Fundamentals of Managerial Economics

Lecture 2
Course Objectives:
1. Overview on the Microeconomics aspects
2. Study the behavior of the producers
3. Identify the kinds of markets
4. Fundamentals of the Macroeconomics
5. The behavior of the international trade
Lecture Outlines:
1. Review the Pricing Policy and elasticity (Pervious Lecture)
2. The behavior of the Producer and Production function
3. Cost Analysis for the Producer
4. Kinds of Markets
The producer Behavior
• The Rational Producer always seeking to achieve maximum profit, which required
to choice ideal point of production that maximize the revenue and minimize the
cost in order to enlarge profit.

• Accordingly, we have to know the factors that affect in the production decision
related to the producer.
Production function
• The Biggest Decision that any firms make is what industry to enter. No one sets
up a firm without believing that it will be profitable.

• Decisions about the quantity to produce and the price depend on the type of
market in which the firm operates. Perfect competition, monopolistic
competition, oligopoly and monopoly all kind of firms with their own special
problems.
 Production function – Cont,
• The production function shows the direct relation between the inputs the
producer need and the amount of output. It relates physical output of a
production process to physical inputs or factors of production.

• It is a mathematical function that relates the maximum amount of output that

can be obtained from a given number of inputs – generally capital and labor.
 Production function – Cont,
A) The short Run:

• The short run is a time frame in which the quantities of some resources (inputs)
are fixed.

• To increase output in the short run, a firm must increase the quantity of variable
inputs it uses. Short-run decisions are easily reversed. the firm can increase or
decrease output in the short run by increasing or decreasing the labor hours it
hires .
 Production function – Cont,
B) The long run:

• The long run is a time frame in which the quantities of all resources (inputs) can
be varied.

• To increase output in the long run, a firm is able to choose whether to change its
plant as well as whether to increase the quantity of labor it hires.
 Firm decision in short run
Short-Run Technology constraint:

• We describe the relationship between output & the quantity of labor employed by
using two related concepts.

• Total Product: is the total amount produced by using an amount of inputs.

• Marginal product: is the change in total product that results from one Unit increase in
labor.
 Firm decision in short run – Cont,
A) Total product curve:

• The following figure shows the firm’s total product. As

employment increase so does the quantity product
increase.

• TP acts as production constrain, as All the point that lie

above the curve unattainable, Points that he below the
curve is attainable but they are inefficiency as they use
more labor than is necessary to produce a given output.
 Firm decision in short run – Cont,
B) Marginal product curve:

• Show changes in output due to change in the inputs.

• Marginal product increase to a maximum (in this

example, when the 2nd worker is employed) and
then declines due to diminishing Marginal returns
which occur when the MP of an additional worker is
less than the marginal product of the previous
worker.
 Firm decision in short run – Cont,
Law of diminishing marginal product

• The main reason for increasing: The MP in the short run is that if we have a fixed
area of land it will reach to its optimal level of productivity if we reached to ideal
number of labor that achieve the specialization.

• The main reason for decreasing: the MP in the short run is the Law of diminishing
returns accrue when more and more worker using the same capital & work in the
same space.
 Firm decision in short run – Cont,
Return to scale:

• the return to scale measure the change in the output due to change in the inputs.

• According to the return to scale, we have three stages:

• Increasing return to scale: (economies of scale) it arise when an increase in all inputs leads to a
more-than-proportional increase in the level of output.

• Constant return to scale: denote a case where a change in all inputs leads to a proportional
change in output

• Decreasing return to scale: it arise when an increase in all inputs leads to a less-than-proportional
increase in the level of output
 Firm decision in short run – Cont,
Cost analysis in short run

• Total cost: is the cost of all the productive resources it uses. We divide it to total fixed
cost & total variable cost.

• Total fixed cost: is the cost of all the firm’s fixed inputs which will not change even if
output change.

• Total variable cost: is the cost of all the firm’s variable inputs which will always
change with change of output
 Firm decision in short run – Cont,
This graph illustrate the following:

• FC will always be horizontal as this cost

will not change with the output

• VC increase as the output increase

• TC Must start from the point of the fixed

cost and it must be parallel to the VC.
 Firm decision in short run – Cont,
Marginal cost

• The MC measure the change in the total

cost due to increase the production
(Output) by one extra unit.

• The MC used to decrease at first due to the

increase in the productivity and then MC
increase due to decrease the productivity
which measured by Marginal product
 Linking Output and Cost
• As discuss previously, the Marginal product increase due to the specialization and the division
of labor till it reached to ideal number of labor then decrease due to the diminishing of labor
productivity, which will have inverse relation with the cost as the labor productivity increase,
the Marginal Cost will decrease due to the mass production and vice versa
Types of market structures
Types of market system
• In market economies, there are a variety of different market systems that exist,
depending on the industry and the companies within that industry and the
products they serve.

• It is important for small business owners to understand what type of market

system they are operating in when making pricing and production decisions, or
when determining whether to enter or leave a particular industry.
Types of market system – Cont,
• Profit maximization that a business makes sound decisions in the market place
(buy the correct quantity of inputs at least cost and choose the optimal level of
output).

• N.B.: Profit equal total revenues minus total cost.

• Value maximization is another objective that the producer need to achieve in the
long run. One of the main factor that leverage the company value is the market
share and the risk factors facing the business.
Types of market system – Cont,
• There are four main kinds of market:

1. Perfect competition

2. Monopolistic competition

3. Oligopoly

4. Monopoly
Characteristics of the types of market
1. Perfect competition:

• In economics, specifically general equilibrium theory, a perfect market, also known as an

atomistic market, is defined by several idealizing conditions, collectively called perfect
competition, or atomistic competition.

• Large No. of sellers

• Identical product – homogenous

• No control over price

• No barriers to entry or exist

• Example : Agriculture products in the market

Characteristics of the types of market
2. Monopolistic competition:

• It is a type of imperfect competition such that many producers sell products that
are differentiated from one another and hence are not perfect substitutes.
• Larger no of sellers
• Differentiated product by quality and advertising or point of sale
• Some control over price
• Low barriers
• Example: Pizza restaurant
Characteristics of the types of market
3. Oligopoly:

• It is a market structure with a small number of firms, none of which can keep the
others from having significant influence
• Few sellers, from 2 to 15 or 20
• Identical or differentiated product
• Some control over price
• High barriers
• Example: Coca Cola and Pepsi
Characteristics of the types of market
4. Monopoly:

• It is a market structure with a monopoly or a company and its product offerings

dominate a sector or industry

• One Seller

• They produce a unique product which has no similarity

• Very high barriers (Advertising)

• Example: Microsoft and Windows or your local electricity company.