Production and Cost curves and Market Structures

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Answer all three questions.

1. Discuss short and long run costs. For the short run discuss the relationship between cost theory and production theory and the concept of diminishing returns --- what is diminishing returns and how does it shape production and cost curves. Then, discuss the relationship between short run cost curves and long run cost curves. Finally discuss the concept of economics of scale and how long run costs curves shape the economic structure of industries.

When any two commodities can be produced with the aid of the same resources of whatever sort, freely transferable from one use to the other, the prices of those commodities must in equilibrium be such that the alternative products of the same or equal units of resources exchange for each other. Price is determined by cost rather than utility, but by cost in a physical technical sense, not that of pain or sacrifice...Comparisons of sacrifice, however, may be and commonly are involved in greater or lesser degree, and the operation of the utility principle is the basis of the whole process of adjustment. This is the alternative cost theory which is definitely the product of the utility approach.

A productively efficient firm organizes its factors of production in such a way that the average cost of production is at lowest point. In the short run, when at least one factor of production is fixed, this occurs at the optimum capacity where it has enjoyed all the possible benefits of specialization and no further opportunities for increasing returns exist.
The phenomena of [alternative] costs are, therefore, a new proof of how greatly the objective conditions of the existence of goods influence the value of goods. How far the value of goods, in its final form of "cost value", is from being the mirror of that subjective fact from which it is derived -- the value of wants! The circumstance that cognate products are produced by different quantities of the same productive elements, brings their subjective valuations into a ratio, the terms of which are derived entirely from the objective conditions of production; while the impulses which call for their emergence...remain subjective, and thus prove the subjectivity of the source and nature of value. This is at the minimum point in the first diagram given to you. Please see the diagram in the attachment.

In the long run, when all factors of production can be changed, the scale of the enterprise can be increased. In this case productive efficiency occurs at the optimum scale of output where all the possible economies of scale have been enjoyed and the firm is not large enough to experience diseconomies of scale. This occurs at output level Q2 in the second diagram given to you in the attachment..
It is argued that increasing the amount of competition in the market will increase allocative efficiency. The need to compete will prevent firms from raising their prices excessively above their costs of production. The greater the competition, the closer the price the firm is able to charge will be to the marginal costs of the firm.

Allocative efficiency is where the countries' firms are producing a combination of goods that maximizes the overall level of satisfaction or welfare of the population.

To understand this is important to realize that the factors of production a firm employs are scarce and thus have an opportunity cost. If a firm is able to produce one more unit of a good by utilizing more factors of production, somewhere else in the economy a good must be foregone. There are insufficient resources to produce everything. Allocative efficiency occurs where a countries resources are allocated in such as way that it is impossible to reallocate factors of production and further increase welfare. If all the factors of production are being utilized efficiently the only way that someone can be made better off through the production and consumption of an extra good is if someone is worse off, because they are having to sacrifice a good. If it is possible to reorganize production and make someone better off without making someone equally worse off then clearly the welfare of society was not being maximized.

The condition where it is impossible to make one person better off without making someone else correspondingly worse off is called a Pareto optimal allocation of resources.
The long run cost curve is a curve depicting the per unit cost of producing a good or service in the long run when all inputs are variable. The long-run average cost curve (usually abbreviated LRAC) can be derived in two ways. On is to plot long-run average cost, which is, long-run total cost divided by the quantity of output produced. at different output levels. The more common method, however, is as an envelope of an infinite number of short-run average total cost curves. Such an envelope is base on identifying the point on each short-run average total cost curve that provides the lowest possible average cost for each quantity of output. The long-run average cost curve is U-shaped, reflecting economies of scale (or increasing returns to scale) when negatively-sloped and diseconomies of scale (or decreasing returns to scale) when positively sloped. The minimum point (or range) on the LRAC curve is the minimum efficient scale.

2. Define the economic characteristics of the market structures (Perfect Competition, Monopolistic Competition, Oligopoly and Monopoly). Select ONE of the market structures and show how we can predict the short run and long run profit maximizing equilibrium positions with respect to quantity produced, price, total costs, total revenues and profits.

PERFECT COMPETITION
The most ...