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Course: BBASubject: Business Economics
Unit: 4
Cost Analysis & Price Output Decisions
Syllabus content
• Market: Meaning of Market, Types of Market and their important features: Perfect Competition, Monopoly, Monopolistic Competition and Oligopoly.
• Cost: Concept of Cost, Cost Function, Short Run Cost, Long Run Cost, Economies and Diseconomies of Scale, Explicit Cost and Implicit Cost, Private and Social Cost.
• Pricing: Under Perfect Competition, Pricing Under Monopoly, Control of Monopoly, Price Discrimination, Pricing Under Monopolistic Competition, Pricing Under Oligopoly.
What is market?
• Market is a place, where the buyers and the sellers of a good are in contact with each other.
• This contact may be direct or indirect.
Check Your Understanding
COST ANALYSIS
What is cost???
• Cost means the amount of money that a company spends on the creation or production of goods or services
"short run” and "long run"
• The difference between the short run and the long run is the flexibility decision makers have
• Short run: period of time in which the quantity of at least one input is fixed and the quantities of the other inputs can be varied.
• Long run: period of time in which the quantities of all inputs can be varied.
"short run cost” and "long run cost"
• short run cost: The costs which incurred over the short run
• long run cost: The costs which incurred over the long run
Explicit Cost and Implicit Cost
• Explicit Cost: Business expense that is easily identified and accounted for.
• For Example: wage expense, rent or lease costs, and the cost of materials
• Implicit costs can also be thought of as intangible costs that are not easily accounted for.
• For example, the time and effort that an owner puts into the maintenance of the company, rather than working on expansion, can be viewed as an implicit cost of running the business.
Economies of Scale
• Economics of Scale exist when the production cost of a single product decreases with the number of unit produced
• Economies of scale is about the benefits gained by the production of large volume of a product
• In business, economies of scale are usually considered in relation to specific areas of the production process, which may be technical, managerial, marketing, finance, and risk bearing .
Diseconomies of scale
• Diseconomies of Scale exist when the production cost of a single product increases with the number of unit produced
• Diseconomies of scale is about the disadvantages faced by the production of large volume of a product
• In business, diseconomies of scale are usually due to Decision making, Managerial problems, Communication problems, Co-ordination/control problems, Staffing problems
Private cost and social cost
• Private cost: Monetary cost, which a firm incurs in the production of a good.
• Social Cost: Real cost, which the society incurs in the production of a good. For example- Pollution from a factory
Cost Function
• Cost is dependent on some factors. These factors make cost function.
• Short Run Cost function C=f (X, Pf ,T,K)
• Long Run Cost function C=f (X, Pf ,T)
Here C=CostX=OutputPf =Price of Factor
T= TechnologyK=Capital
EXAMPLE 1
11,000
9,000
7,000
5,000
3,000
1,000
Total Cost(Rs.)
30005
28004
24003
18002
10001
10,000
8,000
6,000
4,000
2,000
0
1,000
1,000
1,000
1,000
1,000
1,00000
Cost of labor(Rs.)
Fixed Cost(Rs)
Q(Quantity of Pens)
L(no. of
workers)
Total Cost Curve
0 1000 2000 30000
2000
4000
6000
8000
10000
12000
Quantity of Pen
To
tal c
os
t(R
s.)
Marginal Cost• Marginal Cost (MC)
is the increase in Total Cost from producing one more unit:
∆TC∆Q
MC =
Total and Marginal Cost
10.00
5.00
3.33
2.50
2.00
Marginal Cost (MC)
11,000
9,000
7,000
5,000
3,000
1,000
Total Cost
3000
2800
2400
1800
1000
0
Q
∆Q = 1000 ∆TC = 2000
∆Q = 800 ∆TC = 2000
∆Q = 600 ∆TC = 2000
∆Q = 400 ∆TC = 2000
∆Q = 200 ∆TC = 2000
Marginal Cost Curve
0 500 1,000 1,500 2,000 2,500 3,000 $0
$2
$4
$6
$8
$10
$12
Q
Mar
gin
al C
ost
($)
Costs
7
6
5
4
3
2
1
620
480
380
310
260
220
170
$100
520
380
280
210
160
120
70
$0
100
100
100
100
100
100
100
$1000
TCVCFCQ
$0
$100
$200
$300
$400
$500
$600
$700
$800
0 1 2 3 4 5 6 7
Q
Cost
s
FC
VCTC
Average Variable Cost
5207
3806
2805
2104
1603
1202
701
74.29
63.33
56.00
52.50
53.33
60
$70
n/a$00
AVCVCQ Average variable cost (AVC) is variable cost divided by the quantity of output:
AVC = VC/Q
As Q rises, AVC may fall initially. In most cases, AVC will eventually rise as output rises.
$0
$25
$50
$75
$100
$125
$150
$175
$200
0 1 2 3 4 5 6 7Q
Co
sts
Usually, as in this example, the ATC curve is U-shaped.
$0
$25
$50
$75
$100
$125
$150
$175
$200
0 1 2 3 4 5 6 7
Q
Cost
s
Average Total Cost
88.57
80
76
77.50
86.67
110
$170
n/a
ATC
6207
4806
3805
3104
2603
2202
1701
$1000
TCQ
The Various Cost Curves Together
AVCATC
MC
$0
$25
$50
$75
$100
$125
$150
$175
$200
0 1 2 3 4 5 6 7
Q
Cost
s
Total, Average, Marginal Revenue for competitive firm
Pricing under Perfect Competition
Diagrammatic representation
Cost/Revenue
Output/Sales
P = MR = AR
MC
AC
Q1
Total, Average, Marginal Revenue for Monopoly
%Pricing under Monopoly
QuantityQ Q0
Costs andRevenue
Demand
Average total cost
Marginal revenue
Marginalcost
Monopolyprice
QMAX
B
1. The intersection of themarginal-revenue curveand the marginal-costcurve determines theprofit-maximizingquantity . . .
A
2. . . . and then the demandcurve shows the priceconsistent with this quantity.
Controlling Monopoly
• Government may regulate the prices that the monopoly charges(Examples: CNG, PNG prices)
• Rather than regulating a natural monopoly that is run by a private firm, the government can run the monopoly itself (Example: Railway)
• Government can do nothing at all if the market failure is deemed small compared to the imperfections of public policies.
PRICE DISCRIMINATION
• Price discrimination is the business practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same
• Price discrimination is not possible when a good is sold in a perfect competitive market because there are many firms all selling at the market price.
• For price discrimination, the firm must have some market power.
• Perfect Price Discrimination– Perfect price discrimination refers to the situation when the
monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.
PRICE DISCRIMINATION
• Examples of Price Discrimination– Movie tickets– Airline prices– Discount coupons– Financial aid– Quantity discounts
Total Revenue for Oligopoly
GAME THEORY AND THE ECONOMICS OF COOPERATION
• Game theory is the study of how people behave in strategic situations.
The Prisoners’ Dilemma
Bonnie’ s Decision
Confess
Confess
Bonnie gets 8 years
Clyde gets 8 years
Bonnie gets 20 years
Clyde goes free
Bonnie goes free
Clyde gets 20 years
gets 1 yearBonnie
Clyde gets 1 year
Remain Silent
RemainSilent
Clyde’sDecision
Jack and Jill Oligopoly Game
Copyright©2003 Southwestern/Thomson Learning
Jack’s Decision
Sell 40Gallons
Sell 40 Gallons
Jack gets$1,600 profit
Jill gets$1,600 profit
Jill gets$2,000 profit
Jack gets$1,500 profit
Jill gets$1,500 profit
Jack gets$2,000 profit
Jill gets$1,800 profit
Jack gets$1,800 profit
Sell 30 Gallons
Sell 30Gallons
Jill’sDecision
42
Pricing in A Monopolistically Competitive Firm in the Short Run
MR1
$70
30
250
d1
A MCATC
Dollars
Homes Serviced per Month
2. and charges $70 per home.
4. Kafka's monthly profit–$10,000–is the area of the shaded rectangle.
1. Kafka services 250 homes per month, where MC and MR intersect . . .
3. ATC at 250 units is less than price, so profit per unit is positive.
43
Pricing in A Monopolistically Competitive Firm in the Long Run
d2MR2
E
MC
$40
100 250
Dollars
Homes Serviced per Month
ATC
MR1
In the long run, profit attracts entry, which shifts the firm's demand curve leftward.
The typical firm produces where its new MR crosses MC.
d1
Entry continues until P = ATC at the best output level, and economic profit is zero.