Tài liệu CFA Level I - Study Session 5 pptx

define various types of costs, including opportunity costs, sunk costs, fixed costs, variable costs, marginal costs, & average costs; Total Fixed Costs, TFC: Sum of costs that do not va

CFA Level I - Study Session 5

1 A “Demand and Consumer Choice”, including addendum “Consumer Choice and Indifference Curves”

The candidate should be able to:

a explain consumer choice in an economic framework;

Principles behind Consumer Choice

v) Law of Diminishing Marginal Utility : As consumption of a good increases, the additional utility derived eventually declines

Consumer Behavior in making Choices

• Consumer will adjust consumption of a good until the marginal utility of consuming the good just equals the price of the good

Consumer Demand Curve:

• Diminishing Marginal Utility implies that as the price of a good rises, the amount demanded by the consumer should fall

• Income & a substitution effect associated with change in price

b calculate and interpret price and income elasticity of demand;

c discuss the determinants of price and income elasticity of demand;

Price Elasticity of Demand = %∆Qd ÷ %∆P where % ∆ Q d = (Q d – Q d )/[(Q d + Q d )/2], etc.

o Increase in price %∆P > will always reduce quantity demanded %∆Qd < 0

• Shows degree of consumer responsive to variations in good’s price

• Elasticity affected by:

Income Elasticity of Demand = %∆Qd ÷ %∆Income

• Shows degree of consumer responsive to variations in income

i) Normal Goods : positive income elasticity, demand rises with income

ii) Luxuries : high positive elasticity, demand rises strongly with income

iii) Inferior Goods : negative income elasticity, demand falls with income

d describe the relationships among total revenue, total expenditures, and price elasticity of

demand;

%∆expenditures ≅ %∆price + %∆quantityInelastic Demand: when elasticity of demand is less than one in absolute value, a 10% fall in price increases quantity demanded by less than 10% Thus total expenditure by

consumers, and total revenue received by firms, falls.

Elastic Demand: when elasticity of demand is greater than one in absolute value, a 10% fall in price increases quantity demanded by more than 10% Thus total expenditure by

consumers, and total revenue received by firms, rises.

e explain why price elasticity of demand tends to increase in the long run.

Second Law of Demand: buyers’ response will be greater after they have had time to adjust more fully to a price change Why?

• Better able to rearrange consumption patterns to take advantage of substitutes

f discuss the characteristics of consumer indifference curves.

i) More goods are preferable to fewer goods, thus points to upper right preferred to points in lower left of utility curve diagram

ii) Goods are substitutable, hence utility curves slope downward to the right

iii) Diminishing marginal rate of substitution between goods implies utility curves always convex to origin

iv) Indifference curves are everywhere dense, i.e one through every point

v) Indifference curves cannot cross because if they did then individual would not be following a rational ordering

g discuss the role of the consumption opportunity constraint and the budget constraint in

indifference analysis.

Consumption opportunity constraint: separates consumption bundles that are attainable from those that are unattainable

Budget constraint: separates consumption bundles that consumer can purchase from those that cannot be purchased, given the consumer’s limited income and the market prices of the products involved

• Consumer’s choice determined by the point at which their highest indifference curve touches the budget (or consumption opportunity) constraint

• This point yields highest level of utility for given level of income and market prices

h distinguish between the income effect and the substitution effect.

2 Price of Good X falls, Budget line rotates out.

1 B “Costs and the Supply of Goods”

The candidate should be able to:

a describe the principal–agent problem of the firm;

Principal-Agent Problem

• Incentives of principal (purchaser of service) and agent (seller of service) can diverge

if principal cannot observe agent’s performance

• Agent will pursue own goals, which may only partially overlap with the goals of the principal who has purchased the agent’s services

b distinguish among the types of business firms;

Proprietorship: Business owned by an individual who possesses the ownership rights to the firm’s profits and is personally liable for the firm’s debts

Partnership: Business owned by two or more individuals who possesses the ownership rights

to the firm’s profits and is personally liable for the firm’s debts

Corporation: Business owned by shareholders who have the ownership rights to the firm’s profits but whose liability is limited to the amount of their initial investment in the firm

c distinguish between (1) explicit costs and implicit costs, (2) economic profit and accounting

profit, and (3) the short run and the long run in production;

Explicit Costs: Payments by a firm to purchase productive resources

Implicit Costs: Opportunity costs of a firm’s use of resources that it owns These costs do not involve direct payments

Economic Profit: Difference between firms’ total revenue & total cost

Accounting Profit: Firm revenue minus expenses over given time period Does not take implicit costs into account

Short-Run in Production: Time period short enough so not all factors of production can be adjusted Typically plant size fixed

Long-Run In Production: Time period long enough so all factors of production can be

adjusted

d differentiate between economic costs and accounting costs;

Accounting Costs: Payments by a firm to purchase productive resources

Economic Costs: Opportunity costs of a firm’s use of resources that it owns These costs do not always involve direct payments

e define various types of costs, including opportunity costs, sunk costs, fixed costs, variable

costs, marginal costs, & average costs;

Total Fixed Costs, TFC:

Sum of costs that do not vary with level of output

Total Variable Costs, TVC:

Sum of costs that change with the level of output

Change in total cost required to produce an additional unit of output

Average Costs

Sunk Costs:

Costs that have already been incurred as the result of past decisions

f state the law of diminishing returns & explain its impact on a firm’s costs;

Law of Diminishing Returns to a Factor of Production

As more and more units of a variable input are combined with a fixed amount of another input, the additional units of the variable input will yield increased output at a decreasing rate

g describe the shapes of the short-run marginal cost, average variable cost, average fixed

cost, and average total cost curves;

1 Once a firm reaches a level of output at which diminishing returns occur, larger and larger additions of the variable factor are necessary to increase output by one more unit

2 The result is that the MC of the additional output increases So long as MC is below ATC, producing additional units of output will bring down the ATC curve

3 At some point, however, MC will rise by enough to exceed ATC After the point where MC = ATC, additional units of output will raise ATC causing the ATC curve to be U-shaped Thus the MC curve will cut the ATC curve at its minimum point.

Cost Curve Relationships

MC = ∆ TC ÷∆q

AVC = TVC ÷ q ATC = AFC + AVC

Quantity, q

Costs

AFC = TFC ÷ q

MC always cuts ATC and AVC

at their minimum points!

h define economies and diseconomies of scale, explain how they each is possible, and relate

each to the shape of a firm’s long-run average total cost curve;

Economies of Scale: Reductions in firm’s per unit costs as all factors of production are

increased in an optimal way

• Possible reasons: 1) Mass production, 2) specialization of factors of production, and 3)

“learning by doing” scale economies

Diseconomies of Scale: Increases in firm’s per unit costs as all factors of production are

increased in an optimal way

• Possible reasons: 1) coordination inefficiencies, 2) increasing difficulties in conveying information, and 3) increased principal-agent problems

Constant Returns to Scale: No change in firm’s per unit costs as all factors of production

are increased in an optimal way

Economies and Diseconomies of Scale

Diseconomies of Scale

Quantity, q

Costs

Economies of Scale Constant Returns to Scale

i. describe the factors that cause cost curves to shift.

Factors that Cause Cost Curves to Shift

i) Prices of Resources : Increase in price of resources used (inputs to production) will cause a firm’s cost curves to shift upwards

ii) Taxes : Increased taxes shift up a firm’s cost curves Tax on variable input shifts

MC, AVC, & ATC Fixed tax shifts AFC & ATC

iii) Technology : Cost-reducing technological improvements will lower a firm’s cost curves Which curves depend on whether technology affects fixed or variable costs

1 C “Price Takers and the Competitive Process”

The candidate should be able to:

a distinguish between price takers and price searchers;

Price-Takers:

• Firms that take market price as given when selling their product Each is small relative

to market, cannot affect price

Price-Searchers:

• Firms that face a downward-sloping demand curve for their product Price charged by firm affects amount it sells

b discuss the conditions that characterize a purely competitive (price taker) market;

Purely Competitive Markets

• Markets characterized by large number of small firms producing identical products in industry with complete freedom or entry/exit

c explain how and why price takers maximize profits at the quantity for which marginal cost,

price, and revenue are equal;

Marginal Revenue of each unit of output sold = Market Price

• Price-taking firm sets output so Marginal Cost of last unit of output produced equals market price = marginal revenue

• If MR > MC then selling an additional unit adds to profit, should produce more

• If MR < MC then selling additional unit lowers profit, should produce less

Maximum profit when MR = P = MC of last unit produced and sold

d calculate and interpret the total revenue and the marginal revenue for a price taker;

For a price taker, total revenue is simply equal to the price in the market times the number of units of output sold

Marginal revenue, the change in total revenue/change in output, is constant for a price taker and equal

to the market price of the product.

e explain the decision by price takers with economic losses to either continue to

operate, shut down, or go out of business;

A firm that is making losses, i.e AC > P, will choose to continue to operate in the short-run

so long as:

1. it can cover all its variable costs, and

2. it expects price to be high enough to cover its average cost in the future

In the short run, the firm must pay its fixed costs even if it shuts down So long as price exceeds average cost, the firm will be able to pay part of its fixed costs This strategy makes sense so long as the firm expects that at some point price will rise sufficiently to cover both its variable and fixed costs

If either of the conditions above do not hold, i.e price is too low for the firm to cover its variable costs OR the firm does not expect price to be sufficient to cover average total cost

in the future, then the firm should go out of business

f describe the short-run supply curve for a firm and for a competitive market;

SR Supply for Individual Firm

SR Supply for Market

• = horizontal sum of all the marginal cost curves of firms in the industry

g contrast the role of constant cost, increasing-cost, and decreasing-cost industries in

determining the shape of a long-run market supply curve.

Long Run Supply Curve:

• shows minimum price that firms will supply any level of market output, given sufficient time to adjust all factors of production & allow for any entry/exit from the industry

Economies of Scale determine Shape of LR Supply

• Constant Returns to Scale (i.e Constant cost) industry will have horizontal LR Supply Curve

• Increasing Returns to Scale (i.e Declining cost) industry will have sloping LR Supply Curve

downward-• Decreasing Returns to Scale (i.e Increasing cost) industry will have sloping LR Supply Curve

upward-h explain the impact of time on the elasticity of supply.

Elasticity of supply usually increases in long run as more time is allowed to firms to adjust production in response to changes in prices Over time, firms can adjust the levels of all factors of production in optimal ways to meet changes in price

1 D “Price-Searcher Markets with Low Entry Barriers”

The candidate should be able to:

a describe the conditions that characterize competitive price-searcher markets;

Competitive Price-Searcher Markets

• Each firm faces a downward-sloping demand curve for their output

• Firms produce differentiated products Output of other firms close substitutes, so individual firm’s demand curve is highly elastic

• Low entry barriers allow entry or exit of firms if existing firms earn non-zero economic profits Each firm faces competition from existing firms in industry & potential new entrants

b explain how price searchers choose price and output combinations;

Profit-maximizing Behavior for a Price Searcher

• Sets output level so that Marginal Cost equal to Marginal Revenue

• For Price Searcher, Marginal Revenue is related to shape of the Demand Curve

• Intuition for two factors at work to sell additional unit of output.

o Lower price, sell extra unit and receive additional revenue but

o Receive lower price on all existing units also so lose some revenue

o Marginal revenue no longer equals price

c summarize the debate about the efficiency of price-searcher markets with low barriers to

entry, including the concepts of contestable markets, entrepreneurship, allocative efficiency, and price discrimination;

(PRO) In the long run, competition along with free entry and exit will drive prices down to level of average costs

• Contestable markets: market where costs of entry or exit are low, so firms risk little by entry

• Efficient production and zero economic profits should prevail

• Market can be contestable even if capital requirements for entry are high

(CON) LR equilibrium is not allocatively efficient, however, because firms produce less than the minimum ATC level of output

• Advertising in differentiated product markets may be wasteful & self-defeating

• Benefits of dynamic competition improves customer choices of quality and

convenience versus trade-off of higher prices

d explain how price discrimination increases output and reduces allocative inefficiency;

Price discrimination occurs when a producer charges different consumers different prices for the same product

• Requires supplier able to identify and separate at least two groups with different price elasticities, and

• Prevent those buying at low price from reselling to higher priced customers

• Segmentation of groups with different price elasticities allows suppliers to charge different prices to each, possibly resulting in higher profits than with single price

On balance, output in industry higher with price discrimination than without Moves

industry output closer to competitive output level associated with allocative efficiency

1 E “Price-Searcher Markets with High Entry Barriers”

The candidate should be able to:

a discuss entry barriers that protect some firms against competition from potential market

entrants;

• Economies of Scale : Large fixed costs mean decreasing per unit costs

• Government Licensing : Legal barriers to entry established by gov’t

• Patents : Property rights given to newly invented products or processes

• Control over an Essential Resource : Single firm has control over an essential resource

or technology

b differentiate between a monopoly and an oligopoly;

Monopoly is a market characterized by:

• Single seller of a well-defined product with no good substitutes

• High barriers to entry of any other firms into market for the product

Oligopoly is a market characterized by:

• Small number of rival firms in industry

• Interdependence among sellers as each is large relative to market

• Substantial economies of scale in production of the good

• High barriers to entry firms into market

c describe how a profit-maximizing monopolist sets prices and determines output;

Profit-maximizing Behavior for a Monopolist

• Sets output level so that Marginal Cost equal to Marginal Revenue

• Marginal Revenue is related to shape of the Demand Curve Intuition for two factors at work to sell additional unit of output

Profit-Maximizing Monopolist

Cost, C and Price, p

Without Collusion:

Once the collusion by the cartel has established the monopoly price in the market, each member of the cartel has an incentive to cheat by increasing their own supply at the high price to increase its share of profits in the market Thus without collusion, the oligopolists

end up competing with one another on prices, driving the market outcome to that associated with perfect competition, where price is lower, output is higher, and all firms earn zero economic profits.

e discuss why oligopolists have a strong incentive to collude and to cheat on collusive

agreements;

By colluding, i.e acting as a cartel, oligopolists can coordinate supply decisions to

maximize the joint profits of all the firms Cartel seeks to create a monopoly in market that results in higher prices and positive economic profits

Once the collusion by the cartel has established the monopoly price in the market, however, each member of the cartel has an incentive to cheat by increasing their own supply at the high price to increase its share of profits in the market

f discuss the obstacles to collusion among oligopolistic firms;

Incentive for any firm to cheat on cartel agreement to increase its profits Obstacles to success of collusion:

• Increase in number of firms making up oligolpoly

• If price cuts by individual firms difficult to detect & prevent

• Low barriers to entry Successful collusion induces new entrants

• Unstable demand conditions lower likelihood collusion successful

• Vigorous antitrust actions increase cost of collusion

g describe government policy alternatives that are intended to reduce the problems stemming

from high barriers to entry.

i) Restructure existing firm or firms to stimulate competition

• May not be possible if economies of scale form barrier Natural monopoly occurs if declining per unit costs of large range of output

• If few firms dominate domestic market, may get increased competition by encouraging foreign firms to supply market

• Government may regulate price charged by monopolist or oligopolists in the market to achieve more efficient outcomes

o Average Cost Pricing: set output so ATC = Demand Curve

o Marginal Cost Pricing: set output so MC = Demand Curve

• Particularly appropriate for public goods Concerns about efficiency