Introduction to Agricultural Economics

Introduction to Agricultural Economics SAB 101 M-W-F: 9.00 am 9.50 am Fall 2016 Instructor: Sankalp Sharma Email: [email protected] Who am I? A word on my teaching philosophy About this class - In class expectation - Out of class expectation - Book

- Homework - Grading 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 dont be a troll! No cellphones or laptops during the class !! Out-of-class Expectation - No gains without practice. - Reading not enough, you must practice problems.

- Form groups to practice. - Understand concept, memorization wont help you. Book Introduction to Agricultural Economics 4th edition (Penson et al.) Buy used copy from Amazon for $11 Homework - Frequently assigned. - Usually only one question. - A random student will be asked to solve the HW on the board. 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) Questions? What is Economics? Problem Resources Required Solution What is Economics?

- Solutions often compromised due to several moving parts. - Best possible solutions rarely achievable. Economics: How the world works Consumer preferences Producer wants profit Creates Demand Create Supply Equilibrium: create price for

a quantity Does the previous chart hold true always? Consumer preferences Producer wants profit - No, not always - Producers often influence our preferences. - Eg: Lets say a new product Apple Inc. comes out with. 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. So lets begin Theory of Consumer Behavior In the book: chapter 3, part 2: Understanding Consumer behavior. What is utility? What is utility? It is a set of preferences.

What does a typical utility function (U) look like? U(.) Food, wealth, health, etc. What does my utility function look like? U(.) Food, travel, health, swimming, relationship with significant other, Game of Thrones

Goods Each item in the box is defined as a Good Utility: The higher the better What do we require to make our utility higher? Answer: Resources Homework 1: 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. Resource for our purposes: Money - We only focus on money in this class. - Most things besides time can be bought through money. Utility: In-depth - In real life difficult to measure someones level of utility - Think of water (measured in gallons) - But how does one measure somebodys 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? 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 someones level of utility. Utils: No real life interpretation without context - For eg: Lets 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. 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. 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? Solution Solution

Rons utility = Another Example: - Rons friend Dean Thomas also goes to Hogwarts and has the following utility function: Deans Utility = He is able to acquire 1 glass of butterbeer and 4 glasses of pumpkin juice What is Deans utility? Who was able to acquire a higher utility level? Solution Solution Deans utility = ..and who reached a higher utility level? Ron!

What does a utility curve look like graphically? See book (chapter 3) Butterbeers per units of time 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. Marginal utility How to find MU?

Formula represents an increase. Typically in the denominator represents an increase by 1. Can you think of a good that decreases utility? Marginal Utility Two components in the formula: change in numerator ( and change in denominator ( Question: Marginal Utility - Lets return to our previous examples of Ron and Deans 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? Solution What is Rons change in utility from drinking one more glass of butterbeer? We have already calculated Rons utility at 2 butterbeers, which was: 36 * means marginal utility of butterbeers Solution - What is Rons new utility? Recall that Rons 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: Solution -Therefore Rons change in utility is: = 81 36 = 45 Question: Dean Thomass 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: Deans Utility = Find Deans marginal utility of butterbeer?

Homework 2: Marginal utility of pumpkin juice (due, 9/30/2016) - In the previous two examples, suppose instead of Butterbeer, both Ron and Dean receive an additional glass of pumpkin juice. Find both Ron and Deans marginal utility of pumpkin juice. Original Butterbeer Pumpkin juice Ron 2

3 Dean 1 4 Solution? Law of Diminishing Marginal Utility - Draco Malfoy is also Rons friend. His utility function is given by: Lets say he is initially able to consume, 1 glass of butterbeer and 1 glass of pumpkin juice. Subsequently, he consumes:

1) 2 glasses of butterbeer, while his pumpkin juice consumption remains the same. 2) 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. Hint: Solution? Indifference Curves - Again, lets 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.

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? Indifference curves: Graphical representation Butterbeer A and B are two consumption bundles, which give the same utility level.

A 2 B 1 3 6 Utility level = 36 Pumpkin juice

Solution? (?,?) (?,?) Solution (3,2) (1,6) 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.

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. 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: Lets return to Rons 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? Solution? Solution Therefore, Income needed: 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? Budget constraint: Graphical

explanation Equation to graph? - 5*y+4*x=100 Y butterbeer x pumpkin juice y 20 25 x What happens when price of butterbeer changes?

What happens when price of pumpkin juice changes? What happens when price of both changes? What happens when income increases? What happens when income decreases? Midterm October 31st 2016 - Material Covered up to that date will be in the exam.

Consumer Equilibrium and Market Demand - Chapter 4, in Introduction to Agricultutal Economics, Penson et al. Consumer Equilibrium - So now we know what an individuals 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.

Things you need to find the best consumption bundle: Price of goods Utility function Find Marginal Rate of Substitution: Find consumer equilibrium Budget 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. 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. Price Demand curve 3 2 1 2

4 6 Quantity of a good The relationship that matters pumpkin juice butterbeer Goal Find the point on the line that maximizes utility. Graphical representation Butterbeer

A and B are two consumption bundles, which give the same utility level. For the blue budget constraint, utility is maximized at A A 2 B 1

Utility level = 36 For the orange budget constraint, utility is maximized at B. 3 6 Pumpkin juice 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. 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. Graph his indifference curve, point of consumption and budget constraint. 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. Graphical representation: Equilibrium change is the original treacle tart consumption. Treacle tart is the original cauldron cake consumption.

A original consumer equilibrium C A B substitution move B C final equilibrium Substitution effect is the new treacle tart consumption.

Income effect Cauldron cake is the new cauldron cake consumption. 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!! Question: draw graph for new equilibrium when, price of cauldron cake increases by 1. What would happen if income increased to 50? - How do the substitution and income effects work then? Homework 3: Draw graph for when the price of treacle tart decreases by 1? Changes in Other Demand

Determinants - The Demand curve shift, when changes in income and prices of other goods occur. (All other factors are assumed to be constant) - Changes in income: For normal good: are those for which a rise in income will lead to increased consumption. Examples: housing, gasoline, steak etc. For inferior good: are goods for which a rise in income will lead to decreased consumption. Examples, travelling in a bus. Market Demand - The horizontal sum of individual demands is called the market demand. Albus Market

Cornelius Price = + Qty Qty Aggregated quantity Consumer Surplus Is the difference between the maximum price consumers are willing to pay and the actual price they actually pay.

Price 10 2 CS 5 Qty How do we find the consumer surplus? Basically find the area of the triangle. and whats the formula?

Area of triangle = Question: Find the CS for the following problem Price 20 4 CS 7 Solution?

Measurement and Interpretations of Elasticities In the book: Chapter 5 (please review book carefully) 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. This degree of responsiveness is known as an elasticity. Very Elastic

Less Elastic Price Price Quantity Quantity Definitions: 1) 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. 2) Income elasticity of demand is the measure of responsiveness of

quantity demanded of good X to a change in the income. 3) 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. Own Price Elasticity of Demand How do you find it? Own Price Elasticity of Demand How do you find it? response change Response in quantity Change in price Own price elasticity: Specifics

Numerator: Denominator: 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? $ per unit Price Quantity 4 $3

3 slices 3 $2 5 slices Pizza demand curve 2 1 1 2 3 4 5 6

Slices per day Solution Put in the formula: 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? $ per unit Pizza demand curve

4 3 2 1 1 2 3 4 5 6 Slices per day Price Quantity $3

3 slices $2 4 slices Solution? 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. $ per unit Price new demand

Original demand Units of X Income elasticity of Demand How do you find it? response change Response in quantity Change in income 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?

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? Cross-Price Elasticities If the elasticity is: - Positive: The goods are substitutes - Negative: The goods are complements - Zero: The goods are independent. Homework 4: 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 Nathans own-price elasticity of demand and cross-price of elasticity of demand. Are choco-chip cookies: complements? Substitutes or independent? 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.

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

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

Total Physical Product Curve Shows the relationship between output and one input, while holding other inputs fixed. output TPP curve Daily Labor hours Marginal Physical Product Explains how output changes as an input is changed (increase/decrease). Formula 1) The MPP measures the rate of change in output in response to a change in use of labor. 2) When TPP is decreasing MPP is negative.

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. Lets start with an example - 1 Daily labor use 10 16 20 22 26

32 40 50 62 72 2 Daily output level 1 2 4.8 6.5 8.1 9.6 10.8

11.6 12.0 11.7 3 MPP 4 APP Lets start with an example - 1 Daily labor use

3 MPP 4 APP: (2) / (1) 10 10 16 16 20 20 22 22 26 26

32 40 32 50 40 62 50 72 62 2 Daily output level 1 1 3

3 4.8 4.8 6.5 6.5 8.1 8.1 9.6 10.8 9.6 11.6 10.8 12.0 11.6 11.7 12.0

0.33 0.33 0.45 0.45 0.85 0.85 0.40 0.40 0.25 0.15 0.25 0.08 0.15 0.02 0.08

-0.02 0.02 0.1 0.1 0.19 0.19 0.24 0.24 0.30 0.30 0.3 0.3 0.30 0.27 0.30

0.23 0.27 0.19 0.23 0.15 0.19 72 11.7 -0.02 0.15 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. MPP/APP MPP APP Labor Use Homework 5: Calculate the MPP and APP for the following table: 1 Daily labor use

1 2 3 4 5 2 Daily output level 10 15 45 60 55

3 MPP 4 APP ? ? ? ? ? ? ? ? ?

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. 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.

Short-Run Costs Short-run Costs: -Total Variable cost (TVC). (Egs of variables costs?) -Total Fixed cost (TFC). 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 Dollars 500 Total Cost 400

Total variable Cost 300 200 Total fixed Cost 100 1 3 4.8 6.5 8.1 9.6

10.8 11.6 Dollars 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 = 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. 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 its lowest point then. (Graph: next slide) - When output per unit of labor rises, AVC must necessarily decline. Short-Run Cost Schedule

Total ouput 1 TFC AFC TVC 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 AVC TC MC ATC

Short-Run Cost Schedule Total ouput 1 TFC TVC 100 AFC (2)/(1) 100 50

AVC (4)/(1) 50.00 TC (2)+(4) 150 3 100 4.8 MC

ATC (3)+(5) 150 33.3 80 26.67 180 60 100

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

260 27.08 10.8 100 9.26 200 18.52 300

27.78 11.6 100 8.62 250 21.55 350 30.17

12.0 100 8.33 310 25.83 410 34.17 11.7

100 8.55 380 32.48 480 41.03 Marginal Cost (MC) Defined as: the change in firms 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. Returning to our Short-run Cost Schedule MC is: Total ouput 1

TFC TVC 100 AFC (2)/(1) 100 50 AVC (4)/(1) 50.00

TC (2)+(4) 150 3 100 4.8 MC ATC (3)+(5) 150

33.3 80 26.67 180 ? 60 100 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 16.67 260 ? 27.08 10.8 100 9.26

200 18.52 300 ? 27.78 11.6 100 8.62

250 21.55 350 ? 30.17 12.0 100 8.33

310 25.83 410 ? 34.17 11.7 100 8.55

380 32.48 480 ? 41.03 Returning to our Short-run Cost Schedule What is the MC here?: Total ouput 1

TFC TVC 100 AFC (2)/(1) 100 50 AVC (4)/(1) 50.00

TC (2)+(4) 150 3 100 4.8 MC ATC (3)+(5) 150

33.3 80 26.67 180 15.00 60 100 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 9.6 100 10.42

160 16.67 260 20.00 27.08 10.8 100 9.26

200 18.52 300 33.33 27.78 11.6 100 8.62

250 21.55 350 62.50 30.17 12.0 100 8.33

310 25.83 410 150.0 34.17 11.7 100 8.55

380 32.48 480 N/A 41.03 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. - Cant have a negative MC.

Graph: Marginal & Average Cost 60 MC 50 Dollars 40 ATC 30 AVC 20

AFC 10 3 4.8 6.5 8.1 9.6 10.8 11.6 Output

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. Question: Calculate Marginal Cost Output Total Cost MC 1

21 3 51 ? 5 71 ? 8

81 ? 13 101 ? 21 131 ?

23 171 ? 19 211 ? 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 = 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. 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. 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 ? ? 10.8 45 ? 300 ?

300 ? ? 11.6 45 ? 350 ?

350 ? ? 12.0 45 ? 410 ?

410 ? ? 11.7 45 ? 480 ?

480 ? ? 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 45 432

260 172.00 260 20.00 45 10.8 45 486

300 186.00 300 33.33 45 11.6 45 522

350 172.00 350 62.50 45 12.0 45 540

410 130.00 410 150.00 45 11.7 45 526

480 46.50 480 N/A N/A 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. Graphical Analysis: Breakeven point: Average Revenue = Average Total Cost 70 MC 60 50 Dollars

MR 40 Economic Profit ATC 30 AVC 20 10 0,0

Produce at this output level Shut down point 1 3 4.8 6.5 8.1 9.6 10.8 11.6

Output Graphical Analysis: Price 0 Output Summary of Analysis - If marginal revenue (same as average revenue/output price) falls to where the ATC is then: the firms 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. 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. Lets return to the very first table 1 Daily labor use 3 MPP 4

APP: (2) / (1) 10 10 16 16 20 20 22 22 26 26 32 40 32 50

40 62 50 72 62 2 Daily output level 1 1 3 3 4.8 4.8 6.5

6.5 8.1 8.1 9.6 10.8 9.6 11.6 10.8 12.0 11.6 11.7 12.0 0.33 0.33 0.45

0.45 0.85 0.85 0.40 0.40 0.25 0.15 0.25 0.08 0.15 0.02 0.08 -0.02 0.02 0.1

0.1 0.19 0.19 0.24 0.24 0.30 0.30 0.3 0.3 0.30 0.27 0.30 0.23 0.27 0.19 0.23

0.15 0.19 72 11.7 -0.02 0.15 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 =

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. Marginal Value Product Example - Use of Labor MPP

MVP ($45 price) Wage Marginal Net Benefit Cumulative Net Benefit 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 ?

- - - 10 Marginal Value Product Example - Use of Labor MPP

MVP Wage Marginal Net Benefit (3) / (4) Cumulative Net Benefit 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 -3.65 74.30 76 -0.02

-0.90 - - - 10 Marginal Value Product Example - Use of Labor

MPP MVP Wage Marginal 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 -

- 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: Homework 5: 1 Daily labor use 1 2 3 4 5

2 Daily output level 10 15 45 60 55 3 MPP 4 APP

5 MVP ($25 price) 6 Cumulative Net Benefit ? ? ? ? ? ?

? ? ? ? ? ? ? ? ? ? ? ? ?

Draw a graph/s for all the curves. Midterm Reminder - As previously discussed. Midterm is on the 31st 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. - Wont 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 dont have to worry about anything not in the notes. General Advice About the Midterm Economics of Input and Product

Substitution Chapter 7: In the book. 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. 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. Graphical comparison of Isoquants and Isoutility. - Notice the similarities. butterbeer capital isoquant isoutility

1 =20 0 =10 Pumpkin juice labor Isoquants Continued - A higher level of isoquant implies a higher output. Question: Would a producer always want to increase his/her output?

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. 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 substitute

one input for the other to maintain the same level of output. 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. 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. 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. Understanding Min and Max functions: For a perfect complement: Min here stands for minimum function

Max stands for maximum function 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 cant use them. You can think of other examples in agriculture. The Iso-Cost line - Again, the same idea as before: just like a consumers budget constraint: An Iso-cost line is nothing but a producers budget constraint. For example:

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. Graph of Iso-Cost line capital 20 15 10 5

50 100 150 200 labor If the budget doubles then? capital 20 15 10 5

50 100 150 200 labor If budget doubles then? capital 20 15 10

5 50 100 150 200 labor If the budget halves then? capital 20 15

10 5 50 100 150 200 labor Draw graphs for when wage rate decreases to $5

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. 1) Lets say the hourly budget is: $1000. Draw iso-cost line. 2) 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? 3) How much does it cost his business to package 1000 cases of pumpkin juice? 4) If the firm can sell the juice for $50 per case, what is the profit? 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. 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 to the isoquant curve. - Notice again the analogous nature of this setup and the one in consumer theory. Graphical comparison Producer Consumer

butterbeer producers iso-cost Consumers budget constraint Capital isoquant isoutility H 1

=20 G 0 =10 Pumpkin juice Labor 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, Notice again the parallel with consumer theory Consumer theory MRS = Producer theory , = =

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. 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. Cost per unit A typical short-run average cost curve can be graphically expressed as: SAC

output Cost per unit - The presence of the fixed cost gives the SAC its u-shape. - Consider the following SAC curves: O - A B C

output 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. - 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 businesss economic efficiency.

LAC: Definition & Graph Cost per unit 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 output 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. 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. 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. 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. Marginal Rate of Transformation

(MRT) - Represents the rate at which the canning of fruit must contract (expand) for a one-case increase (decrease). Marginal Rate of Transformation (MRT) 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) Cases of Canned Fruit Cases of Canned Vegetables Marginal Rate of Transformation

135,000 135,000 128,000 128,000 119,000 119,000 108,000 108,000 95,000 95,000 80,000 63,000 80,000 44,000 63,000 23,000

44,000 0 23,000 0 0 10,000 10,000 20,000 20,000 30,000 30,000 40,000 40,000 50,000 60,000

50,000 70,000 60,000 80,000 70,000 90,000 80,000 -0.7 -0.7 -0.9 -0.9 -1.1 -1.1 -1.3 -1.3

-1.5 -1.7 -1.5 -1.9 -1.7 -2.1 -1.9 -2.3 -2.1 0 90,000 -2.3

PPF: Graph Canned fruit 140 - The end points indicate specialization in either canning fruit or canning vegetables. PPF curve 120 100 80

- Any point on the line would result in the canning of some of both commodities with the same inputs 60 40 20 0 20 40 60

80 100 120 140 Canned vegetables Profit-Maximizing Combination of Products - The ISO-Revenue line is: Slope of this line is?

Profit-Maximizing Combination of Products - The ISO-Revenue line is: Slope of this line is? Another way to remember the slope 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. Lets return to the table

Cases of Canned Fruit Cases of Canned Vegetables Marginal Rate of Transformation Slope 0 0 10,000 10,000 20,000

20,000 30,000 30,000 40,000 40,000 50,000 60,000 50,000 70,000 60,000 80,000 70,000 90,000 80,000 Revenue: price fruit:

$33.33, price vegetables: ? ? ? ? ? ?? ?? ? ? ?? ?? ? ?

135,000 135,000 128,000 128,000 119,000 119,000 108,000 108,000 95,000 95,000 80,000 63,000 80,000 44,000 63,000 23,000

44,000 0 23,000 -0.7 -0.7 -0.9 -0.9 -1.1 -1.1 -1.3 -1.3 -1.5 -1.7 -1.5 -1.9

-1.7 -2.1 -1.9 -2.3 -2.1 ? ? ? ?? ?? ? ? ?? ?? ?

? 0 90,000 ? -2.3 ? Lets return to the table Cases of Canned Fruit

Cases of Canned Vegetables Marginal Rate of Transformation Slope 0 0 10,000 10,000 20,000 20,000 30,000 30,000

40,000 40,000 50,000 60,000 50,000 70,000 60,000 80,000 70,000 90,000 80,000 Revenue: price fruit: $33.33, price vegetables: $25 4,449,550

4,449,550 4,516,240 4,516,240 4,446,270 4,446,270 4,349,640 4,349,640 4,166,350 4,166,350 3,916,400 3,599,790 3,916,400 3,216,520 3,599,790 2,766,590 3,216,520

2,250,000 2,766,590 135,000 135,000 128,000 128,000 119,000 119,000 108,000 108,000 95,000 95,000 80,000 63,000 80,000

44,000 63,000 23,000 44,000 0 23,000 -0.7 -0.7 -0.9 -0.9 -1.1 -1.1 -1.3 -1.3 -1.5

-1.7 -1.5 -1.9 -1.7 -2.1 -1.9 -2.3 -2.1 0.75 0.75 0.75 0.75 0.75 0.75 0.75

0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0 90,000 2,250,000 -2.3

0.75 Solution? Where is the profit maximizing point? Understanding it Graphically Canned fruit 140 PPF curve 120 Iso-Revenue Line

100 80 60 40 20 0 20 40 60 80

100 120 140 Canned vegetables What happens when price of fruit decreases to $25? - Find new slope? Canned fruit 140

Draw the profit maximizing point on the graph? PPF curve 120 Iso-Revenue Line 100 80 60 40 20 0

20 40 60 80 100 120 140 Canned vegetables

Market Equilibrium in Perfect Competition Chapter 8: Penson book 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 producers production strategies. All we are doing is simply extending the discussion to several producers. Review of the individual Supply

Curve Derivation: Market Supply - Recall the individual businesss supply curve, is derived at the point where marginal cost = marginal revenue. Market Supply curve: found by horizontally summing individual supplies. Graphically Consider two growers of broccoli: A and B Price Broccoli Price Broccoli

Price Broccoli 3.00 3.00 3.00 2.50 2.50 2.50 2.00

2.00 2.00 + 1.50 = 1.50 1.50 1.00

1.00 1.00 0.50 0.50 0.50 1 2 3

4 5 6 Quantity Broccoli 1 2 3 4 5 6

Quantity Broccoli 1 2 3 4 5 6 Quantity Broccoli 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. 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. How did we get that?

Market Supply generally has a positive slope. Because quantity supplied increases as the price received increases. Producers Surplus Producer surplus is the economic return above the firms 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 producers surplus is $3. - Now suppose the MC of producing the 100th unit was $3 then the producer surplus would be $1 Market Supply

Price Product price $4 PS Output For Practice Consumer Surplus Vs Producer Surplus Market Equilibrium - Thus far we have discussed Market Demand and Market Supply.

- Before we move forward a brief refresher on Market Demand: Market Equilibrium - We are now ready to understand how the shifts in demand and supply work. - But first lets look at a simple demand and supply graph: 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. Shifts in Supply - Caused by external shocks to supply. Eg: In agriculture, think weather shocks, etc.

Effects on Consumer and Producer Surplus - How would CS and PS change if demand and supply shifted Shifts in both Demand & Supply Adjustments to Market Equilibrium Market Surplus Vs Market Shortage S D Surplus

Shortage Adjustments to Market Equilibrium Market Surplus

Vs Market Shortage S D x y u

v 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 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. 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. Market Equilibrium: Imperfect Competition - We now tread into concepts such as: 1. Monopolistic Competition. 2. Monopoly. 3. Oligopoly. Market Structure Characteristics 1. 2. 3. 4.

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. 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. 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. 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: 1. 2. 3. 4.

Absolute unit cost advantages. Economies of scale. Capital Access and cost. Preferential government policies. Before we move on Brief refresher on conditions for perfect competition: 1. All firms sell an identical (homogenous) product. 2. All firms are price-takers, they cannot control the market price of their product. 3. All firms have a relatively small market share. 4. The industry is characterized by free entry and exit of firms 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. Monopolistic competition - While monopolistic competition allows producers to set prices. - The extent of it, depends on the degree of product differentiation. - Therefore, youll notice that all producers are desperately trying to differentiate their product through advertisements. - Eg: Think attack Ads as well.

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. - Price Quantity 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 Total Revenue

Marginal Revenue - 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

-8 2 26 52 -10 1 28 28

-12 0 30 0 -14 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)

Monopolistic competition: Short-run - Graphs Monopolistic competition: Long-run - Entrants allowed. - Profits lowered. - Demand curve shifts downwards. - Monopolistic competition inefficient than perfect competition. Long-run: Graphs Homework: 8 Price Quantity

17 14 11 8 5 2 0 0 2 4 6 8 10 12

Total Revenue Total Cost Marginal Revenue Marginal cost 20 24 25 27

29 31 1. Find output of monopolistic firm? (For that you need marginal revenue and marginal cost) 2. Graph everything: indicate output point, demand and marginal revenue curve, finally indicate profit area? 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.

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. 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.

- Important points to remember: 1) 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. 2) 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. 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. 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 dont want keep prices too high, to discourage entry into the market. Goal of a monopoly to remain a monopoly Graphs: Unlike monopolistic competition, monopolies realize profits even in the long-run. Summary table: Imperfect competition Item

Number of sellers Ease of Entry or exit Ability to set price Long-run profits Product differentiation Examples: Perfect Competition Numerous Unrestricted None None None Corn producers

Monopolistic Competition Many Unrestricted Some None Yes Soft-drink bottlers Oligopolies Monopolies Few Partially restricted Yes

Yes Yes Airline Industry One Restricted absolute Absolute Yes Product is unique Microsoft Consumer and Producer Surplus in imperfect competition Consumer and Producer Surplus in Imperfect Competition

Imperfect Competition in Buying 1. Monopsony 2. Oligopsony 3. Monopsonistic Competition 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. Monopsony - Buyers 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. 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. Monopsony: Example Units of variable input Price per unit

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 Total cost of input Marginal input cost 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 Graphical analysis Understanding the relationship of Marginal Revenue Product (MRP), supply of input and marginal cost of input (MIC) 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? Graphical Analysis

MIC Supply of input MVP MRP 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. Oligopsony and Monopsonistic Competition - Oligopsony: Few buyers instead one one. - Monopsonistic Competition: Several buyers but differentiated

services. Monopoly: Ceiling price - Federal regulations force lower price. - Quantity in market increases. - Profit of monopolist lowered Graph: Monopoly ceiling price Monopoly: Lump-sum Tax - Profit of monopoly lowered again because of the tax. - Higher ATC than before causes lower profits. - Quantity remains the same. Graph: Lump-sum Tax

Monopsony: Minimum Price Graph: Chapter 11 Product Markets & National Output - National Economy. - Gross Domestic Product. - Consumption, Savings and Investment 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? 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

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 National Income - The monetary value of the products flowing to households through the product markets represents the national product. This is how a domestic economy works

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