Chapter 14: Firms in Competitive Markets

Chapter 14 starts off with the definition of competitive markets, where there are so many buyers and sellers trading an identical product that everyone is a price taker. We are introduced to average revenue and marginal revenue, which end up being the price of the good in a competitive market. A relationship between marginal revenue and marginal cost come into play here, where is revenue is greater than cost, production should be increased. At the profit maximizing level of output, revenue and cost are exactly equal. Since the firm’s marginal cost curve determines the quantity supplied, it ends up looking like the supply curve.

There are two ways that a firm could leave the market: a short-run shutdown (decision to abstain from activity due to current economic conditions) and exit (a long term decision to leave the market). Since fixed costs cannot be avoided in the short run, firms that shut down would have to pay off the fixed costs. Although, since fixed costs can be changed in the long run, firms can decide to not pay both variable and fixed costs. The fixed costs that cannot be avoided are referred to as sunk costs (in the short run) and this happens when the revenue from a firm’s outputs is less than the cost.The short-run supply curve is the part of the marginal cost curve that lies above average variable cost.

In the long run, firms would decide to leave the market depending on whether or not the revenue from its outputs overweigh the costs. The firm’s long-run supply curve is the portion of the marginal cost curve that lies above ATC. Firms would attempt to maximize profit and minimize losses, which occurs by producing the quantity where price is equal to marginal cost.

In the short run, firms have a nearly identical curve to the supply curve. However, this case is different in the long run. In the long run, firms end up making zero economic profit due to entry and exit. Entry would drive up production and lower price, whereas exit does the opposite. Although they make zero economic profit, that takes into account implicit costs too, so producers actually end up getting a profit. Marginal firms come into play here, where they are the firms that would leave the market if costs increased or prices decreases. Also, since firms can leave and join the market more easily in the long run, the long run supply curve is more elastic than the short run supply curve.

Chapter 13: The Costs of Production

Chapter 11 talks about the costs of production and the profit gained from it. Total revenue is decided from the total money a firm takes in, and when the total cost (cost of inputs of production) is subtracted from it, you get the profit. There are two kinds of profit however, depending on who is doing the analyzing. An economic profit is the total revenue minus total cost (implicit and explicit) while the accounting profit only takes into account the explicit costs.

Production costs can be determined through production function (the main idea surrounding it) which is the relationship between quantity of inputs used to make a good and the output from the inputs. There are two kinds of marginal products; regular and diminishing. A marginal product is the increase in output that comes from added input, and diminishing marginal products are the opposite.

Cost are measured in different ways as well. There are fixed costs which do not change with the amount of quantity produced (rent). On the other hand, there are variable costs that change with output (inputs such as sugar or bananas). There are three equations in relation with the two ideas mentioned above. The average total cost is the total cost divided by output, average fixed cost is fixed cost divided by output, and average variable cost is the variable cost divided by the output. These help firms determine how much of each good to buy to manufacture the goods they are producing. Whenever average total cost is greater than the marginal cost, the average total cost is falling, and the marginal cost curve crosses the average total cost curve at its minimum. Costs end up being fixed in the short run but become more variable in the long run, causing the firm to change its production. Therefore, since the cost may increase in the long run, the average total cost could decrease in the long run.

Chapter 11: Public Goods and Common Resources

Chapter 11 focuses on public goods, private goods, common goods, and natural monopolies. What kind of good something is classified as is determined by the excludability and rivalry of consumption. Excludability depends on whether or not a person can be prevented from using a good, and the rivalry of consumption depends on whether or not a person’s use of one good decreases another person’s use of the same good. Private goods are both excludable and have a rival in consumption, common goods have only a rival in consumption, natural monopolies only have excludability, and public goods have neither.

A primary concern with public goods is the idea of free-riders, people who take advantage of a good but don’t pay for it. Therefore, in an effort to prevent the free-rider problem, governments subsidize private provider (changing a private good into a public good). Governments usually end up providing a public good if the social benefit is greater than the cost. Some of the most important examples of public goods are national defense, basic research, lighthouses, and programs to reduce poverty (such as food stamps). However, some public goods have to follow a cost benefit analysis, which is a study for comparing the costs and benefits to society of providing a public good. This idea is applied to the value of a life, when people determine the own value of their life intrinsically.

Similar to free-riders, common resources have their own problem which is the Tragedy of the Commons. The problem illustrates the idea of the overuse of common resources, using sheep and shepherds as an example. Common resources to know and remember are clean air and water, congested toll roads, and food resources. Property rights are important in how they could causes a market failure because resources don’t have an owner associated with it. Examples of property rights are cows being raised as a private good instead of hunted and pollution permits.

Chapter 10: Externalities

Chapter 10 is about externalities and the efforts at regulating them.

An externality is an effect of a person’s actions on a bystander. These can be both good and bad, or beneficial and negative. The idea of a social cost accompanies externalities, which is the private cost of producing a good and the cost of a bystander. A negative externality would cause the supply curve to shift up, making the optimal quantity less than the equilibrium quantity. However, for positive externalities, the demand curve is shifted up because the optimal quantity is greater than the equilibrium quantity. The externalities can be taken into account when the externality is internalized, making it so that people take into account the external effects of their actions. Governments would internalize positive externalities by imposing subsidies, but taxes on negative externalities.

Technology spillover is a positive externality that refers to the impacts of a firm's research on the access of another firm’s access to technology. The government would attempt to internalize the externality by subsidizing the production of robots, leading to the supply curve shifting down and the equilibrium quantity going up. The government’s use of subsidies to promote technology enhancing industries is called industrial policy, but is in debate between economists about the precision of industrial policy. But, firms themselves would deal with rt technology spillovers through patent protection, giving them exclusive use of their inventions, and gives them property right. So, if other firms would want to use the new product, they would have to go to the original firm for permission, which gives an= incentive to engage in research to advance technology.

The government could also control an externality by prohibiting the behavior that leads to it altogether. The government would need to set a good ground basis for the rules, and so they need specific details of each industry. However, the details are hard to obtain.

The government’s use of taxes to deal with negative externalities are called corrective, or Pigouvian taxes. An ideal tax would equal to the cost from an activity with negative externalities and ideal subsidies would equal the benefit with positive externalities. Corrective taxes places a price on an externality (such as pollution), and it moves pollution to only the firms that spend the most to reduce it. The supply curve would be perfectly elastic because firms could produce as much as they want, as long as they pay the tax.

Governments could also issue pollution permits, which imposes a cost and a set amount of pollution that firm could produce. In this case, the supply curve would remain perfectly inelastic because the quantity of pollution is fixed based off the permits. Pollution permits are seen as a more cost effective and efficient way of keeping the environment clean. With the use of government intervention to reduce the negative externality of pollution, it would reduce the cost of environment protection and increase the public's demand for a clean environment.

An idea proposed by Coase, the Coase Theorem suggests that if private parties can bargain without cost over allocation of resources, they can solve the problem of externalities on their own. The initial distribution of rights does not matter for the ability to reach the efficient outcome. No matter how the rights are initially distributed, it only determines the distribution of economic well being, and both parties could reach max efficiency.

Chapter 8: Application: The Costs of Taxation

Chapter 8 continues on from chapter 6’s brief introduction to taxes. It amplifies the effects of taxes on the economy and introduces a new idea concerning taxes called deadweight losses. Deadweight loss is defined as the fall in total surplus when a tax changes the market. This occurs when taxes reduce the amount of marginal buyers and sellers, so the size of the market decreases (as discussed earlier in Chapter 6). Deadweight loss is determined by the elasticity of the supply or demand curve. Deadweight loss increases as a curve goes closer to elasticity. For example, if the demand curve becomes more and more elastic, the deadweight loss increases. The same applies to the supply curve. As the supply curve becomes more and more elastic, the deadweight loss increases.

Furthermore, deadweight increases with the size of the tax. A small tax would result in a relatively small deadweight loss but also a small tax revenue. A medium tax would result in a slightly larger deadweight loss and tax revenue. The largest tax would result in the most deadweight loss but also the most tax revenue. This occurs because as the tax increases, the area used to calculate the tax revenue increases, but also as the tax increases, marginal buyers and sellers leave the market which results in a higher deadweight loss.

Finally, another topic concerning taxation is the Laffer Curve. The Laffer curve states that by decreasing tax costs, the total tax revenue increases. This idea was implemented by Ronald Reagan when he ran for president. There is no way to determine whether or not the theory was true because history cannot be altered to make it testable. However, it is an idea that is prominent and known by economists today.

Chapter 7: Consumers, Producers, and the Efficiency of Markets

Chapter Seven is titled “Consumers, Producers, and the Efficiency of the Market”. The chapter primarily focuses around the idea of allocation of goods and resources as well as including market efficiency. The three main ideas discussed in the chapter are producer surpluses, consumer surpluses, and market efficiency.

Producer and consumer surpluses are very similar concepts: both include a difference of a preferred price (stemming from a personal perspective) and the actual price. A consumer surplus is the difference between an amount a buyer is willing to pay and the amount they actually pay for it. A consumer surplus is raised by lowering prices because of the larger difference between the preferred price for the good and the actual price paid for the good. Consumer surplus could be measured through the sum of many consumers’ surpluses if there is more than one person involved in the case specified. Although consumer surplus itself does not reflect economic well-being of a consumer, it is useful for making judgements of the desirability of market outcomes.

Producer surplus is a concept similar to consumer surplus but it applies to the supplier of a good. For the producer surplus, people take the difference between the pay for the job versus the cost to finish the job. However, unlike consumer surplus, a higher price increases consumer surplus due to the fact that it increases the price for a good or service for the same cost of producing said service or good. But, on the other hand, since both producer and consumer surplus are so alike, economists usually use them together (such as to calculate market efficiency).

Market efficiency occurs when the allocation of resources maximizes total surplus (calculated by subtracting the value to buyers and the cost to sellers). This occurs between the equilibrium of supply and demand, but could not reach peak efficiency if there are externalities or market power, making the market more prone to market failure.

A rather unorthodox example of market efficiency is the debate over whether or not there should be a market for organs. Since organs cannot be sold for cash (the federal government imposes a price ceiling of $0), there is always going to be a shortage for organs. People would argue that if there was a market for organs, there would not be a shortage of organs and less people would die from failure to find a suitable organ donor (even though it would benefit the highest bidder the most). The idea of an organ market is controversial, but it could be argued that a market for organs would be helpful for lessening a shortage for people who soon cannot live due to failure of organs.