Chapter 9

Summary of Chapter 9

A. Patterns of Imperfect Competition

1. Most market structures today fall somewhere on a spectrum between perfect competition and pure monopoly. Under imperfect competition, a firm has some control over its price, a fact seen as a downward-sloping demand curve for the firm's output.

2. Important kinds of market structure are (a) monopoly, where a single firm produces all the output in a given industry; (b) oligopoly, where a few sellers of a similar or differentiated product supply the industry; (c) monopolistic competition, where a large number of small firms supply related but somewhat differentiated products; and (d) perfect competition, where a large number of small firms supply an identical product. In the first three cases, firms in the industry face downward-sloping demand curves.

3. Economies of scale, or decreasing average costs, are the major source of imperfect competition. When firms can lower costs by expanding their output, perfect competition is destroyed because a few companies can produce the industry's output most efficiently. When the minimum efficient size of plant is large relative to the national or regional market, cost conditions produce imperfect competition.

4. In addition to declining costs, other forces leading to imperfect competition are barriers to entry in the form of legal restrictions (such as patents or government regulation), high entry costs, advertising, and product differentiation.

B. Marginal Revenue and Monopoly

5. We can easily derive a firm's total revenue curve from its demand curve. From the schedule or curve of total revenue, we can then derive marginal revenue, which denotes the change in revenue resulting from an additional unit of sales. For the imperfect competitor, marginal revenue is less than price because of the lost revenue on all previous units of output that will result when the firm is forced to drop its price in order to sell an extra unit of output. That is, with demand sloping downward,
P = AR > MR = P − lost revenue on all previous q

6. Recall Table 9-4's rules relating demand elasticity, price and quantity, total revenue, and marginal revenue.

7. A monopolist will find its maximum-profit position where MR = MC, that is, where the last unit it sells brings in extra revenue just equal to its extra cost. This same MR = MC result can be shown graphically by the intersection of the MR and MC curves or by the equality of the slopes of the total revenue and total cost curves. In any case, marginal revenue = marginal cost must always hold at the equilibrium position of maximum profit.

8. For perfect competitors, marginal revenue equals price. Therefore, the profit-maximizing output for a competitor comes where MC = P.

9. Economic reasoning leads to the important marginal principle. In making decisions, count marginal future advantages and disadvantages, and disregard sunk costs that have already been paid.

Chapter 8

Summary of Chapter 8

A. Supply Behavior of the Competitive Firm

1. A perfectly competitive firm sells a homogeneous product and is too small to affect the market price. Competitive firms are assumed to maximize their profits. To maximize profits, the competitive firm will choose that output level at which price equals the marginal cost of production, that is, Diagrammatically, the competitive firm's equilibrium will come where the rising MC supply curve intersects its horizontal demand curve.

2. Variable costs must be taken into consideration in determining a firm's short-run shutdown point. Below the shutdown point, the firm loses more than its fixed costs. It will therefore produce nothing when price falls below the shutdown price.

3. A competitive industry's long-run supply curve, must take into account the entry of new firms and the exodus of old ones. In the long run, all of a firm's commitments expire. It will stay in business only if price is at least as high as long-run average costs. These costs include out-of-pocket payments to labor, lenders, material suppliers, or landlords and opportunity costs, such as returns on the property assets owned by the firm.

B. Supply Behavior in Competitive Industries

4. Each firm's rising MC curve is its supply curve. To obtain the supply curve of a group of competitive firms, we add horizontally their separate supply curves. The supply curve of the industry hence represents the marginal cost curve for the competitive industry as a whole.

5. Because firms can adjust production over time, we distinguish two different time periods: (a) short-run equilibrium, when variable factors like labor can change but fixed factors like capital and the number of firms cannot, and (b) long-run equilibrium, when the numbers of firms and plants, and all other conditions, adjust completely to the new demand conditions.

6. In the long run, when firms are free to enter and leave the industry and no one firm has any particular advantage of skill or location, competition will eliminate any excess profits earned by existing firms in the industry. So, just as free exit implies that price cannot fall below the zero-profit point, free entry implies that price cannot exceed long-run average cost in long-run equilibrium.

7. When an industry can expand its production without pushing up the prices of its factors of production, the resulting long-run supply curve will be horizontal. When an industry uses factors specific to it, such as scarce beachfront property, its long-run supply curve will slope upward.

C. Special Cases of Competitive Markets

8. Recall the general rules that apply to competitive supply and demand: Under the demand rule, an increase in the demand for a commodity (the supply curve being unchanged) will generally raise the price of the commodity and also increase the quantity demanded. A decrease in demand will have the opposite effects.
Under the supply rule, an increase in the supply of a commodity (the demand curve being constant) will generally lower the price and increase the quantity sold. A decrease in supply has the opposite effects.

9. Important special cases include constant and increasing costs, completely inelastic supply (which produces economic rents), and backward-bending supply. These special cases will explain many important phenomena found in markets.
D. Efficiency and Equity of Competitive Markets

10. The analysis of competitive markets sheds light on the efficient organization of a society. Allocative efficiency occurs when there is no way of reorganizing production and distribution such that everyone's satisfaction can be improved. Put differently, an economy is efficient when no individual can be made better off without making another individual worse off.

11. Under ideal conditions, a competitive economy attains allocative efficiency. Efficiency requires that all firms are perfect competitors and that there are no externalities like pollution or improved information. Efficiency implies that economic surplus is maximized, where economic surplus equals consumer surplus plus producer surplus.

12. Efficiency comes because (a) when consumers maximize satisfaction, the marginal utility (in terms of leisure) just equals the price; (b) when competitive producers supply goods, they choose output so that marginal cost just equals price; (c) since Thus the marginal social cost of producing a good under perfect competition just equals its marginal utility valuation in terms of goods or leisure forgone. It is exactly this condition—that the marginal gain to society from the last unit consumed equals the marginal cost to society of that last unit produced—which guarantees that a competitive equilibrium is efficient.

13. There are exacting limits on the conditions under which an efficient competitive equilibrium can be attained: There can be no externalities and no imperfect competition, and consumers and producers must have complete information. The presence of imperfections leads to a breakdown of the price ratio 5 marginal cost ratio 5 marginal utility ratio conditions, and hence to inefficiency.

14. The outcome of competitive markets, even when efficient, may not be socially desirable. Competitive markets by themselves will not necessarily ensure outcomes that correspond to the society's ideals about the fair distribution of income and consumption. Societies may modify the laissez-faire equilibrium to change the income distribution to correct for a perceived unfairness of dollar votes of demand.

Chapter 7

Summary of Chapter 7

A. Economic Analysis of Costs

1. Total cost (TC) can be broken down into fixed cost (FC) and variable cost (VC). Fixed costs are unaffected by any production decisions, while variable costs are incurred on items like labor or materials which increase as production levels rise.

2. Marginal cost (MC) is the extra total cost resulting from 1 extra unit of output. Average total cost (AC) is the sum of ever-declining average fixed cost (AFC) and average variable cost (AVC). Short-run average cost is generally represented by a U-shaped curve that is always intersected at its minimum point by the rising MC curve.

3. Useful rules to remember are
TC = FC + VC AC = TC/q AC = AFC + AVC
At the bottom of U-shaped AC, MC = AC = minimum AC.

4. Costs and productivity are like mirror images. When the law of diminishing returns holds, the marginal product falls and the MC curve rises. When there is an initial stage of increasing returns, MC initially falls.

5. We can apply cost and production concepts to a firm's choice of the best combination of factors of production. Firms that desire to maximize profits will want to minimize the cost of producing a given level of output. In this case, the firm will follow the least-cost rule: different factors will be chosen so that the marginal product per dollar of input is equalized for all inputs. This implies that
MPL/PL = MPA/PA = …
B. Economic Costs and Business Accounting

6. To understand accounting, the most important relationships are:
The character of the income statement (or profit-and-loss statement); the residual nature of profits; depreciation on fixed assets
The fundamental balance sheet relationship between assets, liabilities, and net worth; the breakdown of each of these into financial and fixed assets; and the residual nature of net worth
C. Opportunity Costs

7. The economist's definition of costs is broader than the accountant's. Economic cost includes not only the obvious out-of-pocket purchases or monetary transactions but also more subtle opportunity costs, such as the return to labor supplied by the owner of a firm. These opportunity costs are tightly constrained by the bids and offers in competitive markets, so price is close to opportunity cost for marketed goods and services.

8. The most important application of opportunity cost arises for nonmarket goods--those like clean air or health or recreation--which may be highly valuable even though they are not bought and sold in markets.

Summary to Appendix

1. A production-function table lists the output that can be produced for each labor column and each land row. Diminishing returns to one variable factor, when other factors are held fixed or constant, can be shown by calculating the decline of marginal products in any row or column.

2. An equal-product curve or isoquant depicts the alternative input combinations that produce the same level of output. The slope, or substitution ratio, along such an equal-product curve equals relative marginal products (e.g., MPL/MPA). Curves of equal total cost are parallel lines with slopes equal to factor-price ratios PL/PA. Least-cost equilibrium comes at the tangency point, where an equal-product curve touches but does not cross the lowest TC curve. In least-cost equilibrium, marginal products are proportional to factor prices, with equalized marginal product per dollar spent on all factors (i.e., equalized MPi/Pi.

Chapter 6

Summary of Chapter 6

A. Theory of Production and Marginal Products
1. The relationship between the quantity of output (such as wheat, steel, or automobiles) and the quantities of inputs (of labor, land, and capital) is called the production function. Total product is the total output produced. Average product equals total output divided by the total quantity of inputs. We can calculate the marginal product of a factor as the extra output added for each additional unit of input while holding all other inputs constant.

2. According to the law of diminishing returns, the marginal product of each input will generally decline as the amount of that input increases, when all other inputs are held constant.

3. The returns to scale reflect the impact on output of a balanced increase in all inputs. A technology in which doubling all inputs leads to an exact doubling of outputs displays constant returns to scale. When doubling inputs leads to less than double (more than double) the quantity of output, the situation is one of decreasing (increasing) returns to scale.

4. Because decisions take time to implement, and because capital and other factors are often very long-lived, the reaction of production may change over different time periods. The short run is a period in which variable factors, such as labor or material inputs, can be easily changed but fixed factors cannot. In the long run, the capital stock (a firm's machinery and factories) can depreciate and be replaced. In the long run, all inputs, fixed and variable, can be adjusted.

5. Technological change refers to a change in the underlying techniques of production, as occurs when a new product or process of production is invented or an old product or process is improved. In such situations, the same output is produced with fewer inputs or more output is produced with the same inputs. Technological change shifts the production function upward.

6. Attempts to measure an aggregate production function for the American economy tend to corroborate theories of production and marginal products. In the twentieth century, technological change increased the productivity of both labor and capital. Total factor productivity (measuring the ratio of total output to total inputs) grew at around 11⁄2 percent per year over the twentieth century, although from the 1970s to the mid-1990s the rate of productivity growth slowed markedly and real wages stopped growing. But underestimating the importance of new and improved products may lead to a significant underestimate of productivity growth.


B. Business Organizations

7. Business firms are specialized organizations devoted to managing the process of production.

8. Firms come in many shapes and sizes—with some economic activity in tiny one-person proprietorships, some in partnerships, and the bulk in corporations. Each kind of enterprise has advantages and disadvantages. Small businesses are flexible, can market new products, and can disappear quickly. But they suffer from the fundamental disadvantage of being unable to accumulate large amounts of capital from a dispersed group of investors. Today's large corporation, granted limited liability by the state, is able to amass billions of dollars of capital by borrowing from banks, bondholders, and stock markets.

9. In a modern economy, business corporations produce most goods and services because economies of mass production necessitate that output be produced at high volumes, the technology of production requires much more capital than a single individual would willingly put at risk, and efficient production requires careful management and coordination of tasks by a centrally directed entity.

shut down

o A company is considered to have shut down, if it temporary ceases production but keeps fixed capital. A company has exit the industry when it has made a permanent decision to leave the industry. The decision to temporarily shut down a business depends on a few factors.

o A firm will want to shut down in the short run when it can no longer cover its variable costs.


o The critically low market price at which revenues just equal variable costs is (or, equivalently, at which losses exactly equal fixed costs is called the shutdown point.

o If prices go up than shutdown point, the firm will produce along its marginal cost curve because, it would lose more money by shutting down.



o if a business shuts down, its total revenue becomes zero, and its total cost equals the fixed cost. So the company should continue producing its product, as long as it covers its variable costs. The firm therefore produces where profit equals marginal cost.


The zero-profit point comes where price is equal to AC, while the shutdown point comes where price is equal to AVC. Therefore, the firm’s supply curve is the solid rust line in figure. It first goes up the vertical axis to the price corresponding to the shutdown point at M1, where P equals the level of AVC and then continuous up the MC curve for prices above the shutdown price.

The analysis of shutdown conditions leads to the surprising conclusion that profit-maximizing firms may in the short run continue to operate even through they are losing money. This condition will hold for firms that are heavily indebted and therefore have high fixed costs.

For these firms, as long as losses are less than fixed costs profits are maximized and losses are minimized when they are able to pay the fixed costs.