Key Concepts in Economics: Production, Costs, Revenue, and Market Structures

Posted on Dec 18, 2024 in Economy

Key Economic Concepts: Production, Costs, and Revenue

Production Timeframes

  • Short Run: A period where at least one factor of production is fixed. All production occurs in the short run. The length is determined by the time needed to increase the quantity of the fixed factor.
  • Long Run: A period where all factors of production are variable, but technology is fixed. All planning occurs in the long run.

Production Metrics

  • Total Product: Total output a firm produces in a given period.
  • Average Product: Output produced, on average, by each unit of the variable factor.
  • Marginal Product: Extra output from using an extra unit of the variable factor.

Law of Diminishing Returns

As extra units of a variable factor are added to a fixed factor, the output from each additional unit of the variable factor will eventually diminish. Similarly, the output per unit of the variable factor will diminish.

Cost Concepts

  • Total Fixed Costs (TFC): Total cost of fixed assets used in a given period. It’s a constant amount.
  • Total Variable Cost (TVC): Total cost of variable assets used in a given period.
  • Average Fixed Cost (AFC): Fixed cost per unit of output (TFC / quantity).
  • Average Variable Cost (AVC): Variable cost per unit of output (TVC / quantity).
  • Average Total Cost (ATC): Total cost per unit of output (TC / quantity).
  • Marginal Cost (MC): Increase in total cost from producing one more unit.

Long-Run Costs and Scale

  • Economies of Scale: Decreases in long-run average costs when a firm increases its scale of output by altering all factors of production. Examples: Specialization, division of labor, financial economies (lower interest rates for larger firms).
  • Diseconomies of Scale: Increases in long-run average costs when a firm increases its scale of output. Example: Control and communication problems.

Revenue and Profit

  • Total Revenue (TR): Money received from selling products in a given period (Price x Quantity).
  • Average Revenue (AR): Revenue per unit sold (TR / quantity).
  • Marginal Revenue (MR): Extra revenue from selling one more unit.
  • Total Profit: TR – TC. If TR > TC, abnormal profits; if TR = TC, normal profits; if TR < TC, losses.
  • Shut-down Price: Price that covers variable costs in the short run (P = AVC). If P < AVC, the firm shuts down in the short run.
  • Break-even Price: Price that covers all costs in the long run (P = ATC). If P < ATC, the firm shuts down in the long run.

Profit and Revenue Maximization

  • Profit-Maximizing Level of Output: Firms aim to maximize profits. Profit is maximized where MC = MR. If MR > MC, increase production; if MC > MR, decrease production. The AC curve determines the amount of profit.
  • Revenue Maximization: Firms may prioritize revenue over profit, producing where MR = 0.
  • Sales Maximization: Firms may produce beyond the profit-maximizing level, potentially to drive out competitors.

Market Structures

Perfect Competition

Assumptions:

  • Very large number of firms.
  • Firms are price-takers, selling at the market price.
  • Homogenous products.
  • Free entry and exit.
  • Perfect information.

Firms can sell any amount at the market price. Profit is maximized where MC = MR.

  • Short-Run Abnormal Profits: Firms cover more than total costs.
  • Short-Run Losses: Firms do not cover total costs.

Transition from Short-Run to Long-Run

  • Short-Run Abnormal Profits to Long-Run Normal Profits: New firms enter, increasing industry supply, shifting the firm’s demand curve down until only normal profits are made.
  • Short-Run Losses to Long-Run Normal Profits: Firms leave, decreasing industry supply, shifting the firm’s demand curve up until normal profits are made.

Efficiency in Perfect Competition

  • Productive Efficiency: Producing at the lowest possible unit cost (MC = AC).
  • Allocative Efficiency: Producing the optimal mix of goods and services (MC = AR).

Monopoly

Assumptions:

  • One firm is the industry.
  • Barriers to entry.
  • Abnormal profits are possible in the long run.

Barriers to Entry

  • Economies of Scale: Existing monopolies have cost advantages.
  • Natural Monopoly: Industries like water, electricity, and gas.
  • Legal Barriers: Patents, copyrights.
  • Brand Loyalty.
  • Anti-Competitive Behavior: Predatory pricing.

Monopolies can control quantity or price, not both. They face a normal demand curve. They can make abnormal profits but may shut down if demand is too low. Monopolies are neither allocatively nor productively efficient.

Potential Problems with Monopolies

  • Productive and allocative inefficiency.
  • Higher prices, lower output.
  • Anti-competitive behavior.

Monopolistic Competition

Assumptions:

  • Large number of firms.
  • Actions of one firm have a limited effect on competitors.
  • Substitutes, but perceived as unique by consumers.
  • No barriers to entry or exit.

In the long run, firms make normal profits. Allocative and productive efficiency are not achieved.

Oligopoly

A few firms dominate the industry. Concentration ratio (CRX) measures market power. Interdependence exists among firms.

Collusive Oligopoly

Firms collude to charge the same prices, acting as a monopoly.

  • Formal Collusion (Cartel): Open agreement on prices, often illegal.
  • Tacit Collusion: Charging the same prices without formal agreement.

Non-Collusive Oligopoly and the Kinked Demand Curve

The kinked demand curve explains price rigidity. Demand is less elastic below a certain point and more elastic above it. Firms are hesitant to raise or lower prices.

Non-Price Competition

Firms compete through branding, packaging, advertising, sales promotion, etc.

Transcription and Translation in Biology

TRANSLATION. Production of polypeptides is under hereditary information and changes depending on cells’ needs and environmental conditions. Stable DNA molecules have to be consulted every time, is used as a guide to make a more short-lived copy: mRNA.

TRANSCRIPTION: mRNA, tRNA (for translation), and rRNA (structural and functional components of ribosomes) are made. RNA is single-stranded, RNA produced has a sequence complementary to guide DNA. RNA polymerase bites to DNA promoter. RNA polymerase separates the DNA to be transcribed the region of the gene. RNA nucleotides pair with complementary bases on one strand of the DNA molecule. RNA polymerase forms covalent bonds between nucleotides. DNA separates from RNA and the double helix reforms.

TRANSLATION: Protein production using mRNA as a guide for assembling amino acids that will be a polypeptide. Takes place at the ribosome (cytoplasm), each compromise a small and large subunit. Genetic code: (universal) enables cellular machinery to convert the base sequence of mRNA into amino acid. Codon: sequence of 3 bases on mRNA. Codes for specific amino acid. tRNA carries amino acids. Anticodon: sequence of 3 bases on tRNA. Complementary to codon bases. 64 possible codons: 3 are stop codons: end of translation. Initiation codon: AUG. mRNA binds to the small sub-unit of the ribosome. tRNA molecules carry amino acids for its anticodons. tRNA binds ribosome where its anti-codon matches the codon of mRNA. tRNA’s bind and polypeptides chain to the second one. The ribosome moves along the mRNA until a stop codon is reached: complete polypeptide.