WEEK 1 (Chapter 1) DEFINITION OF ECONOMICS All economic questions arise because we want more than we can get.

SCARCITY Inability to satisfy all our wants. Because we face scarcity, we must make choices. The choices we make depend on the incentives we face. An incentive is a reward that encourages an action or a penalty that discourages an action. ECONOMICS is the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices ECONOMICS IS DIVIDED INTO MICRO AND MACROECONOMICS Microeconomics Macroeconomics The study of choices that individuals and The study of the performance of the national businesses make, the way those choices and global economies. interact in markets, and the influence of governments. E.g. Why are people buy mobile phones? E.g. Why China economy grows so fast?

TWO big questions summarize the scope of economics

How do choices end up determining what, how, and for whom goods and services get produced? What? Goods & Services are objects that people value & produce to satisfy wants. What determines how much coal, cars or milk to produce? How? Gods & Services are produced by using productive resources called FACTORS OF PRODUCTION they categories into 4 categories: Land gifts of nature (natural resources used to produce Goods & Services) Labour Human Capital knowledge & skill that people obtain from education & work experience. And time & effort used in producing Goods & Services. Capital Tools, machines, buildings & ect. Use to produce Goods & Services (Not a Financial Capital like Money, Shares) Entrepreneurship Human resource that organises land, labour & capital to produce Goods & Services For whom? Who gets Goods & Services that are produced depends on the incomes people earn. People can earn income by selling services of the factors of the production: Land earns Rent Labour earns Wages Capital earns Interests Entrepreneurship earns Profits When do choices made in the pursuit of selfinterest also promote the social interest? Self-interests Making choice in your self interests Using time & resources in the way that benefit you & not concerning about others. E.g. You order pizza, you not concern that delivery guy have too ride on rain to bring you pizza. Social Interests Self-interests promote Social Interest if they lead to an outcome that uses resources efficiently & distributes Goods & Services equally among individuals

TRADE-OFF 2

is choice we make in our decisions giving up one thing to get something else Guns vs. Butter (if u wants more of one thing we have to exchange something else for it) TRADE-OFF (WHAT? HOW? & FOR WHOM?) WHAT? How individuals spend their money? How government spends tax? When business choose what to produce E.g. Spend money or defence and cut from education, Gov. trade-off education for defence. HOW? How goods & services get produced depends on the choice made by business FOR WHOM? For whom goods & services are proceed depends on distribution of buying power (payment, theft & tax). Government redistribution of income from the rich to the poor creates big trade off between equity & efficiency. (E.g. Taxing Rich & give tax breaks to poor) OPPORTUNITY COST The highest- valued alternative that we give up to get something is opportunity cost of the activity chosen. No such idea as free stuff each and every choice has cost. E.g. If you enrolled in uni, the highest value alternative you chose if you were not at uni is work therefore you lose money by not working, but getting greater job opportunities later. Choosing at the Margin MARGIN People make choices at the margin, which means that they evaluate the consequences of making incremental changes in the use of their resources. MARGINAL BENEFIT The benefit from pursuing an incremental increase in an activity. E.g. Student average mark is 60%, to get higher mark student have too study extra night. Mark rises by 10% to 70% the marginal benefit from studding extra night is 10% NOT 70% because you already had 60% from studding 4 nights. MARGINAL COST The cost in increase in activity E.g. By choosing to study extra one night it will cost extra one night lost to spend doing other activities. To make a choice you compare marginal benefits one extra night study with marginal cost. If marginal benefits exceeds the marginal costs you will chose to study extra night. If not you dont. By choosing only actions that bring greater benefits than cost, we use resources in pest possible way. RESPONDING TO INCENTIVES When we make choice we response to incentives, for any activity if marginal benefit exceeds marginal cost, people have an incentive to do more of that activity. E.g. If you are told that the next week home work will be on exam you have grater incentives to do work, rather than if you told none of the next week work will be on exam. If marginal cost exceeds marginal benefit, people have less incentive to do that activity. HUMAN NATURE From economical point of view all people acting in self-interests as it bring most value for you based on your view of the value. Positive Statement Is about what is What are the facts: can be true or false. E.g. unemployment is 20% 3 Normative Statement (cannot be tested) What ought to be What is opinion: E.g. Australia is the best country in world

UNSCRAMBLING CAUSE & EFFECT Economist particularly interested in positive statements about cause & effect. E.g. is computers getting cheaper because people buying more of them or do they buy more computers because they are getting cheaper? Or there is another factor that affects that. To answer questions like this economists create and test economic models ECONOMIC MODEL Description of some aspects of the economic world that includes only those features that are needed for the purpose at hand. E.g. economic model of the mobile phone network might include: price of calls, number of users, volume of calls, model will ignore insignificant data like the ringtone types. The model tested by comparing its predictions with the facts. BUT TESTING AN ECONOMICAL MODEL IS DIFFICULT, SO ECONOMIST ALSO USE: Natural Experiment Statistical Investigations Economic Experiment E.g. Tax study (Australian & Looks at correlation of two E.g. In computer lab NZ economies are similar but variables moving together answering test questions the tax is different, so (same or opposite directions) economist compare this two E.g. cigarettes & cancer are countries to see the tax effect) correlated but smoking cause cancer hard to determine ECONOMIC AS POLICY TOOL THE WAY TO APPROACH PROBLEMS IN ALL ASPECTS OF HUMAN LIVES. Personal Economic Policy Should I buy this product or other one THREE AREAS Business Economic Policy Should Sony make only flat TV & Stop making mobile phones Government Economic Should government lower tax?

Chapter 2 PRODUCTION POSSIBILITIES & OPPORTUNITY COST PRODUCTION POSSIBILITIES FRONTIER (PPF) Boundary between those combinations of goods & services that can be produced & those that cannot. (If want to produce more of something we have too decrease or stop productions of something else). PPF will focus on two goods at time & hold the quantities of all other goods & services constant. Model economy in which everything remains the same except the two goods were considering. Production efficiency producing goods & services at lowest production cost. On diagram it is point Z. 3 mill pizza & 9 mill cola.

TRADE-OFF ALONG THE PPF Every choice along the PPF involves a tradeoff we trade off cola for pizza. E.g. If you want to study more you tradeoff you sleep time. Every Tradeoff involve a cost: an opportunity cost OPPORTUNITY COST An action is the highest valued alternative sacrificed. We can produce more pizzas only if we produce less cola. The opportunity cost of producing additional cola is quantity of pizzas we must sacrificed. THE PPF & MARGINAL COST Cost of goods & services is the opportunity cost of producing ONE more unit of it. This illustrates the marginal cost of pizza. As we move along the PPF in part (a), the opportunity cost of a pizza increases. The opportunity cost of producing one more pizza is the marginal cost (MC) of a pizza.

In part (b) the bars illustrate the increasing opportunity cost of pizza. The black dots and the line MC show the marginal cost of pizza. The MC curve passes through the centre of each bar.

Preferences & Marginal Benefit PREFERENCES Persons likes & dislikes, economists describe preferences by using: Marginal Benefits
MARGINAL BENEFITS

Of a Goods & Services is benefit received from consuming ONE more unit of it. We measuring marginal benefits by the amount person is willing to pay for an additional unit of a goods or service. TO ILLUSTRATE THAT WE USE MARGINAL BENEFIT CURVE. MARGINAL BENEFIT CURVE Shows the relationship between the marginal benefit of a good and the quantity of that good consumed. It is a general principle that the more we have of any goods, the smaller is its marginal benefit and the less we are willing to pay for an additional unit of it. We call this general principle the principle of decreasing marginal benefit. The reason why marginal benefit from good or service decreases because consumer likes variety, consumer get tire of it & switches to something else. E.G. if Pizza was rare item and you can only obtain few pieces a year you will be willing to pay high price for an addition slice. But if you eat pizza on daily bases addition slice has almost no value to you. The MB curve slopes downward to reflect the principle of decreasing marginal benefit. At point A, with pizza production at 0.5 million, people are willing to pay 5 cans of cola for a pizza. At point E, with pizza production at 4.5 million, people are willing to pay 1 can of cola for a pizza

Allocative efficiency When we cannot produce more of any one good without giving up some other good, we have achieved production efficiency. We are producing at a point on the PPF. When we cannot produce more of any one good without giving up some other good that we value more highly, we have achieved Allocative Efficiency. This Illustrates allocative efficiency. The point of allocative efficiency is the point on the PPF at which marginal benefit equals marginal cost. This point is determined by the quantity at which the marginal benefit curve intersects the marginal cost curve

If we produce fewer than 2.5 million pizzas, marginal benefit exceeds marginal cost. We get more value from our resources by producing more pizzas. On the PPF at point A, we are producing too much cola, and we are better off moving along the PPF to produce more pizzas

If we produce more than 2.5 million pizzas, marginal cost exceeds marginal benefit. We get more value from our resources by producing fewer pizzas. On the PPF at point C, we are producing too many pizzas, and we are better off moving along the PPF to produce fewer pizzas

. ECONOMIC GROWTH The expansion of production possibilitiesan increase in the standard of living Two key factors influence economic growth: Technological change Capital accumulation is the development of new goods and of better ways of producing goods and services is the growth of capital resources, which includes human capital

THE COST OF ECONOMIC GROWTH To use resources in research and development and to produce new capital, we must decrease our production of consumption goods and services. So, economic growth is not free. The opportunity cost of economic growth is less current consumption.

WE produce pizzas or pizza ovens along PPF0. By using some resources to produce pizza ovens today, the PPF shifts outward in the future. FIRM Is an economic unit that hires factors of production and organizes those factors to produce and sell goods and services. ECONOMIC COORDINATION MARKET PROPERTY RIGHTS arrangement that enables buyers and sellers and do business with each other Are the social arrangements that govern ownership, use, and disposal of resources, goods or services. Money MONEY is any commodity or token that is generally acceptable as a means of payment

CIRCULAR FLOWS THROUGH MARKETS

WEEK 2 Chapter 3 MARKET & PRICES Market Is any arrangement that enables buyers and sellers to get information and do business with each other Competitive market Is a market that has many buyers and many sellers, so no single buyer or seller can influence the price E.g. Item get produced if price is high enough to cover their opportunity costs Money Price The price of the good or service is number of dollars that is must be give up in exchange for it Opportunity Cost & Relative Price Opportunity cost of an action is highest value alternative forgone. E.g. if buy coffee, the highest valued thing you forgone is chocolate you were planning to buy, the opportunity cost of coffee is quantity of chocolate forgone. We can calculate quantity of chocolate forgone from the money price of coffee & chocolate. If coffee = $2 & chocolate $1 than Opportunity Cost of coffee is 2 chocolate. ($2 coff / $1 Choc) that = ratio of one price to another. Ratio of one price to other called Relative Price

Relative Price Of a goodthe ratio of its money price to the money price of the next best alternative goodis its opportunity cost. DEMAND If you demand something, then you: 1. Want it 2. Can afford it 3. And have defendant plan to buy it Wants are the unlimited desires or wishes people have for goods and services. Scarcity ensure that most of our will never be satisfied. Demand reflects a decision about which wants to satisfy. Quantity demanded of a good or service is the amount that consumers plan to buy during a particular time period, and at a particular price. Quantaty demand is measured as amount per unit of time. E.g. you buy a cup of coffee a day, 7 cups a week & 365 a year. The question is does quantity demand would change if price changes? This were law of demand come in place. Law of Demand States: Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the larger is the quantity demanded. Why does higher price reduces quantity? Two reasons: Substitution Effect & Income Effect Substitution Effect Income Effect When the relative price (opportunity cost) When the price of a good or service rises of a good or service rises, people seek relative to income, people cannot afford all the substitutes for it, so the quantity demanded things they previously bought, so the quantity of the good or service decreases. demanded of the good or service decreases. E.g. Energy bars price drops from $3 to $1.50 people substitute energy bar with an energy drink, but with lowering of price quantity demand increases. If roles changed & energy bars cost increase from $3 to $6 than people will buy more energy drinks & fewer energy bars Demands Curves & Demand Schedule The term demand refers to the entire relationship between the price of the good and quantity demanded of the good Demand curve 10

The term quantity demanded referrers to a point on a demand curve at the quantity demanded at particular price Shows the relationship between the quantity demanded of a good and its price when all other influences on consumers planned purchases remain the same. Shows a demand curve for energy bars. A rise in the price, other things remaining the same, brings a decrease in the quantity demanded. A demand curve is also a willingness-and-ability-to-pay curve.

Six main factors that change demand are: The prices of related goods Expected future prices Income Expected future income Population Preferences

Supply If a firm supplies a good or service, then the firm: 1. Has the resources and the technology to produce it, 2. Can profit from producing it, and 3. Has made a definite plan to produce and sell it.

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The supply is more than just having the resources & the technologies to produce something. Resources & Technologies are the constraints that limit what is possible. Resources and technology determine what it is possible to produce. Supply reflects a decision about which technologically feasible items to produce. E.g. many things can be produced, but they are not produced unless it profitable to do so. The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price. It is measured by as amount of units per time. E.g. Toyota produces 1000 cars per day. The quantity supplied can be calculated as 1K a day, 7K a week, 365K a year. To find out how does quantity supplied of goods change as it price change and all other variables remain the same we look at law of supply. The Law of Supply states: Other things remaining the same, the higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied. The reason why higher price increases quantity supplied because marginal cost of producing a good or service to increase as the quantity produced increases and firm only produces if can at least cover marginal cost of production. WE CAN ILLUSTRATE THE LAW OF SUPPLY WITH SUPPLY CURVE & SUPPLY SCHEDULE. The term supply refers to the entire relationship between the quantity supplied and the price of a good The supply curve shows the relationship between the quantity supplied of a good and its price when all other influences on producers planned sales remain the same.

CHANGE IN SUPPLY When some influence on selling plans changes (other than the price of the good), there is a change in supply of that good.

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The quantity of the good that producers plan to sell changes at each and every price, so there is a new supply curve. When supply increases, the supply curve shifts rightward. When supply decreases, the supply curve shifts leftward.

prices of factors of production E.g. Price of jet fuel increase, air travel decrease

The five main factors that change supply of a good are prices of Expected Number of Technology state of nature related goods future prices suppliers produced E.g. if price Larger New tech that Bad weather expected to amount of lower cost of smaller rise, then firms greater production supply of return is is supply goods & vegetables higher than increase today, so supply supply dicreases today & increases in future

Equilibrium is a situation in which opposing forces balance each other. Equilibrium in a market occurs when the price balances the plans of buyers and sellers equilibrium price price at which the quantity demanded equals the quantity supplied Price regulates buying and selling plans Price of goods regulate the quantity demanded & suppled Price high = quantity supplied exceed quantity demanded and opposite. 13 equilibrium quantity Quantity bought and sold at the equilibrium price. Price adjusts when plans dont match Price changes when there is shortage or surplus Shortage forces price up Surplus forces price down

PRICE ADJUSTMENTS Shortage forces price up Surplus forces price down At the equilibrium price, the price doesnt change until either demand or supply changes.

Predicting Changes in Price and Quantity

AN INCREASE IN DEMAND When demand increases the demand curve shifts rightward. The price rises, and the quantity supplied increases along the supply curve.

AN INCREASE IN SUPPLY when supply increases the supply curve shifts rightward The price falls, and the quantity demanded increases along the demand curve.

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Chapter 4
Price Elasticity of Demand

increase in supply brings A large fall in price A small increase in the quantity demanded

increase in supply brings A small fall in price A large increase in the quantity demanded

The contrast between the two outcomes in Figure 4.1 highlights the need for, A measure of the responsiveness of the quantity demanded to a price change Elasticity is such a measure PRICE ELASTICITY OF DEMAND Units-free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buyers plans remain the same. CALCULATING PRICE ELASTICITY OF DEMAND This is a measure of the responsiveness of demand to changes in price. Price elasticity of demand may be calculated using the point method as follows:

For example, assume the price of particular new car model rose from $20,000 to $25,000, resulting in demand falling from 10,000 to 5,000 new car sales.

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If elasticity is greater than 1 (as in the above example), there is an ELASTIC demand; if elasticity equals 1 (or less) then demand is INELASTIC.

ELASTIC DEMAND the price elasticity of demand is less than 1 and the good has inelastic demand The degree of elasticity depends on the availability of substitutes. Elastic demand tends to be for products often regarded as luxuries, including DVD equipment, cameras, and cars etc.

INELASTIC DEMAND the price elasticity of demand is less than 1 and the good has inelastic demand . Inelastic demand tends to be for essential products, which cannot be done without, such as bread, milk, beer and cigarettes etc.

If the quantity demanded doesnt change when the price changes, the price elasticity of demand is zero and the good has a perfectly inelastic demand

Demand becomes less elastic as the price falls along a linear demand curve. At prices above the mid-point of the demand curve, demand is elastic. At prices below the mid-point of the demand curve, demand is inelastic.

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If the price falls from $15 to $10, the quantity demanded increases from 20 to 30 pizzas an hour. The average price is $12.50 and the average quantity is 25 pizzas. The price elasticity is (10/25)/(5/12.5), which equals 1. TOTAL REVENUE AND ELASTICITY The total revenue from the sale of a good or service equals the price of the good multiplied by the quantity sold. When the price changes, total revenue also changes. But a rise in price doesnt always increase total revenue The change in total revenue due to a change in price depends on the elasticity of demand If demand is elastic, a 1% price cut increases the quantity sold by more than 1%, and total revenue increases. If demand is inelastic, a 1% price cut increases the quantity sold by less than 1%, and total revenues decreases TOTAL REVENUE TEST method of estimating the price elasticity of demand by observing the change in total revenue that results from a price change (when all other influences on the quantity sold remain the same). If a price cut increases total If a price cut decreases total If a price cut leaves total revenue, demand is elastic revenue, demand is inelastic revenue unchanged, demand is unit elastic. If demand is unit elastic, a 1% price cut increases the quantity sold by 1% , and total revenue remains unchanged

DEMAND

TOTAL REVENUE

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As the price falls from $25 to $12.50, the quantity demanded increases from 0 to 25 pizzas. Demand is elastic, and total revenue increases. At $12.50, demand is unit elastic and total revenue stops increasing. As the price falls from $12.50 to zero, the quantity demanded increases from 25 to 50 pizzas. Demand is inelastic, and total revenue decreases.

As the quantity increases from 0 to 25 pizzas, demand is elastic, and total revenue increases. At 25, demand is unit elastic, and total revenue is at its maximum. As the quantity increases from 25 to 50 pizzas, demand is inelastic, and total revenue decreases

THE FACTORS THAT INFLUENCE THE ELASTICITY OF DEMAND The closeness of substitutes The closer the substitutes for a good or service, the more elastic are the demand for it. E.g. Necessities, such as food The proportion of income spent on the good Larger proportion of income spends on good greater elasticity of demand. E.g. Gum price increase barely 18 The time elapsed since a price change The more time consumers have to adjust to a price change, or the longer that a good can be stored without

or housing, generally have inelastic demand. Luxuries, such as exotic vacations, generally have elastic demand.

noticeable, price in rent significantly noticeable

losing its value, the more elastic is the demand for that good. E.g. When price of PC fall demand increased slightly, but as people become more dependent on PC quantity increased significantly. Demand become elastic

CROSS ELASTICITY OF DEMAND The concept of cross elasticity of demand is used for measuring the responsiveness of quantity demanded of a good to changes in the price of related goods. Cross elasticity of demand is defined as: "The percentage change in the demand of one good as a result of the percentage change in the price of another good". Formula Exy = % Change in Quantity Demanded of Good X % Change in Price of Good Y The numerical value of cross elasticity depends on whether the two goods in question are substitutes, complements or unrelated. Types and Example: Substitute Goods When two goods are substitute of each other, Complementary Goods. However, in case of such as coke and Pepsi, an increase in the complementary goods such as car and petrol, price of one good will lead to an increase in cricket bat and ball, a rise in the price of one demand for the other good. The numerical good say cricket bat by 7% will bring a fall in value of goods is positive the demand for the balls (say by 6%). The cross elasticity of demand which are complementary to each other is, therefore, 6% / 7% = 0.85 (negative). E.g. Coke and Pepsi close substitutes. increase in the price of Pepsi good Y by 10% and increases the demand for Coke good X by 5%, the cross elasticity of demand would be: Exy = %qx / %py = 0.2 Since Exy is positive (E > 0), therefore, Coke and Pepsi are close substitutes.

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Increase quantity of pizza demanded when the price of burger (a substitute for pizza) rises. The figure also shows the decrease in the quantity of pizza demanded when the price of a soft drink (a complement of pizza) rises.

INCOME ELASTICITY OF DEMAND The income elasticity of demand measures how the quantity demanded of a good responds to a change in income, other things remaining the same. "The ratio of percentage change in the quantity of a good purchased, per unit of time to a percentage change in the income of a consumer". Ey = Percentage Change in Quantity Demand Percentage Change in Income Simplified formula: Ey = q X P p Q =change

If the income elasticity of demand is greater than 1, demand is income elastic and the good is a normal good. If the income elasticity of demand is greater than zero but less than 1, demand is income inelastic and the good is a normal good. If the income elasticity of demand is less than zero (negative) the good is an inferior good.

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increase in demand brings A large rise in price A small increase in the quantity supplied

increase in demand brings A small rise in price A large increase in the quantity supplied

THE ELASTICITY OF SUPPLY Measures the responsiveness of the quantity supplied to a change in the price of a good when all other influences on selling plans remain the same. Es = Percentage change in quantity supplied Percentage change in price

FACTORS THAT INFLUENCE THE ELASTICITY OF SUPPLY Resource substitution possibilities Time Frame for Supply Decision The easier it is to substitute among the The more time that passes after a price resources used to produce a good or service, change, the greater is the elasticity of supply. the greater is its elasticity of supply. Momentary supply is perfectly inelastic. The quantity supplied immediately following a price change is constant. Short-run supply is somewhat elastic. Long-run supply is the most elastic. WEEK 3 FIRM Institution that hires factors of production and organises them to produce and sell goods and services FIRMS GOAL To maximise profit, if failed then eliminated or bought out by other. MEASURING A FIRMS PROFIT Accountants measure a firms profit to ensure Economists measure a firms profit to enable that the firm pays the correct amount of tax them to predict the firms decisions, and the and to show its investors how their funds are goal of these decisions is to maximise being used economic profit Profit equals total revenue minus total cost Economic profit is equal to total revenue 21

minus total cost, with total cost measured as the opportunity cost of production. FIRMS OPPORTUNITY COST Value of the firms best alternative use of its resources (Real alternative forgone (lost))

TWO TYPES OF OPPORTUNITY COST: Explicit costs Implicit costs Amount paid for resources that could be spend when it uses, deferent resources to produce deferent goods 1. Its own capital. (when instead it could rented capital to another firm) Implicit rental rate opportunity cost of use ur own capital. 2. Its owners time and financial resources. (Cost of owners resources) Owner might supply both entrepreneurship and labour. Return to entrepreneurship is profit. Profit that an entrepreneur can expect to receive on average is called normal profit. Normal profit represe4nt the cost of forgone alternative (running another firm) ECONOMIC PROFIT Equals a firms total revenue minus its total opportunity cost of production. DECISION TIME FRAMES Firm makes many decisions to achieve its main objective: PROFIT MAXIMISATION Some critical and irreversible and some easily reversed DECISIONS CAN BE PLACED INTO TWO TIME FRAMES Short run Long run Resources used in production are fixed. Is a time frame in which the quantities of all Capital called firms plant is fixed. Short-run resourcesincluding the plant sizecan be decisions are easily reversed. varied. Not easily reversed. Firms technology, buildings and capital. E.g. E.g. T-shirt shop to buy more machines or hire In T-shirt firms plant machines to produce more staff shirts SUNK COST When made Long Term decision the firm must live with it for some time. Cost incurred by the firm and cannot be changed. If a firms plant has no resale value, the amount paid for it is a sunk cost. Short-Run Technology Constraint To increase output in the short run, a firm must increase the amount of labour employed. Three concepts describe the Long-Run Cost In the long run, all inputs are variable and all costs are variable.

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relationship between output and the quantity of labour employed: 1. Total product - total output produced in a given period using different amounts of labour holding fixed all other factors of production. 2. Marginal product - change in total product that results from a one-unit increase in the quantity of labour employed, with all other inputs remaining the same. Calculated: labour increase 2 to 3 workers, production increase 10 to 13 shirts. Change in total product (3 shirt) divided by change in labour (1) = marginal product of third worker 3 shirts

THE PRODUCTION FUNCTION Behaviour of long-run cost depends upon the firms production function. The firms production function is the relationship between the maximum output attainable and the quantities of both capital and labour.

3. Average product - total product divided by the quantity of labour employed. E.g. 3 workers, produce 13 shirts 13/3=4.33 shirt per worker MARGINAL PRODUCT CURVE

As the size of the plant increases, the output that a given quantity of labour can produce increases. But as the quantity of labour increases, diminishing returns occur for each plant DIMINISHING MARGINAL PRODUCT OF CAPITAL The increase in output resulting from a one-unit increase in the amount of capital employed (number of machines), holding constant the amount of labour employed. A firms production function exhibits diminishing marginal returns to labour (for a given plant) as well as diminishing marginal returns to capital (for a quantity of labour). For each plant, diminishing marginal product of labour creates a set of short run, U-shaped costs curves for MC, AVC, and ATC. SHORT-RUN COST AND LONG-RUN COST The average cost of producing a given output varies and depends on the firms plant. The larger the plant, the greater is the output at which ATC is at a minimum. The firm has 4 different plants: 1, 2, 3, or 4 machines. Each plant has a short-run ATC curve. The firm can compare the ATC for each output at different plants. 23

E.g. The first worker hired produces 4 units. The second worker hired produces 6 units of output and total product becomes 10 units. The third worker hired produces 3 units of output and total product becomes 13 units

ATC1 is the ATC curve for a plant with 1 machine ATC4 is the ATC curve for a plant with 4machines The long-run average cost curve is made up from the lowest ATC for each output level. So, we want to decide which plant has the lowest cost for producing each output level. Lets find the least-cost way of producing a given output level. Suppose that the firm wants to produce 13 T-shirts a day.

Almost all production processes are like the one shown here and have:

Increasing marginal returns occur when marginal product of worker increase marginal product of previous worker. E.g. if only one worker he have to do everything, if hire another one we can dived and specialise workers Diminishing marginal returns occurs marginal product of worker less that marginal product of previous worker. E.g. because more workers use the same machine and have to wait for their turn, therefore reducing productivity.

13 T-shirts a day cost $7.69 each on ATC1. 13 T-shirts a day cost $6.80 each on ATC2. 13 T-shirts a day cost $7.69 each on ATC3. 13 T-shirts a day cost $9.50 each on ATC4.

LONG-RUN AVERAGE COST CURVE (LRAC) Is the relationship between the lowest attainable average total cost and output when both the plant and labour are varied. The long-run average cost curve is a planning curve that tells the firm the plant that minimises the cost of producing a given output range. Once the firm has chosen its plant, the firm incurs the costs that correspond to the ATC curve for that plant LAW OF DIMINISHING RETURNS ECONOMIES AND DISECONOMIES OF As a firm uses more of a variable input SCALE with a given quantity of fixed inputs, the Economies of scale features of a firms technology marginal product of the variable input that make ATC fall as output increases. E.g. if Ford eventually diminishes. produces 100 p/week each worker have too do many tasks and the capital (machines) but if Ford makes 10K cars a week each worker specialises in one task 24

and becomes proficient Diseconomies of scale features of a firms technology that make ATC rise as output increases. Constant returns to scale are features of a firms technology that keep ATC constant as output increases Illustrates economies and diseconomies of scale

AVERAGE PRODUCT CURVE

Average product curve and its relationship with the marginal product curve. When marginal product exceeds average product, average product increases. When marginal product is below average product, average product decreases. When marginal product equals average product, average product is at its maximum. Short-Run Technology Constraint To produce more output in the short run, the firm must employ more labour, which means that it must increase its costs. We describe the way a firms costs change as total product changes by using three cost concepts and three types of cost curve: Total cost is the cost of all resources used. We divide TC into two categories: Total fixed cost (TFC) Is the cost of the firms fixed inputs. Fixed costs do not change with output. Total variable cost (TVC) Is the cost of the firms variable inputs. Variable costs do change with output That is: TC = TFC + TVC

MINIMUM EFFICIENT SCALE the smallest quantity of output at which the long-run average cost reaches its lowest level. If the long-run average cost curve is U-shaped, the minimum point identifies the minimum efficient scale output level.

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E.g. Machine Rent (TFC) $25 p/day, TVC number of workers 3 x by $25, therefore if Sam produces 13 Shirts a day and have 3 workers TVC = $75 is TFC + TVC=TC (25+75=100) total cost curves

Total fixed cost is the same at each output level. Total variable cost increases as output increases. Total cost, which is the sum of TFC and TVC also increases as output increases. The total variable cost curve gets its shape from the total product curve. The TP curve becomes steeper at low output levels and less steep at high output levels. In contrast, the TVC curve becomes less steep at low output levels and steeper at high output levels.
MARGINAL COST

MC=TC/Q Increase in total cost those results from a one-unit increase in total product. Over the output range with increasing marginal returns, marginal cost falls as output increases. Over the output range with diminishing marginal returns, marginal cost rises as output increases. AVERAGE COST Average cost measures can be derived from each of the total cost measures: Average fixed cost (AFC=TFC/Q) Average variable cost (AVC=TVC/Q) Average total cost (ATC=TC/Q) Total cost: TC = TFC + TVC

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AFC curve shows that average fixed cost falls as output increases. AVC curve is U-shaped. As output increases, average variable cost falls to a minimum and then increases. MC curve is very special. The range of outputs over which AVC is falling, MC is below AVC. The range of outputs over which AVC is rising, MC is above AVC. The output at which AVC is at the minimum, MC equals AVC. Similarly, the range of outputs over which ATC is falling, MC is below ATC. The range of outputs over which ATC is rising, MC is above ATC. At the minimum ATC, MC equals ATC. Why the ATC Is U-Shaped AVC curve is U-shaped because: Initially, marginal product exceeds average product, which brings rising average product and falling AVC. Eventually, marginal product falls below average product, which brings falling average product and rising AVC. The ATC curve is U-shaped for the same reasons. In addition, ATC falls at low output levels because AFC is falling steeply.

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COST CURVES AND PRODUCT CURVES

SHIFTS IN COST CURVES The position of a firms cost curves depend on two factors Technology An increase in productivity shifts the average and marginal product curves upward and the average and marginal cost curves downward. Prices of factors of production An increase in a fixed cost shifts the (TC ) and average total (ATC ) curves upward but does not shift the (MC ) curve. An increase in a variable cost shifts the (TC ), (ATC ), and (MC ) curves upward

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Term Fixed Cost Variable Cost Total Fixed Cost Total Variable Cost Total Cost Total Product (output) Marginal Cost Average Fixed Cost Average Variable Cost Average Total Cost

COMPACT GLOSSARY OF COST Symbol Definition Cost that is independent of the output level Cost that varies with the output level, cost of variable input TFC Cost of fixed inputs TVC Cost of variable inputs TC Cost of all inputs TP Total Quantity Produced (Q) MC AFC AVC ATC Change in total cost resulting from a one unit increase in total product Total fixed cost per unit of output Total variable cost per unit of output Total cost per unit of output WEEK 4 PERFECT COMPETITION Many firms sell identical goods & services No restriction to enter market New & old firms have same price Everyone well informed about prices

Equation

TC=TFC+TVC

MC=TC/Q AFC=TFC/Q AVC = TVC/Q ATC=AFC+AVC

HOW PERFECT COMPETITION ARISES When firms minimum efficient scale is small relative to market demand so there is room for many firms in the industry. And when each firm is perceived to produce a good or service that has no unique characteristics, so consumers dont care which firm they buy from. E.g. Food industry PRICE TAKERS Is firm that cant influence the market price because it produces an insignificant part of the market Each firms output is a perfect substitute for the output of the other firms, so the demand for each firms output is perfectly elastic. ECONOMIC PROFIT AND REVENUE Goal of each firm is to maximise economic profit, which is equal: Total Revenue Total Cost. Total Cost is opportunity cost of production, which includes normal profit. Total Revenue (TR=P x Q) Marginal Revenue (MR=TR / Q) change in TR that result from one unit increase in Q sold

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a) Shows that market demand and market supply determine the market price that the firm must take.

(b) Shows the firms total revenue curve (TR).

(c) Shows the marginal revenue curve (MR). The firm can sell any quantity it chooses at the market price, so marginal revenue equals price and the demand curve for the firms product is horizontal at the market price.

The demand for a firms product is perfectly elastic because one firms T-shirt is a perfect substitute for the T-shirt of another firm. The market demand is not perfectly elastic because a T-shirt is a substitute for some other good. A perfectly competitive firms goal is to make maximum economic profit, given the constraints it faces. So the firm must decide: 1. How to produce at minimum cost. (operating with plant that minimises long run average cost by being on its long run average cost curve) 2. What quantity to produce. (firm output) 3. Whether to enter or exit a market.

PROFIT-MAXIMISING OUTPUT 30

A perfectly competitive firm chooses the output that maximises its economic profit. One way to find the profit-maximising output is to look at the firms total revenue and total cost curves.

a show TR & TC b shows TR-TC=Economic Profit (EP) At low output levels Economic Lossit cant cover its fixed costs. At intermediate output levels= EP At high output levels = Economic Lossnow the firm faces steeply rising costs because of diminishing returns. The firm maximises EP when it produces 9 T-shirts a day

MARGINAL ANALYSIS Firm can use marginal analysis to determine the profit-maximising output which compares Marginal Revenue (MR) & Marginal Cost (MC) If MR > MC, economic profit increases if output increases. If MR < MC, economic profit decreases if output increases. The profit maximizing level of output is that where MR = MC.

TEMPORARY SHUTDOWN DECISION If the firm makes an economic loss it may decide to exit the market or to stay in the market. If the firm decides to stay in the market, it must decide whether to produce something or to shut down temporarily. The decision will be the one that minimises the firms loss Loss Comparison 31

The firms loss = Total fixed cost (TFC) + Total variable cost (TVC) - Total revenue (TR). Economic loss = TFC + TVC TR TFC + (AVC - P) Q If the firm shuts down, Q is 0 and the firm still has to pay its TFC. So the firm incurs an economic loss equal to TFC. This economic loss is the largest that the firm must bear The Shutdown Point The price and quantity at which it is indifferent between producing and shutting down This point is where AVC is at its minimum It is also the point MC curve crosses the AVC curve At the shutdown point, the firm is indifferent between producing and shutting down temporarily. The firm incurs a loss = to TFC from either action. shows the shutdown point Minimum AVC is $17 a T-shirt. If the price is $17, the profit-maximising output is 7 T-shirts a day. The firm incurs a loss equal to TFC. The firm is at the shutdown point. If the price is between $17 and $20.14, the firm produces the quantity at which marginal cost equals price. The firm covers all its variable cost and at least part of its fixed cost. It incurs a loss that is less than TFC

THE FIRMS SUPPLY CURVE

A perfectly competitive firms supply curve shows how the firms profitmaximising output varies as the market price varies, other things remaining the same. Because the firm produces the output at which marginal cost equals marginal revenue, and because marginal revenue equals price, the firms supply curve is linked to its marginal cost curve. But at a price below the shutdown point, the firm produces nothing.

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If price equals minimum AVC, $17 in this example, the firm is indifferent between producing nothing and producing at the shutdown point, T. If the price is $25, the firm produces 9 T-shirts a day, the quantity at which P = MC. If the price is $31, the firm produces 10 T-shirts a day, the quantity at which P = MC. The blue curve in part (b) traces the firms shortrun supply curve

Short-run market supply curve Shows the quantity supplied by all firms in the market at each price when each firms plant and the number of firms remain the same The quantity supplied by the market at any given price is the sum of the quantities supplied by all the firms in the market at that price. At a price equal to minimum AVC, the shutdown price, some firms will produce the shutdown quantity and others will produce zero. The market supply curve is perfectly elastic 33

At $17 all firms are indifferent between shutting or not as none make profit. As price goes up quantity & profits increases.

Short-run equilibrium Short-run market supply and market demand determine the market price and output

Change in Demand An increase in demand bring a rightward shift of the market demand curve: The price rises and the quantity increases. A decrease in demand bring a leftward shift of the market demand curve: The price falls and the quantity decreases

Three Possible Short-Run Outcomes

Output, Price, and Profit in the Long Run 34

In short-run equilibrium, a firm may make an economic profit, break even, or incur an economic loss. Only one of them is a long-run equilibrium because firms can enter or exit the market ENTRY AND EXIT New firms come into market the number of Firms exit an industry in which they incur an firms increases and firm. Firms enter an economic loss. industry in which existing firms make an economic profit A CLOSER LOOK AT ENTRY When the market price is $25 a T-shirt, firms in the market are making economic profit A CLOSER LOOK AT EXIT When the market price is $17 a T-shirt, firms in the market are incurring an economic loss

New firms have an incentive to enter the Firms have an incentive to exit the market as market as long as firms are making economic long as they are incurring economic losses. profits. When they do, the market supply increases When they do, the market supply decreases and the market price falls. In the long run, the and the market price rises. In the long run, the market supply increases, the market price falls market supply decreases, the market price rises and firms make zero economic profit. until firms make zero economic profit

CHOICES, EQUILIBRIUM, AND EFFICIENCY We can describe an efficient use of resources in terms of the choices of consumers and firms coordinated in market equilibrium. Choices A consumers demand curve shows how the best budget allocation changes as the price of good changes. So consumers get the most value out of their resources at all points along their demand curves. With no external benefits, the market demand curve is the marginal social benefit curve Equilibrium and Efficiency In competitive equilibrium, resources are used efficientlythe quantity demanded equals the quantity supplied, so marginal social benefit equals marginal social cost. The gains from trade for consumers is measured by consumer surplusthe area below demand, above price and to the left of the quantity transacted in the market. The gains from trade for producers is measured by producer surplusthe area above the supply curve, below price and to the left of the quantity transacted in the market. 35

Total gains from trade equal total surplus consumer surplus plus producer surplus.

WEEK 5 (Chapter 10) MONOPOLY That produces a good or service for which no close substitute exists In which there is one supplier that is protected from competition by a barrier preventing the entry of new firms. HOW MONOPOLY ARISES No close substitutes Barriers to entry Monopoly sells a good that has no close market in which competition and entry are substitutes. restricted by the granting of a: 1 Public franchise (Australia Post). 2 Government licence controls entry in professions such as law, medicine, and dentistry. 3 Patent or copyright (pharmaceuticals). MONOPOLYS GOAL AND CONSTRAINTS To maximise economic profit Economic profit (EP) is = total revenue - minus total cost. EP=TR TC Total revenue Total cost amount received from selling the firms opportunity cost of the firms production, product. which includes the cost of the labour, capital, land (raw materials), and entrepreneurship used by the firm A monopoly faces two sets of constraints in the pursuit of maximum profit. Market Demand Technology and Cost Monopoly is the only seller in a market, the To produce its good or service, a monopoly demand curve that it faces is the market must set up its production plant and equipment demand curve. and hire the labour and other resources Monopoly sells a good or service that has no needed. Because a monopoly experiences close substitute, so the demand curve for the economies of scale, it has a high fixed cost of firms good or service slopes downward. its plant and a low marginal cost. The greater The lover the price the large quantity demand the quantity produced, the more units over and greater quantity monopoly sells. which the monopoly spreads its high fixed To sell large Q must set lower P cost, so the lower is its average total cost of production 36

A SINGLE-PRICE MONOPOLYS OUTPUT AND PRICE

Demand curve, D, facing a monopoly electricity producer. The ATC curve shows the ATC of producing a kilowatt hour of electricity, which is the TC of operating the plant, divided by the number of units produced. ATC=TC/Q

Monopolys economic profit. Economic profit = TR-TC. The blue rectangle shows the monopolys profit if it produces 2 megawatt hours. The price charged by a monopoly exceeds the average total cost of producing the good.

Producer surplus made by a monopoly electricity producer. The monopolys profit is shown by the blue rectangle. The monopoly sells for a price that exceeds ATC

PRICE AND MARGINAL REVENUE Total revenue (TR) Marginal revenue (MR) TR=P x Q MR= TR / Q For a single-price monopoly, marginal revenue is less than price at each level of output. That is, MR < P.

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Illustrates the relationship between price and marginal revenue and derives the marginal revenue curve. Suppose Paula, a hairdresser in Augathella, has a monopoly and sets a price of $16 and sells 2 units. Now suppose the firm cuts the price to $14 to sell 3 units. It loses $4 of total revenue on the 2 units it was selling at $16 each. And it gains $14 of total revenue on the 3rd unit. So total revenue increases by $10, which is marginal revenue The marginal revenue curve, MR, passes through the red dot midway between 2 and 3 units and at $10. You can see that MR < P at each quantity Economic Profit = TR-TC As output increases, economic profit increases at small output levels, reaches a maximum, and then decreases.

MARGINAL REVENUE EQUALS MARGINAL COST

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Paulas marginal revenue (MR) and marginal cost (MC). When Paulas increases output from 2 to 3 haircuts, MR is $10 and MC is $8. MR exceeds MC by $2 and Paulas economic profit increases by that amount. If Paulas increases output from 3 to 4 haircuts, MR is $6 and MC is $8. MC exceeds MR by $2, so economic profit decreases by that amount. The monopoly produces the profit-maximising quantity, where MR = MC. The monopoly produces the output at which MR equals MC and sets the price at which it can sell that quantity. The ATC curve tells us the average total cost. Economic profit is the profit per unit multiplied by the quantity producedthe blue rectangle. COMPARING PRICE AND OUTPUT Price and quantity produced in competitive equilibrium. A single-price monopoly produces 3,000 haircuts an hour and sells them at $14 a haircut. Compared with competition, monopoly produces a smaller output and charges a higher price

Efficiency Comparison Efficiency of perfect competition. The market demand curve is the marginal social benefit curve, MSB, and the market supply curve is the marginal social cost curve, MSC. So competitive equilibrium is efficient: MSB = MSC. 39

Consumer surplus is the area below the demand curve and above the price. Under competition total surplus is maximised and the quantity produced is efficient The inefficiency of monopoly. Because price exceeds marginal social cost, marginal social benefit exceeds marginal social cost. A deadweight loss arises. Some of the lost consumer surplus (blue rectangle) goes to the monopoly as producer surplus. This portion of the loss of consumer surplus is not a loss to society.

GAINS FROM MONOPOLY The main reason why monopoly exists is that it has potential advantages over a competitive market. Incentives to innovation Economies of scale and economies of scope Firms developing new product or process Increase in the range of goods produced obtain exclusive right of product or process lowers average total cost NATURAL MONOPOLY REGULATION Regulation Social interest theory Capture theory rules administrated by a political and regulatory regulation serves the selfgovernment agency to process relentlessly seeks out interest of the producer, who influence prices, quantities, inefficiency and regulates to captures the regulator entry eliminate deadweight loss Two theories about how regulation works are: => Efficient Regulation of a Natural Monopoly E.g. Distribution of Electricity-natural monopoly When demand and cost conditions create natural monopoly, the quantity produced is less than 40

the efficient quantity. How can government regulate natural monopoly so that it produces the efficient quantity. Marginal cost pricing rule is a regulation that sets the price equal to the monopolys marginal cost. The quantity demanded at a price equal to marginal cost is the efficient quantity. Two possible ways of enabling a regulated monopoly to avoid an economic loss are: Average Cost Pricing Government Subsidy sets the price equal to average total cost. The Direct payment to a firm equal to its economic monopoly produces the quantity at which the loss. To pay a subsidy, the government must ATC curve cuts the demand curve. raise the revenue by taxing some other The monopoly makes zero economic profit activity. But taxes themselves generate breaks even deadweight loss

Which is the better option, average cost pricing or marginal cost pricing with a government subsidy? The answer depends on the relative magnitudes of the two deadweight losses. The smaller deadweight loss is the second-best solution to regulating a natural monopoly. Price Cap Regulation Price ceiling, e.g. the Australia Post stamp price. The rule specifies the highest price that the firm is permitted to charge. This type of regulation gives the firm an incentive to operate efficiently and keep costs under control. Unregulated, a natural monopoly profitmaximises. A price cap sets the maximum price. The firm has an incentive to minimise cost and produce the quantity on the demand curve at the price cap. The price cap regulation lowers the price and increases the quantity 41

Chapter 15 Monopolistic competition 1 A large number of firms compete. 2 Each firm produces a differentiated product. 3 Firms compete on product quality, price, and marketing. 4 Firms are free to enter and exit the industry Each firm has only a small market share and therefore has limited market power to influence the price of its product Each firm is sensitive to the average market price, but no firm pays attention to the actions of others. So no one firms actions directly affect the actions of others Collusion, or conspiring to fix prices, is impossible

PRODUCT DIFFERENTIATION if the firm makes a product that is slightly different from the products of competing firms E.g. Running Shoes Product differentiation enables firms to compete in three areas: quality, price, marketing, and branding Quality includes design, Because firms produce Because products are reliability, and service differentiated products, the differentiated a firm must demand for each firms market its product. Marketing product is downward sloping. takes the two main forms: But there is a tradeoff advertising and packaging between price and quality ENTRY AND EXIT There are no barriers to entry in monopolistic competition, so firms cannot make an economic profit in the long run. Producers of audio and video equipment, clothing, jewellery, computers, and sporting goods operate in a monopolistically competitive environment. FIRMS SHORT-RUN OUTPUT AND LONG RUN: ZERO ECONOMIC PRICE DECISION PROFIT A firm that has decided the quality of its In the long run, economic profit induces entry. product and its marketing program produces And entry continues as long as firms in the the profit-maximising quantity at which its industry earn an economic profitas long as marginal revenue equals its marginal cost (P > ATC). In the long run, a firm in (MR = MC). monopolistic competition maximises its profit Price is determined from the demand curve for by producing the quantity at which its the firms product and is the highest price that marginal revenue equals its marginal cost, MR the firm can charge for the profit-maximising = MC quantity.

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As firms enter the industry, each existing firm loses some of its market share. The demand for its product decreases and the demand curve for its product shifts leftward. The decrease in demand decreases the quantity at which MR = MC and lowers the maximum price that the firm can charge to sell this quantity. Price and quantity fall with firm entry until P = ATC and firms earn zero economic profit.

The firm in monopolistic competition operates like a single-price monopoly. The firm produces the quantity at which MR equals MC and sells that quantity for the highest possible price. It earns an economic profit (as in this example) when P > ATC.

PROFIT MAXIMISING MIGHT BE LOSS MINIMISING A firm might incur an economic loss in the short run. Here is an example. At the profitmaximising quantity, P < ATC and the firm incurs an economic loss.

MONOPOLISTIC COMPETITION AND PERFECT COMPETITION Two key differences between monopolistic competition and perfect competition are: 43

Excess capacity A firm has excess capacity if it produces less than the quantity at which ATC is a minimum E.g. Real estate u can get more customers if u drop a price. But then u occur loses

Mark-up A firms mark-up is the amount by which its price exceeds its marginal cost

MONOPOLISTIC COMPETITION EFFICIENT? Price = marginal social benefit (MSB). The firms marginal cost = marginal social cost (MSC). Under monopolistic competition price exceeds marginal cost, so marginal social benefit exceeds marginal social cost. So the firm in monopolistic competition in the long run produces less than the efficient quantity

WEEK 6 (Chapter 16)

Oligopoly Is a market structure in which: Natural or legal barriers prevent the entry of A small number of large firms compete new firms Because an oligopoly market has a small number of firms, the firms are interdependent Interdependence: With a small number of firms, each firms profit depends on every firms actions.and face a temptation to Cartel: A cartel is an illegal group of firms acting together to limit output, raise price, and increase profit. Firms in oligopoly face the temptation to form a cartel, but aside from being illegal, cartels often break downcooperate. 44

An oligopoly situation where there is a natural duopolya market with two firms. THE KINKED DEMAND CURVE MODEL Key assumption: In the kinked demand curve model of oligopoly, each firm believes that if it raises its price, its competitors will not follow, but if it lowers its price all of its competitors will follow This means the firm faces two different demand curves and their associated marginal revenue curves Above the kink, demand is relatively elastic because all other firms prices remain unchanged. Below the kink, demand is relatively inelastic because all other firms prices change in line with the price of the firm shown in the figure. The kink in the demand curve means that the MR curve is discontinuous at the current quantityshown by that gap AB in the figure. Fluctuations in MC within the discontinuous portion of the MR curve leave profit-maximising quantity and price unchanged. For example, if costs increased so that the MC curve shifted upward from MC0 to MC1, the profit-maximising price and quantity would not change.

Game theory is a tool for studying strategic behaviour, which is behaviour that takes into account the expected behaviour of others and the mutual recognition of interdependence.
All games have four features: Rules the actions the players may take, and the consequences of those actions Prisoners Dilemma game, two prisoners (Art and Bob) have been caught committing a petty crime. Each is held in a separate cell and hence they cannot communicate with each other. If one of them confesses, he will get a 1-year sentence for cooperating while his accomplice gets a 10-year sentence If both confess each receives 3 years in jail. If neither confesses, each receives a 2-year sentence Strategies are all the possible actions of each player Art and Bob each have two possible actions: Confess to crime or Deny committed crime. With two players and two actions for each player, 45

there are four possible outcomes: 1. Both confess. 2. Both deny. 3. Art confesses and Bob denies. 4. Bob confesses and Art denies. Payoffs Each prisoner can work out what happens to himcan work out his payoffin each of the four possible outcomes. We can tabulate these outcomes in a payoff matrix. Payoff matrix is a table that shows the payoffs for every possible action by each player for every possible action by the other player.

A dominant strategy is a strategy which is best no matter what the other player does. In the game above this is for both players to confess.

Formulas Average Total Cost (ATC) = Total Cost / Q (Output is quantity produced or 'Q') Average Variable Cost (AVC) = Total Variable Cost / Q Average Fixed Cost (AFC) = ATC - AVC Total Cost (TC) = (AVC + AFC) X Output (Which is Q) Total Variable Cost (TVC) = AVC X Output Total Fixed Cost (TFC) = TC - TVC Marginal Cost (MC) = Change in Total Costs / Change in Output Marginal Product (MP) = Change in Total Product / Change in Variable Factor
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Marginal Revenue (MR) = Change in Total Revenue / Change in Q Average Product (AP) = TP / Variable Factor Total Revenue (TR) = Price X Quantity Average Revenue (AR) = TR / Output Total Product (TP) = AP X Variable Factor Economic Profit = TR - TC > 0 A Loss = TR - TC < 0 Break Even Point = AR = ATC Profit Maximizing Condition = MR = MC Explicit Costs = Payments to non-owners of the firm for the resources they supply

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