Counter visits from more than 160  countries and 1400 universities (details)

The political economy of development
This academic site promotes excellence in teaching and researching economics and development, and the advancing of describing, understanding, explaining and theorizing.
About us- Castellano- Français - Dedication
Home- Themes- Reports- Statistics/Search- Lecture notes/News- People's Century- Puro Chile- Mapuche

"When I give food to the poor, they call me a saint. When I ask why the poor have no food, they call me a communist".
(Dom Helder Camera -former archbishop of Olinda, Recife, Brasil)(1984)
Basic Knowledge on Economics.- by Róbinson Rojas Sandford
Notes: 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17
Session 5

            The Theory of Production [II]. Oligopoly and Monopoly.
            Effects of oligopoly and monopoly on levels of employment,
            price and output. Contradiction between maximization of
            profits and maximization of employment. Globalization and
            oligopolies: transnational corporations.
            Comparing perfect competition and monopoly competition. The
            case of environmental damage.
                    Economies and dis-economies of scale. Efficiency
                    of production. The role of abnormal profits in
                    research and development. The role of abnormal
                    profits in patterns of consumption. The role of
                    abnormal profits in distribution of income.

Firm "B" will have the same costs than firm "A" but it will be a
"price maker". Its environment will be an imperfect market.
A real life market, that is.


  (1)     (2)     (3)      (4)             (5)       (6)
Output   Total   Total   Profit  Average Marginal   Marginal  Price
(Units   Revenue  Cost   (2)-(3) Cost    Cost       Revenue   Unit
  0         0     100     -100                       
  1       150     150        0    150      50        150      150
  2       280     184       96     92      34        130      140
  3       390     208      182     69      24        110      130 
  4       480     227      253     57      19         90      120
  5       550     250      300     50      23         70      110
  6       600     280      320     47      30         50      100<----
  7       630     318      312     45      38         30       90
  8       640     366      274     46      48         10       80    
  9       630     425      205     47      59        -10       70 
 10       600     500      100     50      75        -30       60
 11       550     595     - 45     54      95        -50       50

                        IMPERFECT MARKET         PERFECT MARKET
Output range:            1-2 to 10-11              2-3 to  13-14
Maximization of profits:         6-7                        9-10
Price per unit:              $100                       $70

Both markets show a contradiction between ECONOMIC EFFICIENCY and
SOCIAL EFFICIENCY. But real markets maximize profits at a higher
price per unit and at a lower level of output. Real markets make
even more antagonistic the contradiction between maximization of
profits and full employment/maximum output.

In both cases profits are maximized before output/employment.

One conclusion is that there is no possibility of reaching the
level of full employment in a capitalist economy, UNLESS owners of
mean of production are forced to make NORMAL PROFITS only and
resign to the possibility of making ABNORMAL PROFITS.

The second conclusion, which is generally referred as THE EXCESS
CAPACITY THEOREM, is that in equilibrium, a monopolistic competitor
will produce an output smaller than the one that would minimize its
costs of production.

The above theorem demonstrates that the capitalist system IS NOT
EFFICIENT ECONOMICALLY. That is, its efficiency is not at a maximum.
The latter, because the point of maximum efficiency in an average
cost curve is where the average cost is minimum.

                .               .------> average cost curve
                 .             .
                  .           .
firm wil           .         .
     produce here--->.      .
                       .   .
                         . <------lowest average cost = max. efficiency

From the above shortcomings of the free-market system, the following
is true:

--the system waste resources (capital and labour) because maximize
  profits at less than maximum output.
--the system is socially imperfect because does not maximize
--the system is economically inefficient because will not produce
  when the average cost is at a minimum.

Summarizing the effects of imperfect markets (which are the only
possible markets in a market system):

-distort resource allocation -allocation of raw materials, capital
                              and labour
-deficient output            -less than maximum capacity
-deficient employment        -less than full employment
-deficient level of prices   -prices are above costs, therefore there
                              is always an inflationary pressure

From the above features of imperfect markets (real markets in a
capitalist system) it follows that the labour market and the capital
market will distort distribution of income.

P. Samuelson and W. D. Nordhaus ("Economics", McGraw-Hill, 1992) warn
their readers at the beginning of the chapter "Wages, rent, and profits:
the distribution of income" with the following statement:

"For most of this century, the fruits of economic growth were shared
 broadly among all gropus in American society. Suddenly, in the 1980s,
 a new pattern emerged as upper-income groups enjoyed rising real
 incomes while the poor suffered from increased homelessness and
 deprivation. The next four chapters analyze the basic determinants of
 factor earnings and incomes: the wages of labor, the rents of land,
 and the profits earned by capital. Once the fundamentals of factor
 incomes are mastered, we can begin to understand the divergent fortunes
 of rich and poor."

Samuelson and Nordhaus (1992) described the real features of the
capitalist market as follows:

"Although the market mechanism is an admirable way of producing and
 allocating goods, sometimes market failures lead to deficiencies in
 the economic outcomes"..."Markets fail to provide an efficient
 allocation of resources in the presence of imperfect competition or
 externalities. Imperfect competition, such as monopoly, produces high
 prices and low levels of output."..."Externalities arise when business
 actions impose costs or bestow benefits on others outside the
 marketplace without compensation"..."air pollution"..."public goods"...
 "Markets do not necessarily produce a fair distribution of income; they
 may spin off unacceptably high levels of inequality of income and
 consumption"..."the business cycle's excesses of inflation and

From the table above, is clear that the owner of the firm will try to
make the difference between total revenue and total costs as large as
possible. Therefore, the system will work with two main pressures:
          a) total revenue increasing, and
          b) total costs decreasing.

Because increasing total revenue will be limited by levels of price,
the most obvious way to maximize profits (abnormal profits) is pushing
costs down. Two main ways of doing the latter:
          1) rising productivity, and
          2) decreasing levels of wages.

Thus, the capitalist system will growth with a driving force pushing
technology, science, inventions to increase productivity, and a
driving force to keep wages growing far behind abnormal profits, or,
even better, push wages down in relative terms or absolute terms.
(Average wages and average rates of profits in the U.S.A. in the last
twenty years illustrate this point).

The above dynamic forces will evolve into what is known as economies
of scale.
Economies and dis-economies of scale:
    This notion is associated with production costs in the long run.
    In the long run all desired resource adjustments can be negotiated
by an industry and the individual firms which it comprises. The firm
can alter its plant capacity, plant size, and new firms can enter and
old firms can leave and industry. There is no distinction between
fixed and variable costs for the obvious reason that all resources and
therefore all costs are variable in the long run.

The long-run Average Total Costs curve shows the least per unit cost
at which any output can be produced after the firm has had time to make
all appropriate adjustments in its plant size. The long-run Average
Total Costs is U-shaped. Why? 
The law of diminishing returns is not applicable here, because the law
of diminishing returns presumes that one resource is fixed in supply,
and the long-run ATC assumes that all resources are available:

         *              *   U-shaped average total cost curve
          *            *    The vertical axis represent cost per unit,
           *         *     the horizontal axis, output
             *     *
               * *

The U-shaped long-run average cost curve is explainable in terms of
what capitalist economists call "economies and diseconomies" of
scale (or large-scale production).

    Economies of scale or economies of mass production, explain the
    downsloping part of the long-run ATC curve:
       a) labour specialization
          increased specialization in the use of labour is feasible
          as a plant increases in size. The worker may become highly
       b) managerial specialization
          greater efficiency and lower unit costs are the net result.
       c) efficient capital
          only large-scale producers are able to afford and operate
          efficiently the best available equipment
       d) by-products
          the large-scale producer is in better position to utilize
          by-products than is a small firm. The large meat-packing
          plant makes glue, fertilizer, pharmaceuticals, and a host
          of other products from animal remnants which would be
          discarded by smaller producers.
   a), b), c) and d) will contribute to lower unit costs for the
business person/firm who is able to expand her/his scale of operations.


In time the expansion of a firm may give rise to diseconomies and
therefore higher per unit costs. The main factor has to do with certain
managerial problems involved in efficiently controlling and coordinating
a firm's operations as it becomes a large-scale producer. The result
is impaired efficiency and rising average costs. From here the rising
right-side section of the U-shaped average total costs curve.


1.- Where economies of scale are many and diseconomies are remote, the
    long-run average total cost curve will decline over a long range
    of output. Automobile, steel, aluminium, heavy industries in
    general, electronics -specially discrete components associated
    with computers (microprocessors, memory, etc)- are this type of
    economies/diseconomies of scale:

            |   .
unit costs  |      .--> long-run ATC declining over a long run of output
            |         .            .
            |            .        .
            |              .     .
            |                 . .

2.- Where economies of scale are few and diseconomies quickly
    encountered, minimum unit costs will be achieved at a modest
    level of production. This will support a large number of
    relatively small producers. Examples: retail trades and some
    type of farming, baking, clothing, shoe, etc.:

unit costs  |   .       .
            |    .     .
            |     .   .
            |      . .
            |       .

3.- When we find a mixture of large and small producers operating
    with roughly the same degree of efficiency, then there will be
    a long range of output where unit costs will not vary, or
    will change very little. Examples are meat-packing, furniture,
    and house appliances, etc.:

            |   .                                   .
unit costs  |   .                                   .  
            |    .                                 . 
            |     .                               .
            |      . . . . . . . . . . . . . . . .