Part 1

Long-Run Average Total Cost (ATC) Curve

Formula:

ATC = TC / Q

(ATC = Average Total Cost, TC = Total Cost, Q = Quantity)

Meaning:

It shows the cost per unit of production when a firm can adjust all its inputs (in the long run).

Efficiency = Minimum Cost

A firm is considered efficient when it produces at the lowest possible cost per unit.

Shape and Phases of the Long-Run ATC Curve

The long-run ATC curve is typically U-shaped, representing three key stages:

From A → B: Economies of Scale
- As quantity (Q) increases, ATC decreases.
- This happens because production becomes more efficient due to factors such as specialization, bulk buying, and better use of fixed resources.
- Point B is the Minimum Efficient Scale (MES) — the lowest output level where ATC is minimized.
→ ↑Q → ↓ATC → Efficient (Economies of Scale)
From B → C: Constant Returns to Scale
- As output (Q) increases, ATC stays the same.
- There is no change in average cost because the firm is already operating efficiently.
- This means expanding production doesn’t change the cost per unit.
→ ↑Q → No change in ATC → Constant Returns to Scale
From C → D: Diseconomies of Scale
- As the firm continues to expand, Q increases but ATC starts to rise.
- This happens when a company grows too large and becomes inefficient (e.g., management problems, communication issues, overcrowded facilities).
- Diseconomies of scale lead to higher long-run average costs and lower profitability.
→ ↑Q → ↑ATC → Inefficient (Diseconomies of Scale)

Key Terms

Minimum Efficient Scale (MES):

The output level at which long-run ATC is at its lowest point. Producing beyond this scale doesn’t lower costs further.
Economies of Scale:

When increasing production lowers average cost. Happens due to efficiencies in production, purchasing, and management.
Diseconomies of Scale:

The negative effects (decreasing returns) that occur when a firm grows too large and becomes inefficient, causing ATC to rise.

Example: Economies of Scale Table

Quantity (Q)	Firm A TC	Firm A ATC	Firm B TC	Firm B ATC	Firm C TC	Firm C ATC
1	$60	$60	$11	$11	$21	$21
2	70	35	24	12	34	17
3	80	26.7	39	13	49	16.5
4	90	22.5	56	14	66	17
5	100	20	75	15	85	17
6	110	18.3	96	16	106	17.7
7	120	17.1	119	17	129	18.4

Interpretation:

Firm A has economies of scale because ATC falls as output increases.
Firm B experiences diseconomies of scale because ATC rises with higher output.
Firm C shows economies of scale up to Q = 3, then diseconomies of scale beyond Q = 3.

Summary Flow:

A → B: Increasing Q → Lower ATC → Economies of Scale
B → C: Increasing Q → Constant ATC → Constant Returns to Scale
C → D: Increasing Q → Higher ATC → Diseconomies of Scale

Part 2

Shutdown and Exit

Question:

At which price should the firm shut down?

In the short run, the firm should stop producing (shut down) if the price falls below the minimum Average Variable Cost (AVC).

Key Formulas

Total Revenue (TR):

TR = P × Q

Price (P):

P = TR / Q

→ TR per unit = Revenue per unit = Average Revenue (AR)

Short-Run Shutdown Rule

A firm should shut down in the short run if:

P ≤ min(AVC)

When this happens, the firm cannot even cover its variable costs.

In that case, loss = fixed cost, since fixed costs must still be paid even when not producing.

Long-Run Exit Rule

In the long run, firms should exit the market if:

P < min(ATC)

Reason: In the long run, there are no fixed costs — all costs become variable.

If price remains below ATC, the firm cannot make normal profit and should leave the industry.

Example Calculation

Q	TC	FC	VC	AVC = VC/Q
0	30	30	0	—
1	50	30	20	20
2	65	30	35	17.5
3	75	30	45	15
4	90	30	60	15
5	110	30	80	16
6	140	30	110	18.3

Minimum AVC = 15 (at Q = 3 or 4)

Interpretation

If Price ≥ 15, the firm should continue operating in the short run.
If Price < 15, the firm should shut down temporarily.
In the long run, if Price < ATC, the firm should exit the market permanently.

Summary Rules

Short Run:

Shut down if P < min(AVC)
Keep producing if P ≥ min(AVC)

Long Run:

Exit the market if P < min(ATC)
Stay if P ≥ min(ATC)

Example Conclusion:

If total cost (TC) = fixed cost (FC) + 0 → The firm should not shut down because it still covers its variable costs.

Part 3

1. How Many Workers a Firm Should Hire

A firm decides how many workers to hire by comparing marginal benefit (MB) and marginal cost (MC) of hiring additional labor.

Two Ways to Answer:

(1) Compare MB and MC

Rule: Hire workers until MB = MC
Example:

If hiring one more worker increases output by 2 units (Q = 2)

and price (P) = $10 \to M B = 2 \times 10 =$ 20

If MC (cost of hiring) = $10 → MB > MC → Hire more

Continue hiring until MB = MC.

(2) Stop Hiring When MB = 0

Do not hire additional workers if marginal benefit = 0,

meaning extra labor adds no additional output.

2. Labor Productivity and the Law of Diminishing Returns

Labor	Total Product (TP)	Average Product (AP = TP/L)	Marginal Product of Labor (MPL = ΔTP/ΔL)
1	10	10	10
2	25	12.5	15
3	35	11.7	10
4	40	10	5
5	42	8.4	2
6	42	7	0

Law of Diminishing Returns

After the second worker, MPL starts to decrease — meaning as more labor is added to fixed resources, the extra output each new worker produces eventually falls.

Summary:

↑ Labor → ↓ Marginal Product of Labor (MPL)

Key Concepts

Average Product (AP): Output per worker

AP = Total Product / Labor

(also called labor productivity)
Marginal Product (MPL): Additional output from hiring one more worker

MPL = ΔOutput / ΔLabor
Law of Diminishing Returns: After a certain point, increasing labor leads to smaller and smaller increases in output.

3. Finding the Quantity (Q) That Maximizes Profit

Q	P	TC	TR = P×Q	Profit (TR - TC)	MR	MC
0	10	5	0	-5	—	—
1	10	9	10	1	10	4
2	10	15	20	5	10	6
3	10	23	30	7	10	8
4	10	33	40	7	10	10
5	10	45	50	5	10	12

Profit Maximization Rule

Marginal Revenue (MR) = ΔTR / ΔQ
Marginal Cost (MC) = ΔTC / ΔQ
Profit is maximized when MR = MC

→ Here, MR = MC = 10 at Q = 4, so the optimal output is Q = 4.

4. Example Problem (from text image)

Given:

C(Q) = 100 + Q²

P = $10

Find Q that maximizes profit (π):

Profit = TR - TC

= P×Q - (100 + Q²)

= 10Q - 100 - Q²

Take derivative:

dπ/dQ = 10 - 2Q = 0 → Q = 5

At Q = 5:

TR = 10 × 5 = 50

TC = 100 + 25 = 125

π = 50 - 125 = -75

→ Firm minimizes loss by producing Q = 5 units.

If it shuts down, loss = fixed cost = 100 → Producing minimizes loss.

5. Market Structures

Characteristic	Perfect Competition	Monopolistic Competition	Oligopoly	Monopoly
Firms in Industry	Many	Many	Few	One
Product Type	Identical	Differentiated	Identical or Differentiated	Unique, no close substitutes
Barriers to Entry	None	Low	Moderate	High
Control Over Price	None (Price Taker)	Some	Considerable	Complete
Concentration Ratio (CR4)	0	Low	High	100
HHI Range	<100	101–999	1,000–9,999	10,000
Examples	Wheat, corn	Food, clothing	Cars, cereals	Local water supply

Notes

Market Power: Ability to influence price.
Barriers to Entry:
- Natural: Economies of scale (cost advantage from large size)
- Legal: Patents, copyrights (government protection)
CR4 Rule:
- Less than 40–60% → Competitive
- Above 60% → Oligopoly/High Concentration
Types of Monopoly:
- Natural: Arises from economies of scale (e.g., utilities)
- Legal: Created by patents or copyrights

Part 4

Market Power

Definition:

Market power is the ability of a firm to raise the price of its product above the competitive level.

In Perfect Competition

Firms have no market power.
Price is constant because it’s determined by the market.
Firms are price takers — they must accept the market price.

In Monopoly

The firm has complete market power.
Price is based on the quantity demanded (Qd) — meaning the monopolist can influence the price by changing its output.

Formula:

\text{Market Share} = \frac{\text{Firm’s Sales}}{\text{Total Industry Sales}} \times 100

Market share shows how much of total market sales a single firm controls.

Market Structure Comparison

Characteristic	Perfect Competition	Monopolistic Competition	Oligopoly	Monopoly
Number of Firms	Many	Many	Few	One
Product Type	Identical	Differentiated	Identical or Differentiated	Unique, no substitutes
Barriers to Entry	None	Low	Moderate	High
Control Over Price	None	Some	Considerable	Complete
Concentration Ratio (CR4)	0	Low	High	100
HHI Range	< 100	101–999	1,000–9,999	10,000
Examples	Wheat, corn	Clothing, food	Cars, cereals	Local water supply

Measures of Market Concentration

1. Four-Firm Concentration Ratio (CR4)

CR4 = (Sales of four largest firms ÷ Total industry sales) × 100

Measures the percentage of total industry sales accounted for by the largest four firms.
If CR4 < 60%, the market is considered competitive.
If CR4 ≥ 60%, the market is oligopolistic.
If CR4 ≈ 100%, the market is a monopoly.

Example:

Big Collar Inc. (50), Shiny Coat Inc. (75), Friendly Pet Inc. (60), Nature’s Way Inc. (65), and other 8 firms (400 total).

CR4 = \frac{50 + 75 + 60 + 65}{650} \times 100 = 38%

→ The market is competitive or monopolistic competition since CR4 < 60%.

2. Herfindahl–Hirschman Index (HHI)

HHI = (Market Share of each firm)²

Then sum the results for all firms.

HHI Ranges:

< 1,000 → Competitive
1,000–1,800 → Moderately Concentrated
1,800 → Highly Concentrated
10,000 → Monopoly

Example Calculation:

Firm	Sales	Market Share (S)	S²
A	50	7.7%	59.29
B	75	11.5%	132.25
C	60	9.23%	85.19
D	65	10%	100
E (others total)	400	61.5%	3,782.25
Total	650	—	4,158.98

→ HHI = 4,158.98

Since HHI > 1,000, the industry is an oligopoly (high concentration).

Market Classification Using CR4 and HHI

Indicator	Perfect Competition	Monopolistic Competition	Oligopoly	Monopoly
CR4	< 40–60%	< 60%	60–99%	100%
HHI	< 1,000	101–999	1,000–9,999	10,000

Key Notes

Market power arises from:
- Strong technology and financial capability
- Legal barriers (patents, copyrights)
- Natural monopolies (economies of scale)
Oligopolies are markets dominated by a few firms — often interdependent in pricing.
Monopolies face no competition and can set prices based on demand.
Perfect competition markets are highly efficient but offer no pricing control.

Part 5

1. Monopoly and HHI Example

If there is 1 firm → Monopoly

Market share = 100%
HHI = (100)² = 10,000

→ A monopoly always has an HHI of 10,000 because it represents complete market concentration.

2. Measures of Market Concentration

(1) Four-Firm Concentration Ratio (CR4)

Formula:

CR4 = \frac{\text{Sales of 4 largest firms}}{\text{Total industry sales}} \times 100

Interpretation:

If CR4 < 60% → The market is competitive
If CR4 ≥ 60% → The market is not competitive (oligopoly or monopoly)
If CR4 = 100% → The market is a monopoly

Purpose:

Helps determine market structure and merger decisions
Indicates how much market power the largest firms hold

(2) Herfindahl–Hirschman Index (HHI)

Formula:

HHI = \sum_{i=1}^{N} (S_i)

Where S_i = Market share of each firm (in percentage).

Example Calculation (before merger):

Firms with market shares: 75%, 10%, 8%, 7%

HHI = 75^2 + 10^2 + 8^2 + 7^2 = 5,833

After merger (75 + 10 = 85):

HHI_{new} = 85^2 + 8^2 + 7^2 = 5,950

→ The change = 117, which is significant — may block merger.

HHI Classification

HHI Range	Market Type
≤ 100	Perfect Competition
101 – 999	Monopolistic Competition
1,000 – 9,999	Oligopoly
10,000	Monopoly

Merger Rules (U.S. FTC Guidelines):

If HHI < 1,000 → Market is competitive → Merger allowed
If 1,000 < HHI < 1,800, and increase < 100 → Merger allowed
If HHI > 1,800, and increase > 50 → Block the merger

Example: Pet Food Industry

Firm	Sales (000s)	Market Share (%)	S²
A	50	7.7	59.29
B	75	11.5	132.25
C	60	9.23	85.19
D	65	10	100
Others	400	61.5	3,782.25
Total	650	—	4,158.98

→ HHI = 4,159 → Oligopoly (since > 1,000)

→ CR4 = 38% → Competitive / Monopolistic competition

3. Economies of Scale and Scope

Economies of Scale

When output increases → Average Total Cost (ATC) per unit decreases.

Formula:

ATC = \frac{TC}{Q}

→ Lower cost per unit as production expands.

Economies of Scope

Firms save costs by producing two or more different goods together instead of separately.

Example:

A company that produces both hardware and software can share technology, labor, and facilities — reducing costs.

4. Profit Maximization Rules

In Perfect Competition

To maximize profit:

P = MC
Note: In perfect competition, P = MR (price equals marginal revenue)

In Monopoly

P ≠ MR
Monopolist faces a downward-sloping demand curve.
Must lower price to sell more, so MR < P.

Profit Maximization Condition:

MR = MC

Example Problem (Monopoly)

Given:

P = 100 - 2Q

C(Q) = 10 + 2Q

Find Q that maximizes profit:

TR = P × Q = (100 - 2Q)Q = 100Q - 2Q

MR = \frac{d(TR)}{dQ} = 100 - 4Q

MC = \frac{d(C)}{dQ} = 2

Set MR = MC:

100 - 4Q = 2 \Rightarrow Q = 24.5

P = 100 - 2(24.5) = 51

→ Optimal Quantity = 24.5 units, Price = $51

Example Problem (Perfect Competition)

Given:

P = 50, \quad C(Q) = 100 + Q

Find Q that maximizes profit:

MC = \frac{dC}{dQ} = 2Q

P = MC \Rightarrow 50 = 2Q \Rightarrow Q = 25

→ Q = 25 units at P = MC = 50

Summary

Concept	Key Rule / Formula	Interpretation
CR4	(Sales of 4 largest ÷ Total Sales) × 100	<60% = Competitive
HHI	Σ(Market Share)²	<1,000 = Competitive
Profit Maximization	MR = MC	Applies to all market types
Perfect Competition	P = MR = MC	Price taker
Monopoly	MR = MC, but P > MR	Price setter
Economies of Scale	↑Q → ↓ATC	Cost efficiency from large scale
Economies of Scope	Multiple goods reduce cost	Shared resources

Part 6

Merger Rules (Federal Trade Commission – FTC)

The FTC uses HHI (Herfindahl–Hirschman Index) to determine whether to allow or block mergers.

If HHI < 1,000:

→ The market is competitive — merger not challenged.
If 1,000 ≤ HHI ≤ 1,800:

→ Market is moderately concentrated.

→ A merger that raises HHI by 100 or more points is challenged.
If HHI > 1,800:

→ Market is highly concentrated.

→ A merger that raises HHI by 50 or more points is challenged.

Drawbacks of Concentration Ratios

1. Geographic Scope of the Market:

Concentration ratios assume the market covers an entire country (e.g., the U.S.), but some markets are smaller (local newspapers) or global (automobiles).
2. Barriers to Entry:

High market concentration doesn’t always mean low competition—new firms can still enter easily in some industries.
3. Market and Industry Correspondence:

Some firms produce multiple products (broad classification), or niche products with few rivals. Thus, concentration ratios may not reflect actual competition.

Example Problems

1. Pet Food Industry (CR4 Calculation)

Firm	Sales (thousands of dollars)
Big Collar, Inc.	50
Shiny Coat, Inc.	75
Friendly Pet, Inc.	60
Nature’s Way, Inc.	65
Other 8 firms	400

Total sales: 650

CR4 = (50 + 75 + 60 + 65) / 650 × 100 = 38%

✅ Market Structure: Competitive / Monopolistic Competition

(because CR4 < 60%)

2. Mat Makers (HHI Calculation)

Firm	Market Share (%)	Square of Market Share
Made-to-Last, Inc.	20	400
Big Wheel, Inc.	17	289
Magic Carpet, Inc.	22	484
Supreme, Inc.	17	289
Copra, Inc.	24	576
Total HHI	—	2,038

✅ Market Structure: Oligopoly (HHI > 1,000 but < 10,000)

Welfare Loss Due to Monopoly

Monopoly vs Perfect Competition

Market Type	Price (P)	Quantity (Q)
Perfect Competition	2	400
Monopoly	4	200

The area of welfare loss (deadweight loss) = triangle between MR, MC, and demand.

\text{Loss} = \frac{1}{2} × \text{Height} × \text{Base}

= \frac{1}{2} × (4 - 2) × (400 - 200)

= 200

✅ Welfare Loss = 200

Profit Maximization Table Example

P	Q	TC	TR = P×Q	MR = ΔTR/ΔQ	MC = ΔTC/ΔQ
20	0	20	0	—	—
18	1	21	18	18	1
16	2	24	32	14	3
14	3	30	42	10	6
12	4	40	48	6	10
10	5	55	50	2	15

To maximize profit:

MR = MC

→ Occurs where both equal 8

✅ Optimal Quantity = 3 units

Proof: MR Slope = Twice the Slope of Demand Curve

Start with the demand function:

P = a - bQ

Total Revenue (TR):

TR = P × Q = (a - bQ)Q = aQ - bQ

Marginal Revenue (MR):

MR = \frac{d(TR)}{dQ} = a - 2bQ

The coefficient of Q in MR (−2b) is twice the slope of the demand curve (−b).

✅ Therefore, the slope of the MR curve is twice as steep as the demand curve.

Derivatives Refresher (for MR Proof)

Function	Derivative	Example
x²	2x	If TR = Q² → MR = 2Q
x³	3x²	—
x	1	—

Concept Summary

Concept	Formula	Key Takeaway
CR4	(Sales of 4 largest ÷ Total Sales) × 100	< 60% → Competitive
HHI	Σ(Market Share)²	1,000–9,999 → Oligopoly
MR = MC	Profit maximization condition	Applies to all markets
MR slope	Twice slope of demand	Monopolist pricing rule
Welfare Loss	½ × (P₁ − P₂) × (Q₂ − Q₁)	Monopoly causes deadweight loss
Merger Rule	ΔHHI ≥ 50 or 100 → Challenged	Prevents market dominance

Q	P	TC	TR = P×Q	Profit (TR - TC)	MR	MC
0	10	5	0	-5	—	—
1	10	9	10	1	10	4
2	10	15	20	5	10	6
3	10	23	30	7	10	8
4	10	33	40	7	10	10
5	10	45	50	5	10	12

P	Q	TC	TR = P×Q	MR = ΔTR/ΔQ	MC = ΔTC/ΔQ
20	0	20	0	—	—
18	1	21	18	18	1
16	2	24	32	14	3
14	3	30	42	10	6
12	4	40	48	6	10
10	5	55	50	2	15

Q	P	TC	TR = P×Q	Profit (TR - TC)	MR	MC
0	10	5	0	-5	—	—
1	10	9	10	1	10	4
2	10	15	20	5	10	6
3	10	23	30	7	10	8
4	10	33	40	7	10	10
5	10	45	50	5	10	12

P	Q	TC	TR = P×Q	MR = ΔTR/ΔQ	MC = ΔTC/ΔQ
20	0	20	0	—	—
18	1	21	18	18	1
16	2	24	32	14	3
14	3	30	42	10	6
12	4	40	48	6	10
10	5	55	50	2	15

Grandeur

Explorer

Test 2

Part 1

Long-Run Average Total Cost (ATC) Curve

Shape and Phases of the Long-Run ATC Curve

Key Terms

Example: Economies of Scale Table

Part 2

Shutdown and Exit

Key Formulas

Short-Run Shutdown Rule

Long-Run Exit Rule

Example Calculation

Interpretation

Summary Rules

Part 3

1. How Many Workers a Firm Should Hire

Two Ways to Answer:

(1) Compare MB and MC

(2) Stop Hiring When MB = 0

2. Labor Productivity and the Law of Diminishing Returns

Law of Diminishing Returns

Key Concepts

3. Finding the Quantity (Q) That Maximizes Profit

Profit Maximization Rule

4. Example Problem (from text image)

5. Market Structures

Notes

Part 4

Market Power

In Perfect Competition

In Monopoly

Market Share

Market Structure Comparison

Measures of Market Concentration

1. Four-Firm Concentration Ratio (CR4)

2. Herfindahl–Hirschman Index (HHI)

Market Classification Using CR4 and HHI

Key Notes

Part 5

1. Monopoly and HHI Example

2. Measures of Market Concentration

(1) Four-Firm Concentration Ratio (CR4)

(2) Herfindahl–Hirschman Index (HHI)

HHI Classification

Example: Pet Food Industry

3. Economies of Scale and Scope

Economies of Scale

Economies of Scope

4. Profit Maximization Rules

In Perfect Competition

In Monopoly

Example Problem (Monopoly)

Example Problem (Perfect Competition)

Summary

Part 6

Merger Rules (Federal Trade Commission – FTC)

Drawbacks of Concentration Ratios

Example Problems

1. Pet Food Industry (CR4 Calculation)

2. Mat Makers (HHI Calculation)

Welfare Loss Due to Monopoly

Monopoly vs Perfect Competition

Profit Maximization Table Example

Proof: MR Slope = Twice the Slope of Demand Curve

Derivatives Refresher (for MR Proof)

Concept Summary

Graph View

Q	P	TC	TR = P×Q	Profit (TR - TC)	MR	MC
0	10	5	0	-5	—	—
1	10	9	10	1	10	4
2	10	15	20	5	10	6
3	10	23	30	7	10	8
4	10	33	40	7	10	10
5	10	45	50	5	10	12

P	Q	TC	TR = P×Q	MR = ΔTR/ΔQ	MC = ΔTC/ΔQ
20	0	20	0	—	—
18	1	21	18	18	1
16	2	24	32	14	3
14	3	30	42	10	6
12	4	40	48	6	10
10	5	55	50	2	15