Microeconomics Study Notes: Production, Market Structures, Externalities, and Factor Markets

Chapter 10: Organizing Production

Economic Cost and Profit

Understanding the costs and profits associated with production is essential for analyzing firm behavior in microeconomics. Firms aim to maximize profit, which is the difference between total revenue and total cost.

• Economic Profit: Total revenue minus total cost, where total cost includes both explicit and implicit costs.

• Explicit Costs: Direct payments for inputs (e.g., wages, rent).

• Implicit Costs: Opportunity costs of using resources owned by the firm.

• Short-run vs. Long-run: In the short run, at least one factor of production is fixed; in the long run, all factors are variable.

• Production Function: Shows the relationship between input quantities and output.

Example: A bakery's economic profit considers both the cost of flour (explicit) and the owner's foregone salary from another job (implicit).

Short-Run Technology Constraint

The short-run production function illustrates how output changes as the quantity of a variable input changes, holding other inputs constant.

• Total Product (TP): Total output produced with a given quantity of inputs.

• Marginal Product (MP): Change in output from one additional unit of input.

• Average Product (AP): Output per unit of input.

• Law of Diminishing Returns: As more units of a variable input are added, MP eventually decreases.

Formula:

• $MP = \frac{\Delta TP}{\Delta L}$

• $AP = \frac{TP}{L}$

Example: Adding more workers to a fixed-size kitchen increases output at first, but eventually, overcrowding reduces productivity.

Short-Run Cost

Short-run costs include fixed and variable costs. Fixed costs do not change with output, while variable costs do.

• Total Cost (TC): Sum of fixed and variable costs.

• Average Total Cost (ATC): Total cost per unit of output.

• Marginal Cost (MC): Change in total cost from producing one more unit.

Formulas:

• $TC = TFC + TVC$

• $ATC = \frac{TC}{Q}$

• $MC = \frac{\Delta TC}{\Delta Q}$

Example: Renting a factory is a fixed cost; buying more raw materials as output increases is a variable cost.

Long-Run Cost

In the long run, all inputs are variable, and firms can choose the most efficient plant size. Long-run average cost curves show economies and diseconomies of scale.

• Economies of Scale: ATC decreases as output increases.

• Diseconomies of Scale: ATC increases as output increases.

Example: Large-scale production may lower per-unit costs due to bulk purchasing.

Chapter 11: Perfect Competition

What is Perfect Competition?

Perfect competition is a market structure with many buyers and sellers, identical products, and no barriers to entry.

• Price Taker: Firms accept the market price; they cannot influence it.

• Free Entry and Exit: Firms can enter or leave the market without restriction.

Example: Agricultural markets, such as wheat or corn.

The Firm's Output Decision

Firms in perfect competition maximize profit by producing where marginal cost equals marginal revenue.

• Marginal Revenue (MR): Change in total revenue from selling one more unit.

• Profit Maximization: $MR = MC$

Example: If the market price is $10, the firm produces up to the point where$MC = 10$.

Output, Price, and Profit in the Short Run

The market supply curve shows the sum of quantities supplied by all firms at each price. Firms may earn positive, zero, or negative economic profit in the short run.

• Shutdown Point: The price below which a firm will cease production in the short run.

Output, Price, and Profit in the Long Run

In the long run, economic profit is driven to zero by entry and exit of firms. Firms adjust plant size and production to minimize costs.

• Long-Run Equilibrium: Firms earn zero economic profit; $P = ATC$.

Chapter 12: Monopoly

Monopoly and How It Arises

A monopoly exists when a single firm supplies a good or service with no close substitutes and significant barriers to entry.

• Barriers to Entry: Legal (patents, licenses), ownership, or natural (economies of scale).

• Market Power: Ability to set prices above marginal cost.

Example: Utility companies often operate as natural monopolies.

A Single-Price Monopoly's Output and Price Decision

A single-price monopoly sets output where marginal revenue equals marginal cost, but charges a price above marginal cost.

• Demand Curve: Downward sloping; monopoly faces the market demand.

• Marginal Revenue: Less than price for all units except the first.

• Profit Maximization: $MR = MC$

Single-Price Monopoly and Competition Compared

Monopolies produce less and charge higher prices than perfectly competitive markets, resulting in deadweight loss.

• Deadweight Loss: Loss of total surplus due to monopoly pricing.

Chapter 13: Monopolistic Competition

Monopolistic Competition and Other Market Structures

Monopolistic competition features many firms selling differentiated products with free entry and exit.

• Product Differentiation: Each firm offers a slightly different product.

• Non-price Competition: Advertising and product development.

Price and Output in Monopolistic Competition

Firms set prices above marginal cost but face competition from similar products. In the long run, economic profit is zero.

• Profit Maximization: $MR = MC$

Chapter 14: Oligopoly

Oligopoly Games

Oligopoly is analyzed using game theory, which studies strategic interactions among firms.

• Interdependence: Firms consider rivals' actions when making decisions.

• Payoff Matrix: Table showing outcomes for each firm's strategy.

Example: Two firms deciding whether to advertise or not.

Repeated Games & Sequential Games

Firms may cooperate or compete repeatedly, affecting long-term outcomes. Sequential games involve decisions made in sequence.

• Nash Equilibrium: No firm can improve its payoff by changing strategy unilaterally.

Anti-Combine Law

Anti-combine laws regulate mergers and prevent monopolistic practices to promote competition.

• Competition Bureau: Government agency enforcing competition law.

Chapter 15: Externalities

Externalities in Our Lives

Externalities occur when a production or consumption activity affects third parties not directly involved in the transaction.

• Negative Externality: Imposes external cost (e.g., pollution).

• Positive Externality: Imposes external benefit (e.g., education).

Negative Externality: Pollution

Pollution is a classic example of a negative externality, where social cost exceeds private cost.

• Marginal Social Cost (MSC): $MSC = MC + External Cost$

• Efficient Outcome: Achieved when $MSC = MSB$ (Marginal Social Benefit).

Positive Externality: Knowledge

Knowledge creation benefits society beyond the individual producer or consumer.

• Marginal Social Benefit (MSB): $MSB = MB + External Benefit$

Chapter 16: Public Goods and Common Resources

Classifying Goods and Resources

Goods are classified based on excludability and rivalry.

• Private Good: Rival and excludable.

• Public Good: Non-rival and non-excludable.

• Common Resource: Rival but non-excludable.

• Club Good: Non-rival but excludable.

Public Goods

Public goods are non-rival and non-excludable, leading to free-rider problems and under-provision in markets.

• Examples: National defense, public parks.

Common Resources

Common resources are rival but non-excludable, often leading to overuse and depletion (tragedy of the commons).

• Examples: Fisheries, groundwater.

Chapter 18: Markets for Factors of Production

The Anatomy of Factor Markets

Factor markets allocate resources such as labor, capital, and land. Prices are determined by supply and demand for each factor.

• Labor Market: Wages determined by supply and demand for labor.

• Capital Market: Rental rate determined by supply and demand for capital.

• Natural Resource Market: Prices for resources like oil, minerals.

The Demand for a Factor of Production

The value of marginal product (VMP) determines the demand for a factor of production.

• Value of Marginal Product: $VMP = MP \times P$

Labour Markets

Wages are set by the intersection of labor supply and demand. Factors such as minimum wage laws and unions can affect equilibrium.

• Equilibrium Wage: Where labor supply equals labor demand.

Capital and Natural Resource Markets

Rental rates and resource prices are determined by supply, demand, and expectations about future scarcity.

• Interest Rate: Influences the price of nonrenewable resources.

Type of Good	Rival?	Excludable?	Example
Private Good	Yes	Yes	Bread
Public Good	No	No	National Defense
Common Resource	Yes	No	Fishery
Club Good	No	Yes	Private Park

Additional info: These notes expand on the original outline by providing definitions, formulas, and examples for key microeconomic concepts, ensuring a self-contained study guide for exam preparation.