UNIT 7 & 8: Part 1
THE FIRM AND ITS CUSTOMERS
CHOOSING THE PRICE:
price-setting firms
- Some firms sell differentiated goods
- These firms have some market power
- In some markets there are many firms that sell similar products (but not perfect
substitutes)
- In some markets there is only one seller, a monopoly
- Such firms have a lot of market power
Price-taking firms
- These firms sell homogeneous (identical) goods
- These firms have no market power
MARKETS
- Markets bring buyers and sellers together so that they can transact.
- Most markets are not specific physical spaces.
- In economics, a market relates to one good or service, e.g. the market for crude oil.
PRODUCT DIFFERETIATION
Homogeneous (identical) goods:
- Goods sold by different sellers in the market are completely identical in every
respect, including how buyers perceive them
- Impossible to sell at a price higher than other sellers
- Firms are price takers
Differentiated goods:
- Products differ by characteristics, such as quality, style, location, etc.
- Consumers value unique characteristics and variety (e.g. shoes)
- Different firms compete for buyers on multiple fronts – price and quality
- Each firm sets own price
- A higher price means some but not all customers will move to competitors
These provide two different models for analyzing firms and markets – we choose the model
most suited to the question we’re trying to answer
CHOOSING THE PRICE
The firm’s objective: profit
Profit = Revenue – Costs
= TR - TC
, CHOOSING PRICE: PROFIT
The equations linking revenue, costs and profit are given by:
For now, we will assume that
Total costs = unit cost x quantity
c is constant: every unit
TC = c ×Q
produced costs c
Total revenue = price x quantity
TR = P ×Q
We can see profit increases if
Profit = TC – TR 1) Cost per unit decreases,
= ( P ×Q )− ( c ×Q ) 2) Price increases, or
= ( P−c ) ×Q 3) Quantity increases (as long as P > c)
ISOPROFIT CURVES:
- Higher indifference curves = higher profit
- Firm can compensate for lower P with higher Q and vice versa
CHOOSING A PRICE: DEMAND
The demand curve shows how much consumers will buy at a particular price
- Higher price lower quantity demanded
- Lower price higher quantity demanded
- Law of demand: demand curves have negative slopes
The demand curve shows which P and Q decisions are feasible for the firm:
- How much do (or will) consumers buy at a particular price
- OR how much are consumers willing to pay for a given
quantity (what they are willing to pay for the marginal
unit)
- It is the firm’s feasible frontier (FF)
- The demand curve represents how the firm has to trade
off P and Q.
- Its slope is the rate at which price can be transformed into quantity.
CHOOSING A PRICE: PROFIT MAXIMIZING CHOICE
- The firm wants to choose a feasible price and quantity combination that will
maximise its profit
- The firm could calculate its profit for every price and quantity combination on the
demand curve:
o 𝜋 = (𝑃 − 𝑐) × 𝑄
o For now, we assume constant per-unit cost 𝑐 = 2
- The profit at each level of P and Q is represented on the profit function
THE FIRM AND ITS CUSTOMERS
CHOOSING THE PRICE:
price-setting firms
- Some firms sell differentiated goods
- These firms have some market power
- In some markets there are many firms that sell similar products (but not perfect
substitutes)
- In some markets there is only one seller, a monopoly
- Such firms have a lot of market power
Price-taking firms
- These firms sell homogeneous (identical) goods
- These firms have no market power
MARKETS
- Markets bring buyers and sellers together so that they can transact.
- Most markets are not specific physical spaces.
- In economics, a market relates to one good or service, e.g. the market for crude oil.
PRODUCT DIFFERETIATION
Homogeneous (identical) goods:
- Goods sold by different sellers in the market are completely identical in every
respect, including how buyers perceive them
- Impossible to sell at a price higher than other sellers
- Firms are price takers
Differentiated goods:
- Products differ by characteristics, such as quality, style, location, etc.
- Consumers value unique characteristics and variety (e.g. shoes)
- Different firms compete for buyers on multiple fronts – price and quality
- Each firm sets own price
- A higher price means some but not all customers will move to competitors
These provide two different models for analyzing firms and markets – we choose the model
most suited to the question we’re trying to answer
CHOOSING THE PRICE
The firm’s objective: profit
Profit = Revenue – Costs
= TR - TC
, CHOOSING PRICE: PROFIT
The equations linking revenue, costs and profit are given by:
For now, we will assume that
Total costs = unit cost x quantity
c is constant: every unit
TC = c ×Q
produced costs c
Total revenue = price x quantity
TR = P ×Q
We can see profit increases if
Profit = TC – TR 1) Cost per unit decreases,
= ( P ×Q )− ( c ×Q ) 2) Price increases, or
= ( P−c ) ×Q 3) Quantity increases (as long as P > c)
ISOPROFIT CURVES:
- Higher indifference curves = higher profit
- Firm can compensate for lower P with higher Q and vice versa
CHOOSING A PRICE: DEMAND
The demand curve shows how much consumers will buy at a particular price
- Higher price lower quantity demanded
- Lower price higher quantity demanded
- Law of demand: demand curves have negative slopes
The demand curve shows which P and Q decisions are feasible for the firm:
- How much do (or will) consumers buy at a particular price
- OR how much are consumers willing to pay for a given
quantity (what they are willing to pay for the marginal
unit)
- It is the firm’s feasible frontier (FF)
- The demand curve represents how the firm has to trade
off P and Q.
- Its slope is the rate at which price can be transformed into quantity.
CHOOSING A PRICE: PROFIT MAXIMIZING CHOICE
- The firm wants to choose a feasible price and quantity combination that will
maximise its profit
- The firm could calculate its profit for every price and quantity combination on the
demand curve:
o 𝜋 = (𝑃 − 𝑐) × 𝑄
o For now, we assume constant per-unit cost 𝑐 = 2
- The profit at each level of P and Q is represented on the profit function
