HL: RATIONAL PRODUCER BEHAVIOR
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WHAT: COSTS, REVENUES AND PROFITS
Understand the concept of rational producer behavior
Be aware that Neo-classical theory assumes that the aim of firms is to maximize profits |
WHY: SO THAT YOU ARE ABLE TO EXPLAIN THE MARKET OUTCOMES (ALLOCATIVE EFFICIENCY AND PRODUCTIVE EFFICIENCY) OF DIFFERENT MARKET STRUCTURES
This subtopic will start with a short introduction to market structures, before developing some fundamental theory on costs, revenues and profits that you will need for a more in-depth analysis of market structures. There are four market structures that you will learn about:
- Monopoly
- Oligopoly
- Monopolistic competition
- Perfect competition
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How happy are you when the products you buy are produced by businesses with little or no competition?
Would you prefer many smaller firms, or fewer large firms? Under what circumstances might it be OK to have fewer firms operating? |
HOW AN ECONOMIST UNDERSTANDS PROFITS (BE AWARE BM STUDENTS)
COSTS
Define and explain the idea of economic costs
Define between explicit costs and implicit costs
Define, illustrate, calculate and give examples of short run costs
Define between explicit costs and implicit costs
Define, illustrate, calculate and give examples of short run costs
| costs_2020_rev.docx |
| costs_2020_rev_-_workings.docx |
| law_of_diminishing_returns.docx |
REVENUES
Define, explain and illustrate total, average and marginal revenues.
Explain and illustrate the relationship between total, average and marginal revenue and price elasticity of demand.
Explain and illustrate the relationship between total, average and marginal revenue and price elasticity of demand.
| revenues_2020-10_v2.docx |
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PROFITS
- Define and explain the measurement of profit
- Distinguish between normal, abnormal profit and losses
- Define, explain and illustrate the concept of profit maximisation
- Describe alternative business objectives of firms
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“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest. We address ourselves not to their humanity but to their self-love, and never talk to them of our own necessities, but of their advantages” |
| profits.docx |
Describing alternative business objectives of firms:
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mARKET STRUCTURES
PERFECT COMPETITION
- Describe, using examples, the assumed characteristics of perfect competition: a large number of firms; a homogeneous product; freedom of entry and exit; perfect information; perfect resource mobility.
- Explain, using a diagram, the shape of the perfectly competitive firm’s average revenue and marginal revenue curves, indicating that the assumptions of perfect competition imply that each firm is a price taker.
- Explain, using a diagram, that the perfectly competitive firm’s average revenue and marginal revenue curves are derived from market equilibrium for the industry.
- Explain, using diagrams, that it is possible for a perfectly competitive firm to make economic profit (abnormal profit), normal profit (zero economic profit) or negative economic profit in the short run based on the marginal cost and marginal revenue profit maximisation rule.
- Explain, using a diagram, why, in the long run, a perfectly competitive firm will make normal profit (zero economic profit).
- Explain, using a diagram, how a perfectly competitive market will move from short- run equilibrium to long-run equilibrium.
- Explain, using a diagram, when a loss-making firm would shut down in the short run.
- Explain, using a diagram, when a loss-making firm would shut down and exit the market in the long run.
- Explain the meaning of the term allocative efficiency.
- Explain that the condition for allocative efficiency is P = MC (or, with externalities, MSB = MSC).
- Explain, using a diagram, why a perfectly competitive market leads to allocative efficiency in both the short run and the long run.
- Explain the meaning of the term productive efficiency.
- Explain that the condition for productive efficiency is that production takes place at minimum average total cost.
- Explain, using a diagram, why a perfectly competitive firm will be productively efficient in the long run, though not necessarily in the short run.
The most competitive market imaginable. Perfect COMPETITION is rare and may not even exist. It is so competitive that any individual buyer or seller has a negligible impact on the market PRICE. Products are homogeneous. INFORMATION is perfect. Everybody is a price taker. FIRMS earn only normal PROFIT, the bare minimum profit necessary to keep them in business. If firms earn more than that (excess profits) the absence of barriers to entry means that other firms will enter the market and drive the price level down until there are only normal profits to be made. OUTPUT will be maximised and price minimised. Contrast with MONOPOLISTIC COMPETITION, OLIGOPOLY and, above all, MONOPOLY.
| is_capitalism_becoming_less_competitive.docx |
| perfect_competiton__-_rational_producer_behavior.docx |
MONOPOLISTIC COMPETITION
- Describe, using examples, the assumed characteristics of a monopolistic competition: a large number of firms; differentiated products; absence of barriers to entry and exit.
- Explain that product differentiation leads to a small degree of monopoly power and therefore to a negatively sloping demand curve for the product.
- Explain, using a diagram, the short-run equilibrium output and pricing decisions of a profit-maximising (loss-minimising) firm in monopolistic competition, identifying the firm’s economic profit (or loss).
- Explain, using diagrams, why in the long run a firm in monopolistic competition will make normal profit.
- Distinguish between price competition and non-price competition.
- Describe examples of non-price competition, including advertising, packaging, product development and quality of service.
- Explain, using a diagram, why neither allocative efficiency nor productive efficiency are achieved by monopolistically competitive firms.
- Compare and contrast, using diagrams, monopolistic competition with perfect competition, and monopolistic competition with monopoly, with reference to factors including short run, long run, market power, allocative and productive efficiency, number of producers, economies of scale, ease of entry and exit, size of firms and product differentiation.
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| monopolistic_competition_notes.docx |
| 392695276-tragakes-overview.pptx |
OLIGOPOLY
- Describe, using examples, the assumed characteristics of an oligopoly: the dominance of the industry by a small number of firms; the importance of interdependence; differentiated and homogeneous products; high barriers to entry.
- Explain why interdependence is responsible for the dilemma faced by oligopolistic firms – whether to compete or to collude.
- Explain how a concentration ratio may be used to identify an oligopoly.
- Explain how game theory (the simple prisoner’s dilemma) can illustrate strategic interdependence and the options available to oligopolies.
- Explain the term 'collusion', give examples, and state that it is usually (in most countries) illegal.
- Explain the term 'cartel'.
- Explain that the primary goal of a cartel is to limit competition between member firms and to maximise joint profits as if the firms were collectively a monopoly.
- Explain the incentive of cartel members to cheat.
- Analyse the conditions that make cartel structures difficult to maintain.
- Describe the term 'tacit collusion', including reference to price leadership by a dominant firm.
- Explain that the behaviour of firms in a non-collusive oligopoly is strategic in order to take account of possible actions by rivals.
- Explain, using a diagram, the existence of price rigidities, with reference to the kinked demand curve.
- Explain why non-price competition is common in oligopolistic markets, with reference to the risk of price wars.
- Describe, using examples, types of non-price competition.
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| oligopoly.pptx |
| oligopoly_ms.docx |
MONOPOLY
HOW: BE ABLE TO...Monopoly (HL):
- Describe, using examples, the assumed characteristics of a monopoly: a single or dominant firm in the market; no close substitutes; significant barriers to entry.
- Describe, using examples, barriers to entry, including economies of scale, branding and legal barriers.
- Explain that the average revenue curve for a monopolist is the market demand curve, which will be downward sloping.
- Explain, using a diagram, the relationship between demand, average revenue and marginal revenue in a monopoly.
- Explain why a monopolist will never choose to operate on the inelastic portion of its average revenue curve.
- Explain, using a diagram,
- the short- and long-run equilibrium output and pricing decision of a profit maximising (loss minimising) monopolist, identifying
- the firm’s economic profit (abnormal profit), or losses.
- Explain the role of barriers to entry in permitting the firm to earn economic profit (abnormal profit).
- Explain, using a diagram, the output and pricing decision of a revenue maximising monopoly firm.
- Compare and contrast, using a diagram, the equilibrium positions of a profit maximising monopoly firm and a revenue maximizing monopoly firm.
- Calculate from a set of data and/or diagrams the revenue maximising level of output.
- With reference to economies of scale, and using examples, explain the meaning of the term 'natural monopoly'.
- Draw a diagram illustrating a natural monopoly.
- Explain, using diagrams, why the profit maximizing choices of a monopoly firm lead to allocative inefficiency (welfare loss) and productive inefficiency.
- Explain why, despite inefficiencies, a monopoly may be considered desirable for a variety of reasons, including the ability to finance research and development (R&D) from economic profits, the need to innovate to maintain economic profit (abnormal profit), and the possibility of economies of scale.
- Evaluate the role of legislation and regulation in reducing monopoly power.
- Draw diagrams and use them to compare and contrast a monopoly market with a perfectly competitive market, with reference to factors including efficiency, price and output, research and development (R&D) and economies of scale.
| 450308255-monopoly.pptx |
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inquiry: Does technology create more perfect or imperfect market structures? |
INTRODUCTION: In this inquiry you will consider how technology will significantly change the nature of competition within markets in the immediate future.
Technology can improve market competitions by reducing barriers to entry, for example third party vendors on Amazon marketplace or drivers who work for Uber or Lyft, it might be possible in the future for households to be less reliant on energy companies if solar panels become cheaper with improvements in technology. It can also create more imperfect markets through raising barriers to entry for example the origins of many natural monopolies are derived from the significant capital costs of technology e.g. 20th century railways or power stations. Further, as technology costs rise it is possible that more and more firms will consolidate into larger firms through merger to take advantage of the Economies of Scale enjoyed by larger firms. What will be the consequences for competition? What will be the consequences for market outcomes and how will the new technological landscape affect consumers and society more broadly?
Technology can improve market competitions by reducing barriers to entry, for example third party vendors on Amazon marketplace or drivers who work for Uber or Lyft, it might be possible in the future for households to be less reliant on energy companies if solar panels become cheaper with improvements in technology. It can also create more imperfect markets through raising barriers to entry for example the origins of many natural monopolies are derived from the significant capital costs of technology e.g. 20th century railways or power stations. Further, as technology costs rise it is possible that more and more firms will consolidate into larger firms through merger to take advantage of the Economies of Scale enjoyed by larger firms. What will be the consequences for competition? What will be the consequences for market outcomes and how will the new technological landscape affect consumers and society more broadly?
| inquiry_does_technology_create_more_perfect_or_imperfect_market_structures_.docx |
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