The verbal explanation is that a firm should continue any activity as long as the additional (marginal) benefits are greater than the additional (marginal) costs. The firm’s profit maximizing solution is one of the major features and important conclusions of economics. There are three ways to communicate economics: verbally, graphically, and mathematically. The total costs are shown in Figure 3.4, and the per-unit costs are in Figure 3.5.ģ.2.3 Monopoly Profit-Maximizing Solution Assume that the cost per unit is ten dollars per ounce (10 USD/oz). This means that the per-unit cost of producing one more ounce of chemical is the same, no matter what quantity is produced. Suppose that the agricultural chemical firm is a constant cost industry. Marginal Cost = the increase in total costs due to the production of one more unit of output. Note that the terms, Average Costs and Average Total Costs are interchangeable. Total Variable Costs = Costs that do vary with the level of output.Īverage Cost = total costs per unit of output. Total Fixed Costs = Costs that do not vary with the level of output. The sum of Total Fixed Costs and Total Variable Costs. Total Cost = The sum of all payments that a firm must make to purchase the factors of production. The costs for the chemical include total, average, and marginal costs. From an economic perspective, the corn farmer should consider both revenues and costs. For example, a corn farmer who maximizes yield (output per acre of land) may be spending too much on inputs such as fertilizer and chemicals make the higher yield payoff. This is one of the major take home messages of economics: maximize revenues may cost too much to make it worth it. This is always true for linear demand (average revenue) curves. The marginal revenue curve has the same y-intercept and twice the slope as the average revenue curve. Substitution of Q* back into the TR function yields TR = USD 2500, the maximum level of total revenues (Figure 3.2).Īverage revenue (AR) and marginal revenue (MR) are shown in Figure 3.3. The first derivative of TR is the slope of the TR function, and when it is equal to zero, the slope is equal to zero. The maximum value can be found by taking the first derivative of TR, and setting it equal to zero. Total Revenues are in the shape of an inverted parabola. Total revenues for the monopolist are shown in Figure 3.2. Marginal Revenue = the addition to total revenue from selling one more unit of output. TR = PQĪverage Revenue = The average dollar amount receive per unit of output sold AR = TR/Q Total Revenue = The amount of money received when the producer sells the product. Revenues are the money that a firm receives from the sale of a product. The profit-maximizing solution for the monopolist is found by locating the biggest difference between total revenues (TR) and total costs (TC), as in Equation 3.1. In Figure 3.1, an agricultural chemical firm faces an inverse demand curve equal to: P = 100 – Q d, where P is the price of the agricultural chemical in dollars per ounce (USD/oz), and Q d is the quantity demanded of the chemical in million ounces (m oz). The patent is a legal restriction that permits the patent holder to be the only seller of the herbicide, as it was invented by the company through their research program. For example, suppose that an agricultural chemical firm has a patent for an agricultural chemical used to kill weeds, a herbicide. However, the monopolist is constrained by consumer willingness and ability to purchase the good, also called demand. Price Maker = A noncompetitive firm with market power, defined as the ability to set the price of a good.Ī monopolist is considered to be a price maker, and can set the price of the product that it sells. Price Taker = A competitive firm with no ability to set the price of a good. On the other hand, firms with market power are also called “price makers.” Each competitive firm is small relative to the market, so has no influence on price. A competitive firm is a “price taker.” Thus, a competitive firm has no ability to change the price of a good. Market power is also called monopoly power. McDonalds is the only provider of Big Macs, yet it is not a monopoly because there are many close substitutes available: Burger King Whoppers, for example. The phrase, “no close substitutes” is important, since there are many firms that are the sole producer of a good. Monopoly = A single firm in an industry with no close substitutes. An industry is defined as a group of firms that produce the same good. Also called monopoly power.Ī monopoly is defined as a single firm in an industry with no close substitutes. Market Power = Ability of a firm to set the price of a good. This chapter will explore firms that have market power, or the ability to set the price of the good that they produce.
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