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Intro to firmsslide 3 Perfect Competition A market form with these characteristics: 1) Large number of firms. 2) Homogeneous product. 3) Easy entry and exit of firms. Some economists add to this list that consumers and firms also have cheap, accurate information about prices.
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Intro to firms slide 1
THEORIES OF THE FIRMTHEORIES OF THE FIRM
Theories of the firm try to explain supply.
Intro to firms slide 2
BACKGROUND TERMSBACKGROUND TERMS
Theories of the firm are organized around the different kinds of market forms in which firms can operate.
In this course, the market forms are grouped this way:Perfect competitionMonopolyMonopolistic competition, andOligopoly
Intro to firms slide 3
Perfect CompetitionPerfect Competition
A market form with these characteristics:1) Large number of firms.2) Homogeneous product.3) Easy entry and exit of firms.
Some economists add to this list that consumers and firms also have cheap, accurate information about prices.
Intro to firms slide 4
What the assumptions boil down to is that each firm in perfect competition is a price taker.
NO FIRM HAS ANY CONTROL OVER MARKET PRICE.
This means that the demand curve the firm sees for its product is infinitely elastic.
Intro to firms slide 5
Infinitely elastic demand curve of a perfectly competitive producer of soybeans in Mason, Michigan:
price
quantity(hundred bushels)
P0
P0 is the current market price.
Intro to firms slide 6
WARNING!
The market demand curve is still negatively sloped:
price
quantity(hundred bushels)
P0
price
P0
quantity(million bushels)
D
MARKET FIRMS
Intro to firms slide 7
In competitive markets, market price is determined by supply and demand.
If a firm were to raise its price above market price it would lose all its sales. It would never be silly enough to charge less because it can sell all it wants at the going market price.
Intro to firms slide 8
OTHER MARKET FORMS OTHER MARKET FORMS DEFINEDDEFINED
MONOPOLY: a market with only one seller of a product for which there are no close substitutes.
MONOPOLISTIC COMPETITION: a market with many firms, easy entry, and product differentiation. (Each firm produces a slightly different version of the product.)
OLIGOPOLY: a market with a small number of firms.
Intro to firms slide 9
PROFITPROFITProfit is the difference between total revenue and total
cost, or Profit = TR - TC.
In economics class cost means OPPORTUNITY cost.
Because opportunity cost is often different from accounting cost, economic profit has a very special meaning and significance.
Intro to firms slide 10
TWO EXAMPLES SHOWING THE DIFFERENCE BETWEEN OPPORTUNITY (a.k.a. ECONOMIC OR FULL) COSTS, AND ACCOUNTING COSTS.
Intro to firms slide 11
Jim’s H&H Mobil -- A Proprietorship Annual costs and revenues
Receipts from sales $200,000Costs
Employees’ labor $100,000Rent 25,000Gas, oil, parts, etc. 30,000
Total explicit costs $155,000
Accounting “profit” = 200,000-155,000=45,000Cost of Jim’s labor resources & effort = Value of Jim’s labor in
next best use (an implicit cost) = $35,000
ECONOMIC PROFIT = $10,000
Intro to firms slide 12
BugOff Software, Inc. -- A Corporation
Receipts $400,000Costs
Employees’ Labor $100,000Disks, computers, advertising, etc. 100,000
Before tax accounting profit 200,000Profit taxes 50,000After tax profit 150,000
Dividends 100,000Retained earnings 50,000
Opportunity cost of capital = $125,000
ECONOMIC PROFIT = 25,000
Intro to firms slide 13
The smallest amount of money that must be paid to shareholders to keep them investing in the company is sometimes called “normal” profit. “Normal” profit is a cost. It is part of opportunity costs.
Intro to firms slide 14
SHORT-RUN VS. LONG-RUNSHORT-RUN VS. LONG-RUN
Short-run: a time period over which the firm has some inputs it can’t change. (Short-run implies at least one fixed input. In the short-run firms can’t enter or leave an industry.)Reasons:
Long-run: a time period over which the firm can choose the amounts of all of its inputs. (Long-run implies no fixed inputs. In the long-run firms can enter or leave an industry.)