3000 firm’s profits could help society

A recent UN study on pollution has shown that if the 3000 largest firms would have paid their social costs than one third of their profits would have been lost and gone to protecting the environment.

Market failure exists when an unregulated market under or over allocation of resources towards a good or service. In this case a demerit good is over allocated towards the production of a particular product. Demerit goods are goods over-provided or over allocated by the free market, examples include, cigarettes and alcohol as well as pollution. Government need to regulate the production of demerit goods through taxation or limiting output of a firm.

During an economical transaction, the firm emits costs and benefits towards society and itself. During production the firm has two costs, marginal social cost, MSC, and marginal private costs, MPC. The firm also emits a benefit, marginal social benefit, MSB. As seen on the graph the MSC and MPC are not equal. This has to do with the fact that the firm is not burdening all of its costs on itself, namely part of its costs are burdened by society. Because of this, negative externalities occur. The gap between the MSC and MPC represents the negative externality, in this case, of production. Furthermore, the gap between MSC and MPC represents the loss of welfare, and is represented by DWL, dead weight loss. MPC intersects MSB at Q_e and C_e, this is the point where the firm is producing at its equilibrium cost and quantity. MSC intersects MSB at Q_so and C_so, this is the social optimal point, allocative efficiency. Since market failure is described as the under or over allocation of resources towards a good or service.

The government solution would be to have a corrective tax. The equilibrium quantity is greater that the socially optimal quantity therefore there is an over allocation towards production of a good or service. With a corrective tax the government increases the cost of production for the firm. This means that the supply will decrease, the equilibrium quantity will decrease to social optimal quantity. This way fewer resources will be allocated towards the production of a good. The amount of tax that has to be inflicted must be the gap between the MPC and MSC. As one can see, the tax is burden by bother consumers and producers. Since the price has increase to buy the good, the demand has decreased. Since the supply has also decreased to the socially optimal level, there is no loss of welfare because the demand has also decreased. The tax that the government receives can be used to repair the damage done by the good.

Another alternative for the government would be to directly control the polluting firm. This way firms are limited to what they are allowed to emit. This is however easier said than done. First, monitoring the emissions of a firm can be very difficult and thus costly for the government. The government has to have a way to enforce it limitation on polluting firms. Another question raised is: Can we put a price tag on environmental damage? The punishment has to have a greater incentive to not pollute than pollute otherwise firms will continue to pollute to lower their costs.

Monopolistic competition and Oligopoly questions

Monopolistic competition page 118

Productively efficient is the point where the cost is minimized. This is at MC = AC (Q2). Allocative efficiency is the social optimum point, where MC = MR (Q3). All firms wish to maximize their profits so they will produce at MC = MR (Q1). As seen on the graph, the firm is producing at Q1 so there for it cannot be allocatively efficient or productively efficient if it is not producing at Q2 or Q3.

Oligopoly page 125

When firms are non-collusive they do not agree on a price to sell. This is an advantage to consumers because the price will be lower and more will be produced opposed to a collusive oligopoly. Since changing their price will have drastic changes in demand firms need to be aware of the reaction of other firms. If an oligopoly, that is non-collusive, raises the price and the other oligopoly doesn't it, will lose consumers and thus revenues and finally profits. If, on the other hand, a firm lowers its price, then the firm will receive more profits. Other firms will follow but undercut the price to make up for lost profits. This will result in a "price war" and the price of a good will keep decreasing until at one point the firm will be selling it at a loss. The price thus remains stable in a non-collusive oligopoly market because the price cannot change without erupting into a "price war" or a loss of profits.

Monopoly question

1. Explain the level of output at which a monopoly firm will produce.
   

All firms with to receive profits, monopolies included. A monopoly will produce at the profit maximization point, where the marginal cost meets the marginal revenue. If the monopoly's average costs are below the demand curve then the firm will be making abnormal profits. Because the monopoly's demand curve is the same as the industry's demand curve, because the monopoly is the industry it will be a downward sloping demand curve. A monopoly can change its price and level of output, but not both at the same time. If a monopoly wishes to increase its profits it will reduce it output, this way the price will increase.

1. Using a diagram, explain the concept of a natural monopoly.
   

A natural monopoly states that there is only room for one firm because there are not enough economies to scale. The economies of scale set the position of the average total cost curve.

When the revenue is higher than the cost the firm is making abnormal profits. When the first is producing between q1 and q2 the monopoly is earning abnormal profits. If another firm entered the market then the demand would decrease to D2. This way the firm will not be covering its average total cost and earn losses.

So it is more productively efficient for an industry to have one firm with limited economies of scale. If there is only one firm and it produces in the demand satisfying area on the graph then that firm will earn abnormal profits. The government usually helps regulate the monopolies, blocking barriers to entry, making the firms more productively efficient.

1. Using appropriate diagrams, explain whether a monopoly is likely to be more efficient or less efficient than a firm in perfect competition.
   

A monopoly, like all firms will produce at the point where marginal cost is equal to marginal revenue. The price will be set high with low output to increase profits, but the monopoly will not be allocative or productively efficient. With large economies to scale, the marginal cost decreases making it possible for the firm to produce more and charge a higher price.

The monopoly will produce where marginal cost is equal to marginal revenue to maximize its profit. At p1, the price of the good is higher than p2, which is the monopoly's cost; thus the monopoly is earning an abnormal profit marked in green. Allocative efficiency is where marginal cost equals average revenue at q2, but the monopoly is not producing there so it is not allocatively efficient. Productive efficiency is where marginal cost is average cost at q1. However the monopoly is not producing there either so it is not productively efficient.

A perfect competition firm needs to be very efficient both allocative and productive because by raising its price, it leaves the market.

Winemaker Monopoly

In a small town next to Pfäffikon, the town where I live, there is a wine maker and seller. It is the only wine maker in the area. When you drive through the area you will see many sloped fields filled with grape plants. These fields are owned by the wine maker. Since it is the only wine sell and producer in the area it can be regarded as a monopoly for wine. Consumers do not have to buy the wine from the wine maker in the town because they could go to the neighboring village and get foreign wine but not enjoy the local wine.

The wine maker in my town is a monopoly. It is the only firm in the market that supplies local wine from the region. It can thus make its own prices because it is unique and regional, it is a price maker. It is also the only producer of the unique wine from the region. Lastly, it frequently uses non-price competition such as free wine tasting gatherings and advertisements in the local newspaper. Furthermore, the winemaker is a monopoly because it has set high barriers to entry. For the most part the winemaker owns the entire agricultural region where he grows his grape plants.

If the winemaker were to be a pure monopoly, it would have to set higher barrier of entry, buying even more agricultural land in the region, owning all the resources and making it impossible for other firms to enter the market for the regional wine.

Monopoly

Chapter 8 questions 1,2,3

1) In the short run firms have to cope with different costs, variable and fixed. The variable cost are usually wages, it can vary in the short run, for example, longer work days or hiring more workers. Fixed cost are rents and interest, they cannot change in the short run. The short run is also when are unable firms enter or leave the market.

Perfect competition, an economical theory, is where all the many firms are equal in size and produce identical products as well as same amount of output. Moreover, they also face equal costs and since there are no barriers of entry or exit, firms are allowed to enter or leave as they see put. Firms in perfect competition are “price takers” which means that the firm is not influential enough to affect the price of a good or service. In this case the market price is determined by the demand and supply of the market. Furthermore, the demand for goods in a perfectly competitive market is perfectly elastic. This means that the firm can only sell at that price because if they raise the price no consumer would buy a good at that particular firm. Likewise, if the firm decreased its price, then infinite amount of consumers would buy their good; however this is unrealistic.

When the marginal revenue intersects the marginal cost, it is known as the profit maximization rule, in order to maximize a firm’s profits, the firm must produce at that quantity. On the graph MR=MC.

When the firm is producing at the profit maximization point it is most efficient at producing. When the average total cost is below the price of the good then the firm is producing abnormal profits. For example, if a kebab’s cost is 8 CHF to produce and the kebab producer can sell it for 10 CHF then the producer has made profits of 2 CHF.

However, it is only possible for firms to earn abnormal profits in the short run. Since firms can only enter or exit a market the supply of the industry’s product will not vary. When a firm in a perfectly competitive market is earning abnormal profits, many new firms will enter the market because firms are profit seekers. The supply for goods in the market will increase with the increased number of firms. The price of the good will thus decrease. On the graph, the supply shifts to the right, from Qe1 to Qe2, the price moves from Pe to Pe1. Since firms in the perfect completion are price takers, they receive the price of the market. It has now decreased to Pe1. Firms must now charge at price Pe1 for consumers to buy at their firm, if they don’t, no one would buy there because the firms demand is perfectly elastic.

1) 2) In the short run firms face no fixed costs, wages, rent and interest on a firms costs are all variable, this why the long run is considered the variable plant size. Unlike the short run, firms are able to enter or exit the market in perfect competition in the long run.

It is possible for firms in perfect competition to earn abnormal profits. When the selling price of goods is higher than the cost of production then the firm is earning abnormal profits. When a firm is earning abnormal profits it attracts other firms because firms are profit seekers. With more firms entering the market the overall supply of the market increases. The supply shifts to the right and thus the price drops. There will be a new equilibrium point; the firms will now be earning normal profits. Since normal profits are points where the cost s equals the revenue, no more firms would enter the market because there is no more chance of earning abnormal profits.

When firms make losses in the short-run, some firms will pull out of the market. This will decrease the supply and thus the price will increase. Firms will now be able to sell their goods at the increased price. Since this will help raise the revenues, the loss will not be as big, if the costs remain the same.

The market is constantly changing, thus there will be new equilibrium points. The firms in perfectly competitive markets will never earn abnormal profits, only normal profits.

1) 3) Abnormal profits are when the revenue earned exceeded the costs. When a firm is producing at the profit maximization point, MC=MR, at Q then the firm is being most efficient at producing. When the average total cost is lower than the price of sell the good the firm earns abnormal profits.

Productive efficiency is the point where P= minimum ATC. The firm is using its resources to it maximum efficiency by producing at the lowest average total cost. Since all firms are equal in size and output there is a huge competition going on. There is a large incentive for reducing the costs as much as possible because the output and price is the same; the only thing variable is the costs, so if a firm has a lower cost than another the other firm and could possible shut down due to higher costs.

Allocative efficiency is where P=MC. At that point the right amount of output is produced. If the price were higher that the marginal cost, this is a signal that more output is desired, if the price were lower than the marginal cost, the signal from buyers to sellers is that less output is desired.

If a firm produces at the minimum ATC then it is productively efficient. However in this case it is not, because the price doesn’t intersect the minimum point on the ATC. The firm is still producing at the profit maximization point because MC=MR. The ATC is however, intersected by the MC. So the firm is earning abnormal profits but not productively efficient. Since the P=MC at the profit maximization point the firm is allocative efficient.

Chapter 7 questions 1,2,3

Chapter 7 question

1. The short run is considered the fixed plant size, meaning the land and capital resources are limited. The labor resource, however, is not limited; it can be changed, for example, the amount of workers or the length of working time. All the production is done in the short run. The long run is the planning phase, the firm plans how it could be more efficient lowering cost, or how to produce more. The long run is made up of many short run. The long run is considered the variable plant size, where all the factors or production are variable, land, labor, and capital. The only thing halting a firm's efficiency and total product is the state of technology, for example a ox plow versus a tractor.
   
2. As more units of the variable factor, labor, are added to the fixed factors of production, capital and land, the output of the extra input will eventually diminish. This is because there is not land or not enough capital for the increase amount of labor. For example, the soup in the kitchen will not amazing if 100 cooks work on it at once, they will just get in each other's way.
   

3. The accountant's definition of profit is the total revenue minus the total cost. The economist's definition of profit is the total revenue minus the opportunity cost. For example, if you start a business for $100,000 and your profits are $120,000. An accountant would say your profits are $20,000. An economist would say it would be an economic loss, if you were employed and had received $45,000. There is an economic loss of $25,000, $45,000 - $20,000 = $25,000, because of the opportunity cost of not being employed opposed to employing someone else.