Riassunto esame Microeconomics, prof. Vannoni, libro consigliato Microeconomics, Pindyck

MRTS=MPL/MPK

OPTIMAL CHOICE FOR PRODUCERS

SMALL SUMMARY

INDIFFERENCE CURVE ISOQUANT

Slope: MRS=- deltaC/deltaF Slope: MRTS= - deltaK/deltaL

Diminishing marginal returns Diminishing marginal returns

MRS=MUF/MUC MRTS= MPL/MPK

By now we have just considered the possibility of substituting inputs to get the same output

level.

Now we consider also the possibility of increasing output by increasing inputs.

What happens to the production level?

1. input doubles> output doubles, constant returns to scale, sum of the coefficients of the

function is = 1, isoquants are equidistant

2. input doubles> output more than doubles, increasing returns to scale, sum >1, isoqants are

close together

3. input doubles> output less than doubles, decreasing returns to scale, sum< 1, isoquants are

far apart 3

The cost of production

• cost in the short run

As we have diminishing marginal returns in the production, output decreases when adding labor

after a certain level, so this means I need more labor to produce an amount of output, so I have

more costs, so the marginal cost( cost of producing one unit more) is increasing.

Marginal product is decreasing(diminishing marginal returns) > marginal cost is increasing

Fixed costs decrease with output.

When marginal cost is under the average cost, the average cost decreases.

When marginal cost is over the average cost, the average cost increases.

Average cost curve is U shaped because of diminishing marginal returns.

• Cost in the long run

Here we can change both inputs, so we can choose those inputs with the lowest costs to have the

same output.

1. The firm wants the output to be fixed.

We use ISOCOST LINES, whose function is the total cost one and whose slope is

deltaK/deltaL. They are similar to the budget line.

Where the isoquant intersects the lowest isocost that is the Optimal choice in terms of costs.

MRTS=MPL/MPK=w/r

OPTIMAL CHOICE OF PRODUCTION IN TERMS OF COSTS, MINIMIZING THEM

Average cost curve in the long run is U shaped because of the returns to scale:

• Constant returns to scale> same prices> same costs

• Increasing returns to scale> lower prices> lower costs

• Decreasing returns to scale> higher prices> higher costs

Where marginal cost is under average cost, average cost is decreasing

Where marginal cost is over the average cost, the average cost is increasing.

2. Output level changes > isoquants change> we have different optimal choices>expansion path

joins all the points of choices.

In the short run, because og the inflexibility of capital, the expansion path is a horizontal line

In the long run, the expansion path is a line from the origin.

Conclusions on both chapter 6 and 7:

If output doubles and costs less than double> economies of scale

If output doubles and costs more than double> diseconomies of scale

Economies and diseconomies of scale depend on the elasticity of cost on quantity>

Ec= (deltaC/deltaQ)/ (C/Q)= MC/AC

• If Ec=1> , MC=AC, nothing

• IF Ec>1, MC>AC, diseconomies of scale

• If Ec< 1, MC< AC, economies of scale

Increasing returns to scale: output more than doubles when the inputs double.

Economies of scale: output double but costs less than double 4

Profit maximization and competitive supply

Given what the demand is and what the costs are, the firm should decide how much to produce, that

is the supply function.

In perfect competition:

1. homogenous goods, products are perfectly substitutable

2. price taking, each firm takes the price as given

3. free entry and exit.

Introduction:

Marginal revenue is the slope of the revenue curve and marginal cost is the slope of the cost curve.

At the beginning when we have zero output costs are positive because we have fixed costs which do

not depend on the ouput, revenues are zero of course so the profit is negative.

Then when output increases, revenues increase and costs increase but less than revenues so profit is

finally positive until it reaches a point where it is maximum. The output level chosen is where

MC=MR. Any output lower than this would lead to MR> MC, any higher output would lead to

MC>MR.

This point is exactly where MC=MR=P

PROFIT MAXIMIZATION

Marginal costs and revenues are equal to price because the firm in the market is price taker so the

demand curve for a single firm is horizontal, whilst the demand curve for the industry is downward

sloping.

• Choosing an output that maximizes profit in the short run

Here we have fixed capital.

The profit is thus maximized at MC=MR and it is equal to the area of the rectangle between

ATC, MC and MR.

If fixed costs are high, it might happen that ATC is above MR=P, so there would be a

subsequent loss and the firm should better go out of the market. But, if these fixed costs are

sunk costs, then the firm should stay in the market and use as a profit the one formed by MR,

AVC and MC.

In the short run, the supply curve is then a part of the MC where MC is above AC=P.

Perfectly inelastic supply > a greater output can be achieved only if new plants are built.

Perfectly elastic supply> marginal cost is constant

The producer surplus= revenues – variable costs

Profit= revenues – variable costs- fixed costs

• Choosing output in the long run

Here, the firm can change its inputs and also decide to rearrange its plant size.

The profit is maximized where MC= P

PROFIT MAXIMIZATION IN THE LONG RUN

If MC= ATC then profit = 0, ZERO ECONOMIC PROFIT.

In the long run the equilibrium occurs where:

1. all firms in the industry are maximizing their profit 5

2. all firms are making zero economic profit so there is not incentive for the others to enter or

exit the industry

3. the price is such that quantity demanded= quantity supplied

The long run supply curve shape depends on the costs:

1. constant costs> horizontal supply curve

2. increasing costs> upward sloping

3. decreasing costs> downward sloping

The analysis of competitive markets

First of all we have to underline the definitions of

PRODUCER SURPLUS, the area of the triangle between the supply curve and the market price

CONSUMER SURPLUS, the area of the triangle between the demand curve and the market price.

Government’s adjustment of the prices can lead to a change in both surpluses.

• Ceiling price: the gov establishes that the market price can be no higher than a certain level,

some consumers will buy at a higher price, some wont buy at all so in the end they lose. The

same applies for consumers, because they earn less from the consumers who buy at a lower

price, but at the same time they lose some consumers who wont buy at all. So we have a

deadweight loss.

Consumers: a-b

Producers: -a-c

Final: -b-c

• Price above market level

Here the consumers will lose only from the consumers who don’t buy, but will only earn from

those who will buy at a higher price. The consumers will lose double.

Consumers: -a-b

Producers: a-c

Final: -b-c

• Minimum prices

Here again we have a Pmin that is higher than the market price, the situation is like the one

above, but the firm loses more because it loses what it had produced and wont sell.

C: -a-b

P: a-c-d

Final: -b-c-d

• Price supports

Here the government buys the quantity in excess but society as a whole suffers a loss.

C: -a-b

P: a+b+d

Final: C+P – COST TO GOV= D- (Q2-Q1)Ps

• Production quotas

The gov establishes that no more than a certain level of quantity can be supplied. Thus the

supply curve is here a vertical line. The gov gives incentives 6

C: -a-b

P: a-c+payments for not producing=a-c+b+d=a+b+d

Final: -a-b+a+b+d-b-c-d=-b-c

• Import quotas:

The gov decides that imports are not allowed.

C: -a-b-c

P: a

Final: -a-b-c+a=-b-c

• Tariffs:

C: -a-b-c-d

P: a

Final: -a-b-c-d+a-b-c-d

• Tax

Qd=QdPb

Qs=QaPs

Qd=Qs

Pb-Ps=tax

The more inelastic is the demand function the more tax is on consumers.

• Subsidy

the contrary of a tax.

Ps-Pb= S

The benefits of a subsidy accrue mostly to buyers if Ed/Es is small and mostly to sellers if Ed/Es

is large.

Market power: monopoly and monopsony

Monopoly

DEFINITION

Monopoly means one seller, many buyers.

DEMAND

In this case the demand for the firm is the market demand. So the firm’s revenues are the market’s

revenues. When the marginal revenue is positive, revenues are increasing. When marginal revenue

is negative, revenues are decreasing.

A monopolist maximizes profit when MC= MR, so a firm should decide a price so that MR=MC>

>MARKUP>(P-MC)/P=-(1/Ed)

P=MC/1+(1/Ed)

RULE OF THUMB FOR PRICING AT A POINT WHERE MR=MC

• Ed for the firm is large > markup is small

• Ed is small> markup is large

SUPPLY

No curve, because there’s no one to one relation between price and quantity produced.

TAX

MR=MC+t 7

Monopoly power

Most of the times we are not in front of a real monopoly, but just in front of a firm with

MONOPOLY POWER.

For this kind of firms, the demand curve is not that elastic like the one in a competitive market

neither inelastic like in a monopoly. Moreover, their price is not exactly equal to MC, but slightly

exceeding.

We can measure the degree of monopoly power using the

LERNER INDEX OF MONOPOLY POWER

L=(P-MC)/P=-(1/Ed)

where o<L<1

if L=0> perfectly competitive market

L=1 monopoly

The larger L, the greater the degree of monopoly power.

Monopoly power is not that good in terms of welfare. In fact, the price is higher than MC and the

quantities are lower, so consumers spend more or don’t buy at all.

So, to limit monopoly power, the government regulates the price.

Suppose the gov establishes a certain price. What happens to AR and MR?

• AR turns to be horizontal

• MR is identical to AR

Natural monopoly

Is a firm that can produce the entire output of the market with a cost that is lower than what it would

be the one if several firms were producing the same output. It’s the case of strong economies of

scale. Here the average cost is declining everywhere and marginal cost is always below average

cost. So the firm should be regulated so that AC=AR to avoid not covering the costs because of a

too low price and going out of business. This is a rate of return regulation: the max price allowed is

based on the expected rate of return that the firm will earn.

Monopolistic competition and Oligopoly

Definition

Monopolistic competition is quite similar to perfectly competitive markets, but here products are

differentiated to that customers are loyal to their favourite brand, so products are not perfect

substitutes like in the competitive market.

EQUILIBRIUM

In the short run the equilibrium is reached wher