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Notes on Chapter 9
ORGANIZING PRODUCTION
Firms differ in the size and in the type of business they are doing but all firms
perform the same basic economic functions.
A firm is an institution that hires factors of production and organizes them to
produce and sell goods and services.
To predict a firm's behavior, we need to know the firm's goals and the
constraints it faces.
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Example:
Calculating Economic Profit
Total Revenue 400,000
Opportunity Cost
Explicit costs:
Cost of merchandise sold 80,000
Wages 120,000
Utilities 20,000
Interest paid 10,000
Taxes 10,000
Total explicit costs 240,000
Implicit costs:
Owner's wage forgone 40,000
Interest forgone 20,000
Economic Depreciation* 25,000
Normal Profit 50,000
Total implicit costs 135,000
Total Economic Cost (Opportunity Cost) 375,000
Economic Profit 25,000
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MARKET STRUCTURE
The opportunity of the firm to maximize its profit may be limited by the
structure of the industry.
Market structure refers to the number and the relative size of the firms in an
industry
There are four main types of market structure: perfect competition,
monopolistic competition, oligopoly and monopoly.
It is important to note that: (1) these markets may change over time from one
structure to another, and (2) some real life markets may not fit well in any of
these four structures
Perfect Competition
o Perfect competition refers to a market in which there are many firms
selling an identical product and many buyers. None of the buyers or
sellers has market power. Each firm is a price taker. No barriers to enter
or exit this type of market. Information is available to all. In the long
run, economic profit of any firm in this type of market is zero.
o Market Power refers to the ability to influence the market price of a
good or service
o Examples: the markets for agricultural product (corn, wheat, coffee),
financial instruments (stocks, bonds, foreign exchange), precious metals
(gold, silver, platinum) and the global petroleum industry
o In each of these markets, the products are standardized commodities, and
supply and demand are the primary determinants of their market price.
Monopolistic Competition
o Monopolistic competition is a market in which large number of
relatively small firms produce similar but different product
(differentiated products). Each firm maintains some control of its own
price. It is easy to enter or exit this market. In the long run, economic
profit of any firm in this type of markets is zero.
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Oligopoly
o Oligopoly is a market in which a small number of firms producing all or
most of the market supply of a particular good or service. The product
may be identical or differentiated. This market is generally considered to
be for large firms. It is difficult to enter this market. Firms in this market
can make positive economic profit based on whether they compete with
each other severely or they have some kind of mutual agreements
regarding prices, market share and products.
o Examples: manufacturing sector, oil refining, certain types of computer
hardware and software, chemical and plastics, steel, automobile, soft
drinks, airline travel, banking industry, insurance companies,
telecommunications, etc
Monopoly
o Monopoly refers to the firm that produces the entire market supply of a
particular unique good or service (no close substitutes for this product).
It has market power. It is a price maker. It is very difficult or impossible
for any other firm to enter this market. This firm makes high economic
profit subject to regulations.
o Examples of pure monopoly are not easy to find. Electricity and water
industry in some countries, patent laws sometimes provide companies
with temporary monopolies, a company that is so dominant might be
said to exhibit monopolistic status (such as Microsoft)
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