1 half of the relationship needed to understand changing market conditions.

We now turn our attention to the

market supply curve

.

Recall that in the previous two chapters we discussed the producer’s production strategies.

All we are doing is simply extending the discussion to several producers.

Slide220

Review of the individual Supply Curve

Slide221

Derivation: Market Supply

- Recall the individual business’s supply curve, is derived at the point where

marginal cost = marginal revenue

.

Market Supply curve: found by horizontally summing individual supplies.

Slide222

Graphically

Consider two growers of broccoli:

A

and

B

+

=

0.50

1.00

1.50

2.00

2.50

3.00

1

2

3

4

5

6

1

2

3

4

5

6

Price Broccoli

Price Broccoli

Quantity Broccoli

Quantity Broccoli

0.50

1.00

1.50

2.00

2.50

3.00

1

2

3

4

5

6

0.50

1.00

1.50

2.00

2.50

3.00

Price Broccoli

Quantity Broccoli

Slide223

Graph: Explanation

Grower

A

would be willing to supply 1 ton of fresh broccoli if the market price of were $1.00 per pound

And 2 tons if price was $1.50 per pound.

Grower

B

on the other hand would not produce at $1.00 per pound.

He/she wants $1.50 per pound to produce 1 pound of broccoli.

Slide224

Graph: Explanation

Now suppose that the market supply of broccoli was limited to these two suppliers then:

Market Supply:

At $1.00 per pound, the supply is 1 pound of broccoli.

At $1.50 per pound, the supply is 3 pounds of broccoli.

Slide225

How did we get that?

Market Supply generally has a positive slope.

Because quantity supplied increases as the price received increases.

Slide226

Producer’s Surplus

Producer surplus is the economic return above the firm’s variable cost of production.

When economic profit exists, surpluses are accruing to businesses.

A business will supply the first unit of output at the price equal to marginal cost of producing it.

Say, MC was $1 and product price was $4, then the producer’s surplus is $3.

Now suppose the MC of producing the 100

th

unit was $3 then the producer surplus would be $1

Slide227

Product price

Market Supply

$4

PS

Output

Price

Slide228

For Practice

Slide229

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Consumer Surplus Vs Producer Surplus

Slide236

Market Equilibrium

Thus far we have discussed Market Demand and Market Supply.

Before we move forward a brief refresher on Market Demand:

Slide237

Market Equilibrium

We are now ready to understand how the shifts in demand and supply work.

But first let’s look at a simple demand and supply graph:

Slide238

Shifts in Demand

Caused by an external factor impacting utility.

A shift is not a movement on a demand curve.

We can expect both prices and quantities to respond in unison.

Slide239

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Slide241

Shifts in Supply

Caused by external shocks to supply.

Eg

: In agriculture, think weather shocks, etc.

Slide242

Shifts in both Demand & Supply

Slide243

Adjustments to Market Equilibrium

Market Surplus Vs Market Shortage

D

S

 

 

 

 

 

 

Surplus

Shortage

Slide244

Adjustment to the Market Equilibrium

Below the market equilibrium / clearing price: Quantity demanded is more than quantity supplied. So we would have a shortage.

Above the market equilibrium / clearing price: Quantity supplied is more than quantity demanded. So we would have a shortage.

Eventually we expect the prices and quantities to return to the equilibrium

Slide245

Homework 7

Q: Consider the beef market, where currently demand and supply is relatively stable. However, due to production problems the supply decreases. Also, after the supply decrease, the government restricts the total quantity of beef in the market, which is lower than the new equilibrium. Draw the market movements in a graph and label all prices and quantities.

Slide246

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Market Equilibrium: Imperfect Competition

Upto

this point we have assumed that conditions required for perfect equilibrium exist in the market place.

In reality, the economy does not consist of perfectly competitive firms.

In this chapter we will examine several forms of imperfect competition.

Slide251

Market Equilibrium: Imperfect Competition

We now tread into concepts such as:

Monopolistic Competition.

Monopoly.

Oligopoly.

Slide252

Market Structure Characteristics

The number and size distribution of sellers and buyers.

The degree of product differentiation.

The extent of the barriers to entry.

The economic environment within which the industry operates.

First 3 much more important.

Slide253

Number of Firms & Size Distribution

Competitive conditions break down when the number of firms declines.

The prices are less likely to set by the forces of supply and demand.

- Greater market concentration as firms decline.

Slide254

Product Differentiation

Refers to the extent buyers in the market perceive of the differentiation in the product.

If the buyers perceive the product to be identical, then the product is said to be homogenous.

In a homogenous market, a seller has difficulty in setting a high price.

Because products supplied are identical, buyers have little incentive in paying for higher prices.

Slide255

Barriers to Entry

Forces that make it difficult for firms to enter the market.

Some barriers are created by existing firms.

Four common barriers to entry:

Absolute unit cost – advantages.

Economies of scale.

Capital Access and cost.

Preferential government policies.

Slide256

Before we move on…

Brief refresher on conditions for perfect competition:

All firms sell an identical (homogenous) product.

All firms are price-takers, they cannot control the market price of their product.

All firms have a relatively small market share.

The industry is characterized by free entry and exit of firms

Slide257

Monopolistic Competition

Conditions of monopolistic competition basically mirror those of perfect competition,

with one key difference.

Monopolistic competition occurs when

products in the market are differentiated

.

The differentiation in the product gives some flexibility in pricing the product.

A monopolistic competition becomes a price taker if it can effectively differentiate its product in the market, when others in the market are offering similar products.

Classic example in agriculture: Farm input manufactures advertising to promote branded hybrid seeds.

Slide258

Monopolistic competition

While monopolistic competition allows producers to set prices.

The extent of it, depends on the degree of product differentiation.

Therefore, you’ll notice that all producers are desperately trying to differentiate their product through advertisements.

Eg

: Think attack Ads as well.

Slide259

Monopolistic competition: Specifics

Cost structure of firms monopolistic competition is same as perfect competition.

No new firms allowed to enter in the short-run.

However, product differentiation allows for

downward sloping demand and marginal revenue.

In perfect competition

demand and marginal revenue were flat.

Slide260

-

Price

Quantity

Total Revenue

Marginal Revenue

15

0

14

2

13

4

12

6

11

8

10

10

9

12

8

14

7

16

6

18

5

20

4

22

3

24

2

26

1

28

0

30

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-

Price

Quantity

Total Revenue

Marginal Revenue

15

0

0

14

2

28

14

13

4

52

12

12

6

72

10

11

8

88

8

10

10

100

6

9

12

108

4

8

14

112

2

7

16

112

0

6

18

108

-2

5

20

100

-4

4

22

88

-6

3

24

72-822652-10

12828-120300-14

Slide262

Monopolistic Competition: Short-run Equilibrium

Output determined at the point where marginal cost = marginal revenue.

Price determined through demand curve.

Profit: Area between price and ATC (average total cost)

Slide263

Monopolistic competition: Short-run

- Graphs

Slide264

Monopolistic competition: Long-run

Entrants allowed.

Profits lowered.

Demand curve shifts downwards.

Monopolistic competition inefficient than perfect competition.

Slide265

Long-run: Graphs

Slide266

Homework: 8

Price

Quantity

Total Revenue

Total Cost

Marginal Revenue

Marginal cost

17

0

14

2

20

11

4

24

8

6

25

5

8

27

2

10

29

0

12

31

Find output of monopolistic firm? (For that you need marginal revenue and marginal cost)

Graph everything: indicate output point, demand and marginal revenue curve, finally indicate profit area?

Slide267

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Oligopoly

Similar to monopolistic competition with

one key difference

.

There are few sellers.

Each of which is large enough to have an influence on the market volume and price.

Differentiating the product is still the objective of an oligopolist.

Oligopolists have what is known as

market power

.

Slide269

Oligopoly: continued

If an oligopolist tries to raise its price, then there is no reason for other oligopolies to follow.

If an oligopolist attempts to lower its price, then the other firms will immediately retaliate.

Oligopolies emerge because of thin markets or barriers to entry.

Price leadership occurs in oligopolies, where one firm leads and other set prices accordingly.

Classic example: airline industry.

Slide270

Oligopoly: continued

Creates opportunities for collusion

amongst firms

.

But this does not necessarily occur.

Mergers and Acquisitions another common feature of oligopolies. (One of the reason oligopolies are formed).

Most recent example: Merger of AT&T and Time Warner.

Slide271

- Important points to remember:

If an oligopolist reduces prices, then other

oligopolists

in the market will follow suit because they do not want to be undercut in the market.

However, if 1 oligopolist increases his price, then it is not necessary that others follow the leader, since the rest might be eyeing a higher market share.

Slide272

Monopoly

At the opposite end of perfect competition is

monopoly.

Only

1 seller

in the market.

Number one reason for monopolies to exist: barriers to entry.

Classic example: Microsoft, only recognizable broad social network.

Slide273

Monopoly: continued

- A monopoly is similar to an oligopoly, except that a monopolist does not have to worry about retaliation.

Monopoly prices are usually higher. Should make sense, it has no competition.

If input costs increase, monopolies can easily pass that cost to the consumer.

However, in practice monopolists don’t want keep prices too high, to discourage entry into the market.

Goal of a monopoly

 to remain a monopoly

Slide274

Graphs:

Unlike monopolistic competition, monopolies realize profits even in the long-run.

Slide275

Summary table: Imperfect competition

Item

Perfect Competition

Monopolistic Competition

Oligopolies

Monopolies

Number

of sellers

Numerous

Many

Few

One

Ease of Entry or exit

Unrestricted

Unrestricted

Partially restricted

Restricted absolute

Ability to set price

None

Some

Yes

Absolute

Long-run profits

None

None

Yes

Yes

Product differentiation

None

Yes

Yes

Product is unique

Examples:

Corn

producers

Soft-drink bottlers

Airline Industry

Microsoft

Slide276

Consumer and Producer Surplus in imperfect competition

Slide277

Consumer and Producer Surplus in Imperfect Competition

Slide278

Imperfect Competition in Buying

Monopsony

Oligopsony

Monopsonistic Competition

Slide279

Imperfect Competition in Buying

Upto

this point we have considered imperfect competition in selling activities.

Imperfect competition can influence the market price for resources used in production.

Eg

: Think of a single grain elevator in a region, on which several farmers are dependent for selling their grain.

Slide280

Monopsony

Buyer’s monopoly is basically known as a monopsony.

A monopsonist is the only buyer in the market and therefore faces and faces an upward sloping market input supply curve.

As a consequence, its buying decisions affect input prices.

Slide281

Monopsony

The monopsonist typically considers the

marginal input cost

of purchasing an additional unit of resource.

Marginal input cost:

is defined as the change in the cost of a resource used in production as more of this resource is employed.

Slide282

Monopsony: Example

-

Units of variable

input

Price per unit

Total

cost of input

Marginal input cost

1

$3.00

2

3.50

3

4.00

4

4.50

5

5.00

6

5.50

7

6.00

8

6.50

9

7.00

10

7.50

Slide283

Monopsony: Example

-

Units of variable

input

Price per unit

Total

cost of input

Marginal input cost

1

$3.00

3

2

3.50

7

4

3

4.00

12

5

4

4.50

18

6

5

5.00

25

7

6

5.50

33

8

7

6.00

42

9

8

6.50

52

10

9

7.00

63

11

10

7.50

75

12

Slide284

Graphical analysis

Understanding the relationship of Marginal Revenue Product (MRP), supply of input and marginal cost of input (MIC)

Slide285

The case of sole buyer and sole seller

Eg

: Consider the case of a meat packer, who is the only buyer of beef cattle in the region and the only one supplying packaged beef to restaurants.

What is the profit maximizing level of input?

Slide286

Graphical Analysis

MRP

MVP

MIC

Supply of input

 

 

 

 

 

 

 

 

Slide287

Notation for graph

 monopsonist buyer, monopoly seller.

 perfect competition buyer and seller.

 perfect competition in selling and monopsonist buyer.

 perfect completion in buying and monopoly seller.

 

Slide288

Oligopsony and Monopsonistic Competition

Oligopsony: Few buyers instead one

one

.

Monopsonistic Competition: Several buyers but differentiated services.

Slide289

Monopoly: Ceiling price

Federal regulations force lower price.

Quantity in market increases.

Profit of monopolist lowered

Slide290

Graph: Monopoly ceiling price

Slide291

Monopoly: Lump-sum Tax

Profit of monopoly lowered again because of the tax.

Higher ATC than before causes lower profits.

Quantity remains the same.

Slide292

Graph: Lump-sum Tax

Slide293

Monopsony: Minimum Price

Graph:

Slide294

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Chapter 11

Product Markets & National Output

National Economy.

Gross Domestic Product.

Consumption, Savings and Investment

Slide297

Circular Flow of Payments

Barter Economy:

In which households and businesses exchange goods and services as a means for paying for their purchases.

Since there is no money to pay to serve as a medium for exchange.

Households/businesses barter amongst themselves to obtain goods and services.

Problem with barter economy?

Random question:

When was money invented?

Study of money is known as?

Slide298

Circular Flow of Payments

Barter Economy:

In which households and businesses exchange goods and services as a means for paying for their purchases.

Since there is no money to pay to serve as a medium for exchange.

Households/businesses barter amongst themselves to obtain goods and services.

How would that work?

Problem with barter economy?

Random question:

When was money invented?

Study of money is known as:

Numismatics

Slide299

Monetary Economy

When there is “money” in the economy, households/businesses now receive money for the services rendered/goods exchanged.

Typically businesses receive “money” for the goods and services provided to household

Slide300

National Income

- The monetary value of the products flowing to households through the product markets represents the

national product.

 

Slide301

This is how a domestic economy works

Slide302

Quick Announcement

Syllabus for the final exam:

6,7,8,9,

12 (partial)

Not 11!

Slide303

Composition & Measurement of GDP

GDP : Gross Domestic Product

Two approaches:

– Expenditures approach

 activity in the product market.

- Income Approach

 activity in the resources market.

Slide304

GDP

GDP =

Total Consumption + Gross Private Domestic Investment +

Government purchases of goods and services +

Net exports of goods and services