Short-run and long-run costs
In the short run some inputs are (a) . Since these inputs have to be paid
regardless of the level of output produced, these payments to the fixed inputs remain (b)
no matter what level of output is produced. Such payments are called fixed
costs. An example of a fixed cost is a machine that is (c) for one year at a cost
of $500 per month. The cost of the machine is $500 every month for one year regardless of how many units of output are produced using the machine. Even if the firm shuts down for a month and does not use the machine, the firm still must pay $500 for the machine that month.
The payments to variable inputs are called variable costs. Producing more output requires more variable inputs. Thus, variable costs increase as the level of output increases. Examples of variable costs would be the payments for many types of labour, ingredient inputs or raw materials, or the energy used in production. As noted above, in the short run the levels of use of some inputs are fixed, and the costs associated with these fixed inputs must be paid regardless of the level of output produced. Total fixed cost (TFC) is the sum of the short-run fixed costs that must be paid regardless of the level of output produced. Total variable cost (TVC) is the sum of the amounts spent for
each of the variable inputs used. Total variable cost (d) as output increases.
Short-ran total cost (TC), which also increases as output increases, is the sum of total variable and total fixed cost:
TC = TVC + TFC
The long ran simply means that all input are (e) to the firm. One of the first
decision to be made by the firm is to (f) the scale of operations, that is, the size
of the firm. To make this decision, a manager must know the cost of producing each relevant of output.
Similar to the short ran, we define long-run (g) cost as
LAS = Long-run total cost (LTC)/Output (Q)
and long-run (h) cost as
LMC = ∆LTC/∆Q
2. Comprehension check.
Say if he following sentences are true or false. Correct the false ones.
Total fixed cost is the total amount paid for fixed inputs. Total fixed cost can vary with output.
Total variable cost is the amount paid for variable inputs, it increases with increases in output.
Total cost is the sum of total fixed cost and total variable cost, it increases with increases in output.
Long run average cost is long run total cost divided by output.
Discussion
Work in pairs.
Discuss in pairs what you have learned about short-run and long-run costs.
Unit 5 perfect competition
Reading
1. Skim through text 32 and think of the suitable title. TEXT 32
This unit addresses an important question facing all managers: What can I do to achieve the highest possible profits for my firm? Although the answer sometimes differs, depending on the type of market in which the firm sells its products, the fundamental principles are quite similar for all firms. The decision maker chooses the level of an activity or activities so as to maximize the net benefits - total benefits minus total costs. To maximize net benefits, marginal benefits must equal marginal cost for the last unit of the activity. In the case of firms, the net benefits are called profits. Profits is the difference between total revenue and total cost. Thus profit is maximized where marginal revenue equals marginal cost for the last unit of the activity undertaken. A manager can choose either the level of output or the level of employment of inputs to maximize profits. Choosing either the output level or the level of input usage will lead to the same maximum profit outcome.
The theory of perfect competition is important for two reasons. First, the theory describes important segments of an economy, the most important of which are the markets for most agricultural products. Typically, in agricultural markets, there are a large number of firms that are small relative to the entire market - each firm produces only a small fraction of the total industry output. Each agricultural producer recognizes that the price of the product is determined by the market forces of demand and supply, and thus cannot be set by an individual producer. In addition to agricultural products, many other products are also sold in markets that are perfectly competitive, or nearly perfectly competitive.
A second reason the theory of perfect competition is important is that the conclusions derived from it frequently permit accurate explanation and prediction of real world phenomena. The theory often works well as a model of economic processes even though it does not precisely describe the firms and industries under consideration. Therefore, the fundamentals of the theory are useful not only to economists but to managerial decision makers as well. Managers can profitably use the conclusions of the theory, even though all of its assumptions do not exactly fit the characteristics of their firms.
To summarize, although relatively few markets are perfectly competitive, the behavior of many markets closely approximates the model of perfect competition. Thus, we can use the model as an approximation of real-world markets that are close to being perfectly competitive.
2. Comprehension check.
Working in pairs, take turns answering the questions:
What is perfectly competitive market?
What decisions should a manager make for profit maximizing?
Why is the theory of perfect competition important for economists and managers?
3. There are four paragraphs in the text. Make a list of key words from each paragraph.
Discussion
Work in pairs.
Using the key vocabulary that you have made in the previous task, discuss what you
have learned about perfectly competitive markets and the theory of perfect competition.
Reading
1, Skim through text 33 and think of the suitable title.
TEXT 33
Because firms in perfectly competitive markets produce identical products and face a given market price, the essence of the theory is that producers do not recognize any competitiveness among themselves; that is, no direct competition among firms exists. Therefore, the theoretical concept of competition in these markets is diametrically opposed to the generally accepted concept of competition. We could say that the automobile industry or the personal computer industry is quite competitive since each firm in these industries must consider what its rivals will do before it makes a decision about advertising campaigns, design changes, quality improvements, and so forth. However, that type of market is far removed from the theory of perfect competition, which permits no personal rivalry. ("Personal" rivalry is personal in the sense that firms consider the reactions of other firms in determining their own policy). In perfect competition all economic magnitudes are determined by impersonal market forces. Several important conditions define perfect competition:
The product of each firm in a perfectly competitive market is identical to the product of every other firm. This condition ensures that buyers are indifferent as to the firm from which they purchase. Product differences, whether real or imaginary, are precluded under perfect competition. Thus, the market is characterized by a homogeneous (or perfectly standardized) commodity.
Each firm in the industry must be so small relative to the total market that it cannot affect the market price of the good it produces by changing its output. If all producers act together, changes in quantity will definitely affect market price. But, if perfect competition prevails, each producer is so small that individual changes will go unnoticed. Neither is any individual firm able to affect the price of any input by its usage of that input. Again all producers could, under certain conditions, change their usage of an input and affect its price. In other words, the actions of any individual firm do not affect the market supply of the product produced or the market demand for any input.
There exists unrestricted entry and exit into and out of the industry. Hence, there can be no artificial restrictions on the number of firms in the industry. New firms do not require huge amounts of capital equipment and investment to enter perfectly competitive industries.
Each firm has full and complete knowledge about the product and the market. Thus each firm knows the best - least cost - method of production, the price of output, and input price. Even potential entrants know whether or not firms in the industry are making economic profits. This assumption of complete information is made for analytical convenience only and is not necessary for the development of the theory.
2. Comprehension check.
Working in pairs, answer the questions:
What is the concept of perfect competition?
What conditions are essential for perfect competition?
Discussion
Working in pairs, discuss what you have learned about characteristics of perfect competition.