Assume that a society has three firms, A, B, and C, situated in a row. The society faces the fol

Assume that a society has three firms, A, B, and C, situated...

Key Concepts

Merger and Internalization of Externalities

When firms merge, the resulting entity may internalize external effects that previously existed between separate firms. By combining decision-making processes, the merged firm can account for the external benefits or costs generated by their production on associated firms. However, the merged firm's output decision may still diverge from the social optimum if not all externalities are fully internalized, especially when some external effects fall outside the control of the merged entity.

Marginal Cost

Marginal cost is the additional cost incurred by producing one more unit of output. It serves as a key criterion in production decisions because firms typically increase production until the cost of producing an extra unit equates to the marginal revenue obtained from selling it. In social analysis, marginal cost must be adjusted to include any external marginal costs imposed on others, which is important for achieving the social optimum.

Externalities

Externalities are the spillover effects that production or consumption activities have on third parties who are not directly involved in the market transaction. They can be positive when production creates benefits for others, or negative when it imposes costs. In economic analysis, properly accounting for these externalities is essential in moving from a competitive market outcome to a socially optimal outcome.

Social Optimality

Social optimality involves determining the level of production or consumption that maximizes total societal welfare, taking into account all externalities—both positive and negative. Unlike competitive market equilibrium, the social optimum requires including all marginal benefits to society and all marginal costs, ensuring that external effects, whether beneficial or harmful, are factored into decision-making.

Competitive Market Equilibrium

This concept refers to the situation in which individual firms make production decisions based solely on private costs and benefits, equating marginal cost with the market price. In competitive markets, firms do not take into account external effects—the benefits or costs their production imposes on other parties—leading them to choose an output level that maximizes their own profit rather than overall social welfare.

Transcript

00:01 Hello, in this video, we're going to look at a perfectly competitive firm, and we know that we know the total revenue cost of this firm and their corresponding quantity.

00:15 And we also know that the fixed cost of this firm is $6.

00:22 And we know that the price, which is also the marginal revenue that this firm could make on this market would be $5.

00:31 And we want to know what is the profit maximizing or loss minimizing quantity that the firm should produce.

00:38 And there are two approaches to solve this kind of problem.

00:42 The first approach is to first figure out the marginal cost given the diagram, given this table for this company.

00:52 And we look for the point where marginal cost is actually small or equal to the price or marginal revenue.

01:03 Price or marginal revenue.

01:07 And we will keep producing until the marginal cost become greater than the price.

01:15 And this is our first approach.

01:17 So let's start from there.

01:21 So given the total variable cost, we could figure out the marginal cost.

01:28 So from zero unit to one unit, the variable cost occur is $6.

01:34 So the marginal cost will be $6.

01:39 From one unit to two units, total variable costs become $11.

01:45 And the difference between first unit and the second unit and the first unit is $5.

01:54 So the marginal cost is five.

01:57 So to save space, i'm going to just keep the five here.

02:10 From two units to three units, the additional cost is 15.

02:14 Minus 11, which is $4.

02:17 From three units to four units, additional cost is $18 minus $15, which is $3.

02:25 And from four units to five units, the additional cost is $22 minus $18, which is $4.

02:33 From $5 to $6, costs increase by, again, $6.

02:41 So we can see that at the very beginning, marginal cost is greater than the marginal revenue.

02:46 Which is $5.

02:48 But if we increase our production to two units, we see that marginal cost equals to marginal to the price, which is marginal revenue.

02:57 And if we keep increasing our production from 2 to 3, the marginal cost is lower than the price.

03:05 So we are actually making some marginal profits if we increase our production from 2 units to 3 units.

03:14 And if we keep going, the marginal cost is even.

03:17 Lower.

03:17 So we are actually making additional more additional profits by increasing production from three to four, right? and if we keep producing four units to five units, we see that the marginal cost is $4 and is lower than the marginal price again.

03:36 So we are making additional profits if we increase our production.

03:41 However, if we increase from five to six, we know the marginal cost is greater than the marginal revenue here.

03:50 So making this additional production, our total revenue will actually increase because this additional units we produce will generate loss.

03:59 So for this firm, you should keep producing until they reach five units and stop producing at this point, right? because producing additional unit here will generate loss.

04:15 So our answer is the firm should actually produce five units.

04:22 And we have an additional question that we need to answer, which is whether or not at these five units the firm is making profits or generating loss.

04:31 To answer this question, which it might be easier if we look at our second approach to solve this question.

04:38 Our second approach is using the total revenue and total cost function.

04:49 So we want to know, we know that the profits that the firm produce or generate is the difference between the total revenue and the total cost, right? so we could, given the cost of this firm, we know it's total revenue, total variable cost and total fees costs.

05:10 We could calculate the total cost for this firm at different units...

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