LEARNING OUTCOMES 3

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LEARNING OUTCOMES 3 4

• PRODUCER BEHAVIOUR
• IN THE OPERATION
• OF THE MARKET

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PRODUCER BEHAVIOUR
Producers pay for factors of production which
they combine to produce goods and services.
Short Term only one factor variable
(usually labour)
Rent
Wages
Interest
Profit
Factor Costs
Long Term all factors variable but
technology fixed
Land
Labour
Capital
Enterprise
? Output
Factor Inputs
Very Long Term all factors and the state of
technology is variable
In order to attract the right factors of
production away from their present use,
entrepreneurs may have to pay Economic Rent- the
cost over and above what they are presently
earning.
Transfer Earnings is what factors earn in their
next best use.
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OUTPUT IN THE SHORT TERM
When only one factor (usually labour) is variable
and the others fixed, total output will at first
rise at an increasing rate, then rise at a
decreasing rate, then will eventually fall.
This is due to the law of variable (diminishing)
returns to labour which says that as more and
more labour is added to fixed factors, marginal
output that which is contributed by the last
man added - will initially rise, then fall, then
become negative.
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AVERAGE AND MARGINAL OUTPUT
Output is often referred to as product (as in
production).
When we plot average output per man and marginal
output per man on the same graph we can see an
important relationship.
While Marginal Product is higher than Average
Product, technical efficiency is increasing and
Average Output is rising.
When Marginal Product is lower than Average
Product, technical efficiency is decreasing and
Average Product is falling.
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AVERAGE PRODUCT AND AVERAGE COST
Due to the fact that Average Product per unit of
labour increases and then decreases because of
the law of variable returns, then Average Costs
are U-shaped.
Average Costs at first fall, reach a minimum,
then start to rise again.
The lowest point on the Average Cost Curve is
known as the optimum output.
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TOTAL AND AVERAGE COSTS
Total Costs
Average Costs
These are each of the above costs divided by
output at each level of output.
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AVERAGE AND MARGINAL COSTS
When we plot the Average Cost and Marginal Cost
Curves on the same graph we see an important
relationship between them.
While Marginal Cost is lower than Average Cost,
Average Cost is falling and economies of scale
are being achieved.
When Marginal Cost is higher than Average Cost,
Average Cost is rising and diseconomies of scale
are being experienced.
The Marginal Cost Curve always cuts through the
Average Cost Curve from below at the lowest point
(optimum output) on the Average Cost Curve.
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PROFIT IN THE LONG TERM
In economics it is assumed that entrepreneurs
prime motivation is profit.
Entrepreneurs will combine resources in order to
produce goods and services for which consumers
express effective demand.
Through the sale of these goods and services at a
price higher than the cost of production,
entrepreneurs earn their return profit.
Profit will be maximised by entrepreneurs when
the marginal revenue charged for the last item
sold (ie its price) equals the marginal cost of
producing it.
To reach the level of output at which this
occurs, entrepreneurs will strive to take
advantage of economies of scale through
specialisation, the division of labour and to
achieve technical efficiency through the use of
the least resources necessary and economic
efficiency by using resources in their highest
valued uses.
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ECONOMIES OF SCALE
These fall into 2 categories Internal and
External Economies of Scale.
INTERNAL ECONOMIES
EXTERNAL ECONOMIES

• Technical

• Good Infrastructure

• Pool of skilled labour

• Marketing

• Ancillary Firms

• Financial

• Co-operation

• Risk Bearing

• Managerial

• Administrative

It is to achieve these economies that most firms
strive to grow.
internal growth
This can be done through
amalgamation
integration takeover merger
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INTEGRATION
Integrating with other firms will enable firms to
grow.
Integration can be
horizontal
vertical
lateral
Horizontal Integration
Where firms in the same industry and at the same
stage of production integrate.
Vertical Integration
Where firms in the same industry but at different
stages in the production process integrate.
Lateral Integration
Where firms at the same stage of production but
in different industries integrate.
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QUIZ
Name the 4 factor inputs.
Land, Labour, Capital, Enterprise
Name the 4 factor costs.
Rent, Wages, Interest, Profit
Period in which only one factor can vary.
What is meant by the short term?
Period in which all factors vary except the state
of technology.
What is meant by the long term?
All factors and technology can vary.
What is meant by the very long term?
To attract factors away from their present use.
When is economic rent paid?
What is meant by transfer earnings?
Payment to a factor in its next best use.
Why do returns to labour diminish?
Too much labour to capital.
What is meant by optimum output?
Level of output with the lowest AC.
What are economies of scale?
Savings made by scaling up output.
At what point are profits maximised?
The output at which MC MR.
Farm, flour mill, bakery, bakers shop.
Give an example of vertical integration.
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MARKET STRUCTURE
A market is any situation which allows buyers and
sellers to interact.
Markets differ mainly in the following 5 areas

• the number of firms operating

• the size of the firms operating

• the number of customers

• the type of competition used eg price, marketing

• ease of entry into and exit from the market

The most competitive markets are those in which
there are lots of suppliers supplying the same
product to lots of consumers.
In a perfectly competitive market there are so
many buyers and sellers that no-one is able to
influence market price through their own
individual actions.
Suppliers are therefore price takers since they
are unable to influence price.
If a supplier tries to raise price customers will
simply find an alternative firm.
Suppliers can maximise abnormal profits in the
short run by supplying up to the point where MC
MR.
In the long run new firms will be attracted in,
increasing supply to such an extent than price is
forced down for all firms and only the lower cost
firms are able to continue to make abnormal
profits.
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PERFECT COMPETITION
The individual firm in Perfect Competition faces
a horizontal demand curve due the suppliers all
being small in size and large in number, all
supplying the same product.
This is what makes the firm in this market a
price taker.
As new firms enter the market, attracted by the
abnormal profits available, price is forced down
due to the extra supply.
Firms which can keep their costs low will make
most profits.
Firms which are unable to keep costs low will
leave the market when they cease even to make
normal (built-in) profits.
Examples of perfectly or nearly perfectly
competitive markets are coffee, cotton, and wheat
where price is established in the world market
and individual farmers have to accept this price.
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IMPERFECT COMPETITION
Imperfect markets are any markets which are not
perfect and describe

• monopoly

• oligopoly

• monopolistic competition

• monopsony

MONOPOLY
This describes a market with only one supplier
and many buyers.
Its monopoly position is determined by the
strength of the barriers to entry to new firms
which it erects and the availability or otherwise
of substitutes.
The monopolist can determine either the price at
which to sell or the quantity it wants to sell
but not both.
The government will monitor, and where necessary,
regulate the actions of monopolies (in reality,
firms which supply more than 25 of the total )
through

• regulators/watchdogs such as Oftel, Ofwat,

• The Competition Commission, previously the
  Monopolies Mergers Commission.

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OLIGOPOLY
This is a market dominated by a handful of large
firms.
Unlike perfect competition and monolopy, this is
a fairly common market type.
Examples of this market type are petrol and
detergents.
The detergent market is a special type of
oligopoly known an duopoly because it is
dominated by 2 large firms (Proctor Gamble and
Unilever who each control over 40 of the market
for these products, the remaining 20 is shared
by all the other detergent manufacturers).
Price competition is not possible in this market
structure due to the kinked demand curve ie it
has an elastic top section and an inelastic
bottom section.
Knowledge by firms of the actions of the other
firms in this market is such that each knows what
the others are doing.
This means that if one firm raises price the
others do not and therefore they attract
customers away from that firm.
Competition tends to be through product
differentiation and advertising and firms may
collude to erect barriers to entry.
If one firm reduces price, the others do follow
suit and therefore no-one gains over the others.
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OTHER MARKET STRUCTURES
MONOPOLISTIC COMPETITION
A market with a large number of firms each
producing a differentiated or branded product to
a large number of buyers. Firms have some
control over price and market share due to
customer loyalty to the brand or firms name.
Other firms can enter the market due to the weak
barriers to entry.
Restaurants and hairdressers are examples of
this market structure.
MONOPSONY
This is a market with only one buyer and many
suppliers.
In this market structure it is the buyer who has
the control to negotiate
price, product
specification and delivery.

An example might be the MacDonalds chain
which
is so large that it can dictate to
suppliers
exactly what it wants or it could
take its custom elsewhere.
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PRICING POLICIES
Ultimately prices are determined by market forces
ie the interaction of demand and supply, so that
if firms price their products higher than
customers are willing to pay, price is forced
down.
Firms price their products in a number of
different ways
Competition based pricing due to the large
number of suppliers each firm is
forced to take the
market price and produce
accordingly in order to
maximise profit.
Penetration pricing new entrants to the market
may undercut existing firms in
order to establish a customer base.
Predatory pricing existing firms lower price to
force out new entrants who have
not yet built up reserves or
economies of scale to compete.
Highest price possible monopolists may charge
the maximum price they think
the customers will bear.
Price discrimination when a firm sells to
different customers at different prices
thereby maximising
revenue eg air fares and telephone calls.
Psychological pricing higher prices brand to
create the impression of better quality eg
Haagen Dazs ice cream.
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QUIZ
What is a market?
Any situation where buyers and sellers can
interact
What are the main defining characteristics of a
market?
Size, number of firms, number of customers, ease
of entry, type of competition.
Horizontal
Describe the demand curve faced by a firm in
perfect competition.
Describe the demand curve faced by a market in
perfect competition.
Downward sloping from left to right.
Does the firm in perfect competition make
abnormal profits?
Yes, in the short run.
Name 2 barriers to entry erected by a monopolist.
Patents, expensive advertising to create Powerful
brand image
Elastic section above the kink and
inelastic below due to the perfect knowledge of
the market leaders.
Why is an oligopolists demand curve kinked?