Unit 7 The firm and its customers

7.13 Summary

  • Firms producing differentiated products choose their price and quantity of output to maximize their owners’ profits, while taking into account the product demand curve and the cost function; they set a price that is above their marginal cost of production.
  • Technological and cost advantages of large-scale production favour large firms.
  • Firms face fixed and variable costs of production, but some costs are only fixed in the short run.
  • The demand curve depends on consumers’ willingness to pay for the product.
  • The responsiveness of consumers to a price change is measured by the elasticity of demand. If a firm faces little competition, the price elasticity of its demand curve is low, and its markup of price above marginal cost is high.
  • The gains from trade in a market are divided between consumers and firm owners, and prices above marginal cost cause a deadweight loss for society.
  • Firms can increase profit by differentiating their products through product selection, innovation, and advertising, and by exploiting the advantages of large scale.
  • Firms with few competitors set prices strategically, taking into account the effect their own decision will have on their competitors.
  • Policymakers use competition policy to reduce market power and deadweight loss, and improve outcomes for society.