1. What are the characteristics of a perfectly competitive market?
2. What is the difference between variable and fixed costs, how do they change in short-run vs. long-run? Provide an example in healthcare.
3. What does increasing returns mean in the short-run? Provide an example of increasing returns?
4. From an economic perspective, at what point does a firm decide to shut-down? Explain.
5. When a market is perfectly competitive what does this imply about the supply curve and the price charged for a particular good?
6. What is the level of profits in the long-run in a perfectly competitive market? Explain why.
7. What is the difference between an economic and accounting profit?
8. What is the principle of diminishing marginal return?
Week 4: The
UMUC HMGT 435
Key Learning Objectives Week 4
• Understand difference between accounting vs. economic costs
• Understand characteristics of cost in short-run vs. long-run and
• Average vs. marginal
• Input specialization
• Diminishing returns
• Understand what costs matter for a firm’s pricing decision
• Breakeven vs. shut-down prices
• Understand what factors constitute a “perfectly competitive”
Accounting vs. Economic Costs and Profits
• Economic costs include the “opportunity” cost of inputs used in
the production process
Economic Cost = Explicit cost + Implicit Cost
Accounting Cost = Explicit cost
• Explicit cost : actual monetary payments for inputs
• Implicit cost: opportunity cost of inputs that do not require a monetary
• Applies to Profit Equation as Well
• Economic Profit = Total Revenue minus Costs (Explicit + Implicit)
• Accounting Profit = TR minus C (Explicit only)
Factors of Production in Healthcare
• From Week 1 introduced the concept of factors of production
also called input into the production process
• Labor- Doctors, nurses, administrative staff, etc.
• Physical capital – Hospitals, doctor’s offices, medical technology, etc.
• Natural Resources and Raw Materials – land for the capital to be built, energy
sources (oil and gas), raw materials for pharmaceuticals
• Entrepreneurship – scientists who develop cures for cancer, drug companies who
develop new drugs.
• Production Function: Relationship between Inputs (e.g. labor,
capital) to and Outputs (e.g. patient care) from the production
The Production Function and Time
• Production Function and Time
• Short-run: period of time in which firms are able to vary one of the
inputs to production
• Long-run: period of time in which firms can vary all inputs to production
• All inputs are variable in long-run, you can hire and fire labor, you can build more
physicians offices and hospitals
• Thus, the production function is largely a short-run decision
• Within the Short-Run timeframe, firms do face different stages
of production based on how much output (and marginal product)
they can get from a given input (e.g. labor).
The Stages of Production
• Increasing returns (Marginal Product (MP) > Average Product (AP)
• Each additional worker contributes more to their output.
• Example: New physician office with a number of exam rooms and one physician and
one admin staff. Adding another physician and admin staff can allow the office to see
more patients in a day.
• Diminishing returns (MP = AP)
• As firm increases workers, output increases but at a diminishing rate.
• Example: Too many physicians for same amount of office space means that they will
start bumping into each other and rate of growth in patient care will decline
• Negative (or decreasing) returns (MP < AP) • As firms add workers, output declines • Example: waiting room and exam rooms at full capacity, so cannot see any more partients even if add physicians, only solution is a long-run option to expand office space. 6 Short-Run Costs • Total Costs = Fixed Costs + Variable Costs • Fixed costs do not vary with quantity produced • Variable costs vary with quantity produced • In the long-run, all costs are variable • Distinguish between Average and Marginal Costs • Average Costs = Total Costs/Quantity • Marginal Costs = Change in Total Costs resulting from a one-unit increase in output • Principle of Diminishing Returns • As more variable inputs are added, in the SR, MC must eventually be increasing • Example: Crowded hospital waiting room 7 Supply Curve of A Perfectly Competitive Firm • Characteristics of a perfectly competitive market: • Many sellers (large number of firms) and buyers • Homogeneous product (identical and no branding) • No barriers to entry • Firms in Perfectly Competitive Market must determine: • What price to charge? • How much to produce? 8 What Price Does Perfectly Competitive (PC) Firm Charge? • PC firm is a “price taker” accepts market price (no influence over market price) • P=MR for the firm • Demand curve is horizontal at the market P (perfectly elastic) • A price above market price, demand would drop to zero and everyone would go to competitors 9 How Much Does a PC Firm Produce? • Total Revenue = Price (times) Quantity • Economic Profit = Total Revenue (minus) total economic cost • Marginal revenue: • Increase in revenue from selling one more unit • P = MR in Perf. Comp. market • Using Marginal Principal choose Q where MR = MC 10 Firm’s Shut Down Decision • Total Cost = FC + VC • A firm must cover it’s variable cost (also thought of as operating cost) to be viable • It still must cover it’s fixed cost. • Shutdown P = AVC = MC • Point where firm indifferent between operating or not • Any point where P > AVC the firm
can still operate
• A firms would shutdown if P