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Introduction to Economics

This introduction to economics explores the concepts of revenue and profit in both perfect and imperfect competition. Learn about the objectives of producers, different types of profit, and the factors that determine optimal production levels. Discover how perfect competition leads to price-taking behavior and how firms determine their profit-maximizing quantity.

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Introduction to Economics

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  1. Introduction to Economics

  2. Revenue and profit Perfect competition Imperfect competition

  3. Rational producer • Producer aims at achieving an efficient level of production with given inputs (and sales) in order to maximize his profit. • Further examples of firms’ objectives: • Market share • Survive in the long run • Good reputation for management • Stakeholder interests • However, profit is an important factor of firm’s competitiveness

  4. Revenue MR = TR / Q • Total revenue (TR) – income that a company receives from the sale of goods and services. • Average revenue (AR) – income per unit of product. • Marginal revenue (MR) – is the extra income generated by selling one more unit of production. TR = P*Q AR = TR / Q

  5. Profit • Profit is the difference between revenue and the costs of bringing products to market: • Accounting profit = TR – explicit costs • Economic profit = accounting profit – implicit costs • If the economic profit is equal to zero, the firm is still getting the so-called “normal profit” which is the minimum required by entrepreneur to stay in business and not to think of changing the job. Z = TR - TC

  6. Revenue and profit Perfect competition Imperfect competition

  7. What is competition? • Competition is a situation in which two or more people or groups are trying to get something which not everyone can have. • Competition is an activity involving two or more firms, in which each firm tries to get people to buy its own goods in preferenceto the other firms' goods. • Competition appears when there is two or more subjects whose interests (needs) are in rivalry (i.e. not everyone is allowed to reach the objects of their interests).

  8. Where can we find competition? • Competition on the demand side • Competition on the supply side • Competition between demand and supply Is competition good or bad? • It depends on the point of view….  What should competition look like?

  9. Ideal market model: 5 traits (attributes) of perfect competition (1) • Numerous small producers and consumers: none of them is capable of influencing the price. • If any of them increases the price, consumers will easily switch to the substitute. • Homogenic product: product parameters are alike. = The agriculture market is very close to perfect competition. However, it is not totally the same…

  10. Ideal market model: 5 traits of perfect competition (2) • No entrance or exit barriers: neither producers nor consumers have problems with entering or leaving the market. If the firm stops generating profit, the entrepreneur would easily leave. • Independent market agents: neither firms nor customers can agree on common behavior strategy and therefore influence the price. • Perfect information: firms and consumers have a perfect overview of prices and other market conditions and therefore act rationally.

  11. Ideal market model: perfect competition • In perfect competition conditions the invisible hand of market does work; source allocation is efficient and the economy is on its production possibility frontier. • Price is independent from the firm’s actions: the firm is capable of selling all its stock without influencing the price; demand is perfectly elastic.

  12. Perfect competition: Price takers • Market supply and demand determine the price; single firms are too small to influence prices. • The demand curve of the firm is perfectly elastic. P P The firms are price takers D S P = AR = MR D In perfect competition the price, average revenue and marginal revenue are constant. Q Q Industry Single firm

  13. Perfect competition: profit maximizing TR = P*Q • Since the price is exogenous, producers should determine the optimal production volume based on interaction between costs and price. TC = AC*Q Z = TR - TC Rule: In perfect competition the firm would maximize its profit by producing such quantity when MC are equal to price. P, AC, MC MC AC P Max Z: MC = MR=P 2 3 1 4 5 6 Q

  14. P i Q i If the revenues gained from selling additional unit of production are higher than the costs paid for producing this additional unit (i.e. MR > MC), then increasing the production leads to higher profit => Produce more! If the revenues gained from selling additional unit of production are lower than the costs paid for producing this additional unit (i.e. MR < MC), then increasing the production leads to lower profit => Produce less! Profit maximizing Relative loss MC AC Absolute loss 13 12 LOSS P(= AR = MR) 10 Profit 3 500 8 6,5 6 Q5 Q4 Q3 Q2 Q1 1600 1200 1000 800

  15. Perfect competition: when should the firm stop its activities in the short run?

  16. Další informace dole v poznámce P i Q i Shut down point in SR and LR Lowest price in long run (MC = AC) Shutdown point in long run P=AC = S MC AC AVC P1 = 45 P = AR = MR Profit is maximized at price P1 and production volume Q1 (MR = MC) Profit (P = AC) Shutdown in long run Loss = FC + Loss P2 = 30 Loss = FC (P = AVC) Shutdown in short run P3 = 20 + VC (P < AVC) Firm leaves the market P4 = 10 Shutdown point in short run P = AVC Q 4 Q 2 Q 3 Q 1 Lowest price in short run (MC = AVC) 4 000 10 000 7 000 13 000

  17. Revenue and profit Perfect competition Imperfect competition

  18. Imperfect competition: • Imperfect competition exists there, where sellers have certain control over the price of their output (market power). • This, however, doesn’t necessarily mean that the control is absolute: its extent depends on the type of imperfect competition. • Main types of imperfect competition: • monopoly, • oligopoly, and • monopolistic competition.

  19. Monopoly:opposing perfect competition • It is an extreme case: one seller with the total control over industry branch. • Pure monopolies are rare today, before all, due to antimonopoly laws.Reasons for their existence: • Legal barriers (patents, licences - Microsoft),protectionist policy,high entrance barriers (ČEZ), geographic location. • Natural monopoly • Is the case when the only one big firm with the lowest AC is capable of satisfying market demand instead of many smaller firms. Exists in branches with wide returns to scale possibilities.

  20. Oligopoly • Several(2, 5 or even 15) firms on the market given each can influence the market price. • Some economists assume that oligopoly is the situation when 4 biggest firms have over 40 percent market share. • Returns to scale are lower than monopoly has. • Firms compete with each other: • Price wars: if one reduces the price, others have to react. • Threat of cartel agreements.

  21. Monopolistic competetion • A lot of firms satisfying demand together . • Each of them has a small market share. • Product is differentiated, each producer tends to create and hold its own segment. • Importance of non-price competition: ads, marketing, customer services, etc. …

  22. Imperfect competition:Common traits (1) • Differentiated product: • One product differs from competitive ones. • Significant market shares of firms: • The firm can influence price and quantity supplied. • Entrance and exit barriers: • Legal restrictions • Customer loyalty • Ads – not all products can be sold • Existing returns to scale and diminishing costs

  23. Imperfect competition:Common traits(2) • Unfair competition: firms can agree on the common strategy – cartel agreements • Insufficient information • Neither firms, nor consumers have the complete overview of prices and market conditions; uncertainty exists.

  24. Imperfect competition:profit maximizing • Producers can influence price: e.g. by limiting production they increase the price. The price change therefore influences the revenues depending on elasticity. • The firm is maximizing its profit by producing the amount of goods that corresponds to equality of marginal revenue and marginal costs. TR = P*Q Max Z: MC = MR !!! MC = MR < P

  25. TR, AR and MR in percect and imperfect competition € € TR TR AR= P = MR= d AR= P P Q Q MR

  26. Optimal production volume of a monopolist • Firms in imperfect competition get monopolist profits; it may last much longer than in perfect competition conditions due to entrance barriers. P, C TR = P*Q TC = AC*Q D=AR MC MR AC Z = TR - TC Max Z: MC = MR P Profit Rule: In order to maximize profits the monopolist sets production on the level where MC=MR. This output level is lower compared to what could have been under perfect competition conditions. ??? E 2 3 1 4 5 6 Q 29

  27. Production volume optimization differences between perfect and imperfect competition P, C P, C MC MC D=AR MR AC AC P Profit P = = D=AR =MR=P E E 2 2 3 3 1 1 4 4 5 5 6 6 Q Q

  28. Conclusion many homogenous none low many differentiated limited low few differentiated medium high Homogenous without close substitutes one high very high

  29. Thank you for attention! Refernces: SAMUELSON, P. A., NORDHAUS, W. D. Ekonomie 18. vydání.Praha: Svoboda, 2005. KRAFT, J., RITSCHELOVÁ, I. Ekonomie pro environmentální management. Ústí n. L.: UJEP, 2003. MCDOUGAL LITTELL. Economics: Concept and Choices. Canada: McDougal Littell, 2008. www.intel.com

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