1. Market Interactions
 Interactions of goods and services take place in the market
between firms and households.
 Market interactions are voluntary.
Study Session 4, Reading 13

2. Demand Functions and Demand
Curve
 The Demand Curve is the graphical representation of the
Demand Function. The demand curve is the graph of the
inverse Demand Function.
 The Demand Curve shows both the highest price and the
highest quantity that buyers are willing to pay and are willing
and able to purchase at for each price.
Study Session 4, Reading 13

3. Demand Functions and Demand
Curve
The Demand Curve is governed by the Law of Demand which
says that as the price of a good rises (falls), the buyers will buy
less (more) of it.
Study Session 4, Reading 13

4. Supply Functions and Supply Curve
 The Supply Curve is the graphical representation of the Supply
Function.
 The Supply Function is the mathematical representation of
Supply as the dependent variable, and price as the
independent variable.
Study Session 4, Reading 13

5. Supply Functions and Supply Curve
 The supply curve is governed by the Law of Supply which says
that as the price of a good rises (falls), the supplier will sell
more (less) of it.
Study Session 4, Reading 13

6. Changes in Demand vs. Movement
along the Demand Curve
 A change in price (all other variables being constant) causes a
change in demand, known as a movement along the demand
curve or a change in the quantity demanded.
 A change in any other variable shifts the entire demand curve
and is called a change in demand.
Study Session 4, Reading 13

7. Aggregating the Supply and
Demand Functions
 In order to find aggregate demand of the market, all individual
buyer quantities are added together, not the prices.
 The Market Supply Curve is the aggregate of all individual
sellers’ supply curves.
Study Session 4, Reading 13

8. Market Equilibrium
 Markets achieve equilibrium at the price and quantity
combination which satisfies both the market demand function
and the market supply function.
 The equilibrium price and supply can be calculated by
equating the demand function to the supply function.
Study Session 4, Reading 13

9. Market Mechanism
 When the market is not in equilibrium, it tends to move
towards equilibrium.
 In the case of excess supply, prices fall.
 In the case of excess demand, prices rise.
 Prices remain unchanged if there is neither excess supply nor
excess demand.
Study Session 4, Reading 13

10. Negatively Sloped Demand and
Supply Curves
 When supply and demand curves are negatively sloped and
the supply curve intersects the demand curve from above, the
market mechanism will ensure a stable equilibrium.
 When the supply curve intersects the demand curve from
below (a price above the equilibrium) there will be excess
demand and prices will rise further, resulting in an unstable
equilibrium.
Study Session 4, Reading 13

11. Non-Linear Supply Curves
 When supply curves are non-linear, there are two
combinations of prices and quantities that satisfy the demand
and supply curves.
 The lower priced equilibrium is stable because the supply
curve is positively sloped and the demand curve is negatively
sloped.
Study Session 4, Reading 13

12. What is Market Interference?
Law makers often interfere with the market if they think that the
prices are too high for consumers to pay.
Study Session 4, Reading 13

13. Price Ceiling
 A Price Ceiling is a type of market interference.
A maximum price is set for a product which is typically below
the equilibrium price.
Study Session 4, Reading 13

14. Deadweight Loss
 Deadweight Loss is the loss of a surplus to any member of the
economy. That is, it reduces the economic benefit of
transactions.
 In the example of the price ceiling, the surplus is not
transferred. As a result, there is a loss of surplus, and hence
lower economic efficiency.
Study Session 4, Reading 13

15. Price Floor
 A Price Floor is a lower limit on the price of goods or services.
 Price floors are typically set above the equilibrium price.
Study Session 4, Reading 13

16. Taxes
 Per unit tax can be imposed on either the producer or
consumer. Like any form of market regulation, it leads to a
deadweight loss.
Study Session 4, Reading 13

17. Taxes of Producers
 The imposition of tax on producers, increases the market
price, and reduces the equilibrium quantity.
 The imposition of taxes on producers shifts the supply curve
upwards. Given it results in a lower quantity of equilibrium
volume, it leads to a deadweight loss. Additionally, some of
the surplus is transferred to the Government.
Study Session 4, Reading 13

18. Taxes on Consumers
 When unit taxes are imposed on the consumer, it results in a
downward shift in the demand curve.
 Unit taxes on consumers therefore result in a lower quantity
equilibrium tax, whereby some of the surplus under a market
equilibrium price (without the tax) is transferred to the
Government, and some is lost
Study Session 4, Reading 13

19. Total Revenue
 Total revenue is derived by multiplying the total units sold by
the price per unit
 Under perfect competition, for every additional unit sold, the
total revenue increases by the price of the product.
Study Session 4, Reading 15

20. Average Revenue
 Average revenue (AR) is the total revenue divided by the
quantity sold.
 It is the average price that a firm receives for selling a product
in the market.
Study Session 4, Reading 15

21. Marginal Revenue
 Marginal Revenue is the additional revenue generated by
selling one more unit of the product.
 It is calculated by dividing the change in total revenue by the
change in the quantity sold.
Study Session 4, Reading 15

22. Factors of Production
 Land
 Labour
 Capital
 Materials
Study Session 4, Reading 15

23. Total Cost
 Total Cost is the cost of all of the factors of production.
 Total Cost is the sum of Total Fixed Costs and Total Variable
Cost.
Study Session 4, Reading 15

24. Average Cost
 Average Cost is the average total cost per unit.
 Average Fixed Cost is the average fixed cost per unit, and is
calculated as Total Fixed Costs divided by the number of units.
 Average Variable Cost is the Total Variable Costs divided by the
number of units.
 Average Total Cost is the total costs divided by the number of
units.
Study Session 4, Reading 15

25. Marginal Cost
 Increase in cost for one additional unit
 Marginal cost at low outputs is low
 Due to law of diminishing returns it increases
 How total cost changes as input changes is explained by
marginal cost
Study Session 4, Reading 15

26. Fixed Cost
 Fixed Costs are the costs of the factors of production that
don’t vary with the number of units produced.
 Fixed cost remains constant regardless of the level of output
Study Session 4, Reading 15

27. Variable Cost
 Variable Costs are the costs of the variable factors of
production.
 Total Variable Costs change with the level of output.
Study Session 4, Reading 15

28. Breakeven Point
 Breakeven occurs when Total Revenue = Total Cost.
 At breakeven point the price, average revenue and marginal
revenue equal average total cost.
 The firm makes no profit or no loss at breakeven.
 New firms bear start-up losses due to lower quantity sold and
struggle to achieve breakeven. They try to reach the
breakeven point as soon as possible .
Study Session 4, Reading 15

29. Shutdown Point
 At the shutdown point, firms no longer produce.
 Fixed costs are still borne by the firm.
 Firm will not shutdown as long as the selling price exceeds the
variable costs per unit.
 At the Shutdown Point, average revenue is less than average
variable costs.
Study Session 4, Reading 15

30. Shutdown Point
Study Session 4, Reading 15

31. Economies of Scale and Effects on
Costs
 Economies of scale refers to the decreasing unit costs as the
size increases.
 The better use of technology and efficient labour results in
lower costs.
 In the long run, average costs decrease.
 The minimum point of the Long range average total cost curve
is the called minimum efficient scale. It is the optimal firm size
under perfect competition.
Study Session 4, Reading 15

32. Diseconomies of Scale and Effect
on Costs
 Under Diseconomies of Scale, unit costs start to rise after a
certain level of production.
 Firms become less efficient with size.
 It occurs when size cannot be managed efficiently.
 The result is that average total costs increase in the long run.
Study Session 4, Reading 15

33. Diseconomies of Scale and Effect
on Costs
Study Session 4, Reading 15

34. Profit Maximizing Output
 Profit is maximized when total revenue exceeds total cost by
the maximum amount.
 Given technology and physical capital are fixed in the short
run, the profit maximising level of output is likely to occur
where some economies of scale benefits are present.
 Economic profit is the vertical distance between the total
revenue and total cost curves.
 In economics, normal profit is considered part of firm’s costs
Study Session 4, Reading 15

35. Profit Maximizing Output
Study Session 4, Reading 15

36. Short Run Profit Maximization
 In the short run, Profit Maximization occurs when MR = MC.
 Firm will earn economic profit when TR>TC.
 Regardless of the time frame, the firm’s motive is always to
maximize profit:
Study Session 4, Reading 15

37. Long Run Profit Maximization
 Economies of scale benefits occur in the long run.
 In the long run, the firm will operate at the minimum efficient
scale of the long run average total cost curve
Study Session 4, Reading 15

38. Long Run Profit Maximization
 Lower prices may occur in the long run due to perfect competition
and greater market supply.
 In a perfectly competitive market, price equals marginal revenue.
Study Session 4, Reading 15

39. Decreasing Cost Industry
 A decreasing cost industry occurs due to a reduction in
resources cost.
 As a result, firms are able to charge a lower price.
Study Session 4, Reading 15

40. Increasing Cost of Industry
 An increasing cost industry results in higher prices and costs in
the long run.
 An increasing cost industry results in an expansion by current
participants of market.
 An increasing cost industry leads to new entrants in the
market.
Study Session 4, Reading 15

41. Constant Industry Cost
 No change in the prices or costs of resources.
 The long run supply curve is horizontal.
 Prices remain constant in the long run.
Study Session 4, Reading 15

42. Total Product of Labour
 Total Product of Labour is the sum of production of the firm
during a specific period of time.
 It is a good measure for gauging the productivity and efficiency
of the firm.
 It provides an insight into the firm production volume relative
to the industry.
 Efficiency in producing output is not measured by the total
product of labour.
Study Session 4, Reading 15

43. Marginal Product of Labour
 The Marginal Product of Labour is the productivity of each
unit.
 It is the difference in total product as a result of using an
additional unit of labour.
 It is calculated as:
or
Study Session 4, Reading 15

44. Average Product of Labour
 The Average Product of Labour measures the productivity of
inputs.
 It is an overall measure of labour productivity.
 It is calculated as the total product divided by the quantity of
input:
or
Study Session 4, Reading 15

45. Diminishing Margin Returns
 Diminishing marginal returns is the decreasing productivity as
more units are added.
 It occurs when at least one resource is fixed in the short run.
 Fixed resources restrict the output potential of the worker.
 The quality of labour constraints can also be a driver of
diminishing marginal returns.
Study Session 4, Reading 15

46. Diminishing Margin Returns
Study Session 4, Reading 15

47. Market Structures
 Perfect Competition
 Monopolistic Competition
 Oligopoly
 Pure Monopoly
Study Session 4, Reading 16

48. Perfect Competition
 Demand shares an inverse relationship with price .
 Demand increases as price falls due to the income and
substitution effect.
 Output is produced at a level where MR=MC.
 Marginal Revenue is the increase in total revenue as a result of
one more unit sold.
 Marginal Cost is the increase in total cost for a one unit
increase in input.
Study Session 4, Reading 16

49. Perfect Competition
Study Session 4, Reading 16

50. Economic Profit and the Elasticity
of Demand – Perfect Competition
 In the short run, a firm can make an economic profit, loss, or
breakeven.
 In the long run equilibrium, economic profit is zero.
 The elasticity of demand is higher.
Study Session 4, Reading 16

51. Monopolistic Competition
 Downward sloping demand curve.
 Firms produce at the profit maximizing level of output.
 In the short run, the level of output occurs where MR=MC.
Study Session 4, Reading 16

52. Economic Profit and the Elasticity
of Demand – Monopolistic
Competition
 Firms earn zero economic profit and excess capacity exists in
the long run due to entry and exit.
 Demand is less elastic due to brand loyalty and product
differentiation.
Study Session 4, Reading 16

53. Oligopoly
 Firms face a kinked demand curve.
 Pricing interdependence exists between firms.
 Output levels are produced where MR=MC.
Study Session 4, Reading 16

54. Economic Profit and the Elasticity
of Demand – Oligopoly
 Firms can make economic profits in the long run.
 Demand elasticity is high.
Study Session 4, Reading 16

55. Monopoly
 Demand curve is negatively sloped.
 Income and substitution effect.
Study Session 4, Reading 16

56. Economic Profit and the Elasticity
of Demand – Monopoly
 Economic profit is earned by a monopoly producer is called
monopoly profit.
 A monopolist tries to provide a good which has no substitutes,
which results in inelastic demand.
Study Session 4, Reading 16

57. Supply Function of Firms in Perfect
Competition
 The supply curve has a positive slope, whereby firms produce
more as prices increase.
 The sum of the individual firm supply curves results in the
market supply curve.
Study Session 4, Reading 16

58. Supply Function of Firms in
Monopolistic Competition
 The intersection of MR and MC determines the optimal level
of output.
 The supply curve shows the level of quantity a firm is willing to
provide at different prices.
Study Session 4, Reading 16

59. Supply Function of Firms in
Oligopoly
 Firms in an oligopoly will only produce the profit maximizing
quantity which are MR=MC.
 Price change is determined by the demand function.
Study Session 4, Reading 16

60. Supply Function of Firms in
Monopoly
 Supply based on the firm’s cost structure.
 No well-defined supply function.
 Profit maximizing output is MR=MC.
 No supply curve for monopolists.
Study Session 4, Reading 16

61. Profit Maximizing Output and Price
for Firm in Perfect Competition
 Horizontal demand curve for firms.
 Downward sloping demand curve for the market.
 The horizontal line is also the average revenue and marginal
revenue schedule of the firm.
Study Session 4, Reading 16

62. Profit Maximizing Output and Price
for a Firm in Monopolistic
Competition
 Profit maximized at MR = MC
 Economic profit = TR – TC
 Firm will not produce where MR<MC
Study Session 4, Reading 16

63. Profit Maximizing Output and Price
for a Firm in an Oligopoly
 No single optimum price or output level.
 Interdependence for pricing makes it very difficult to have one
optimum price.
 For a kinked demand curve, the price is at the spot of the kink
in the demand curve.
 In the case of one dominant firm, the profit maximization
point occurs where MR=MC .
Study Session 4, Reading 16

64. Profit Maximizing Output and the
Price for a Firm in an Monopoly
 The profit maximizing output level occurs in the elastic part of
the demand curve.
 MR will always intersect MC where MR is positive.
 Demand is considered elastics when the quantity
demanded responds more than the price change.
Study Session 4, Reading 16

65. Effects of Demand Changes, Entry
and Exit of Firms, and Other Factors
on Long-Run Equilibrium
Perfect Competition
 Economic profits make the market more attractive to new
entrants.
 As a result, output increases as new players enter the industry.
 Aggregate supply increases and shifts the supply curve to the
right.
 This results in lower equilibrium price for a specific level of
demand.
 Perfectly competitive firm operates at the level of output
where MR=AC, where entry is no longer profitable.
Study Session 4, Reading 16

66. Effects of Demand Changes, Entry
and Exit of Firms, and Other Factors
on Long-Run Equilibrium
Perfect Competition
Study Session 4, Reading 16

67. Effects of Demand Changes, Entry
and Exit of Firms, and Other Factors
on Long-Run Equilibrium
Monopolistic Competition
 Economic profit will attract new firms to the industry.
 Customers will be divided between a higher number of
producers. Demand for every firm will decrease.
 In the long run, economic profit will be zero.
Study Session 4, Reading 16

68. Effects of Demand Changes, Entry
and Exit of Firms, and Other Factors
on Long-Run Equilibrium
Monopolistic Competition
Study Session 4, Reading 16

69. Effects of Demand Changes, Entry
and Exit of Firms, and Other Factors
on Long-Run Equilibrium
Oligopoly
 Economic profit is possible in the long run.
 The market share of a dominant firm decreases.
 Due to increasingly efficient production techniques, new firms
have lower costs.
 Demand and MR for a dominant firm decreases.
Study Session 4, Reading 16

70. Effects of Demand Changes, Entry
and Exit of Firms, and Other Factors
on Long-Run Equilibrium
Monopoly
 Unregulated monopolies can earn economic profit in the long
run.
 All of the factors of production are variable in the long run.
 Some factors of production are fixed in the short run.
 Monopolies are protected by barriers to entry.
Study Session 4, Reading 16

71. Concentration Ratio
 The Concentration Ratio is the sum of market shares of the
largest firms in the market.
 The Concentration Ratio is bounded between 0 and 100%.
 It is simple to compute.
 The Concentration Ratio does not directly measure market
power.
 The Concentration Ratio is unaffected by mergers between the
participants of the market.
Study Session 4, Reading 16

72. Herfindahl-Hirschman Index
 The Herfindahl Hirschman Index (HHI) measures the market
shares of the top companies squared and then summed.
 HHI is 1 if one firm controls the market (monopoly).
 If more than one firms operates in the market, then the
HHI=1/M (where M is number of firms).
 The entry of a new firm and the elasticity of demand are
ignored.
Study Session 4, Reading 16

73. Identifying the Type of Market
Structure
 Markets where firms have pricing power can be inefficient if
unregulated.
 This occurs because producers have an incentive restrict
output.
 Prices tend to rise in industries where products have a high
market value.
 Excessive market concentration is hard to measure and define.
 In the instance of an imminent merger, analysts should
consider the impact of competition law
Study Session 4, Reading 16