Having just completed Perfect Competition with my A2 class I used a couple of packets of M&M’s to drum home the concept of marginal analysis MC=MR. It has always been something that students have struggled with but I am hoping this experience of creating graphs with M&M’s might help their understanding and when to use the concept.
Profit is maximised at the rate of output where the positive difference between total revenues and total costs is the greatest. Using marginal analysis, the perfectly competitive firm will produce at a rate of output where marginal revenue equals marginal cost. Marginal revenue, however, is equal to price. Therefore, the perfectly competitive firm produces at an output rate where marginal cost equals the price of output. Remember that the firm will make profits as long as the extra revenue brought in from selling the last unit of output(MR) is greater than the extra cost which is incurred in producing it(MC). Below are some of the graphs they created – subnormal profit and normal profit
For the last lesson before the Easter break I got students to do a variety of graphs using M&M’s. Long-run Perfect Competition, Short-run Perfect Competition, MC, AC and AVC to name just a few. A good exercise and an incentive to get them correct with the reward of eating the graph. Some creations below:
Here is another clip from Seinfeld which is an example of moral hazard and imperfect information.
Jerry’s car is stolen, so he rents a car. The rental company doesn’t give him the car he reserved; he gets a small economy car. They ask if he wants insurance, and he replies, “Yes, because I’m going to beat the hell out of this car.” Source: Seinfeld Economics
The Economist wrote in one its ‘Leaders’ that macro economists could learn a lot from their micro economist colleagues. Micro economists tend to focus more on individual markets or firms and through the use of technology are able to acquire huge amounts of data on each producing amazingly accurate forecasts of human behaviour. Rather than taking the standard textbook supply and demand, the new breed of micro economists help nudge the two into line. An example that they use is Uber – the taxi service – where prices surge during peak hours and this attracts more drivers onto the road.
Another example that The Economist use is the online book market. Research from MIT showed that used books (335 titles) typically sold for $17.50 which is 50% more than in book stores. By accessing all the readers interested in a book through the Internet you create more demand for the book which translate into higher prices. Furthermore the reader is better off as without the Internet they would not have found the book. One of the authors of the research bought a 30 year old book on pharmaceuticals online as the MIT library didn’t have it. She paid $20 for the book but was surprised to see that on the inside cover it had been priced in the second hand bookshop at $0.75.
The macro economists seem to create theoretical models before testing them against the data whilst the micro economists let computers spot patterns from the actual data.
With the A2 essay paper tomorrow here is a quick revision note on monopolistic competition. This is a market structure in which there are a large number of firms selling commodities which are very close substitutes. There are weak barriers to entry and firms may enter the industry with ease. Notice on the diagram that the firm initially makes supernormal profit at Q0 – at MC=MR Price = P0 and Cost = AC0. However with weak barriers to entry these profits are competed away and they now produce at Q1 where at MC=MR and the Price and Cost = AC1
Modern capitalism is characterised by a large number of ‘limited’ monopolies. They are sole suppliers of branded goods, but other firms compete with them by selling similar goods with different brand names. This is the market structure described as monopolistic competition. Thus the commodities produced by any one industry are not homogeneous; the goods are differentiated by branding and the use of trade marks. The individual firm has a monopoly position, but it faces keen competition from firms supplying very similar goods. It has, therefore, only a limited degree of monopoly power – how much depends upon the extent to which firms are free to enter the industry. Product differentiation is emphasised (some would say, created) by the practice of competitive advertising which is, perhaps, the most striking feature of monopolistic competition.
Advertising is employed to heighten in the consumer’s mind the differences between Brand X and Brand Y. It is important to realise that we are concerned with the differentiation of goods in the economic sense and not in the technical sense. Two branded products may be almost identical in their technical features or chemical composition, but if advertising and other selling practices have created different images in the consumer’s mind, then these products are different from our point of view because the consumer will be prepared to pay different prices for them.
For all the python fans here is some very amusing footage from the Holy Grail which focuses on Marginal Analysis. Put together by Mr Clifford of EconMovies. Worth a look.
I went through this graph with my A2 class today. Note that the firm’s short-run supply curve starts at P4. Useful for multiple-choice questions.