Bring It Home
In less than two decades, online bookstores have transformed the way books are sold, bought, and even read. Prior to online bookstores, books were primarily sold through independent, physical bookstores located within a building. Physical bookstores, therefore, had limited inventories often due to their small retail locations. There were exceptions, of course; some stores offered larger locations in urban areas. In the past decade, however, independent bookstores have become few and far between. Some have gone out of business, while others struggle to stay open. Online delivery and purchase of books has indeed overtaken the more traditional business models. How have online book stores changed the book selling industry? How has it managed to crush its competition?
A major reason for the success of online bookstores is their production model and cost structure, which has enabled them to undercut the prices of their competitors, even when factoring in the cost of shipping. Read on to see how firms great and small determine what to sell, and at what output and price.
In this chapter, you will learn about the following:
- Explicit and implicit costs, and accounting and economic profit
- The structure of costs in the short run
- The structure of costs in the long run
This chapter is the first of four chapters that explore the theory of the firm. This theory explains that firms behave in much the same way as consumers behave. What does that mean? Let’s define what is meant by the firm. A firm—or business—combines inputs of labor, capital, land, and raw or finished component materials to produce outputs. If the firm is successful, the outputs are more valuable than the inputs. This activity of production goes beyond manufacturing, or, making things. It includes any process or service that creates value, including transportation, distribution, wholesale, and retail sales. Production involves a number of important decisions that define the behavior of firms. These decisions include, but are not limited to the following:
- What product or products should the firm produce?
- How should the products be produced; in other words, what production process should be used?
- How much output should the firm produce?
- What price should the firm charge for its products?
- How much labor should the firm employ?
The answers to these questions depend on the production and cost conditions facing each firm. The answers also depend on the structure of the market for the product(s) in question. Market structure is a multidimensional concept that involves how competitive the industry is. It is defined by questions such as these:
- How much market power does each firm in the industry possess?
- How similar is each firm’s product to the products of other firms in the industry?
- How difficult is it for new firms to enter the industry?
- Do firms compete on the basis of price, advertising, or other product differences?
Figure 7.2 illustrates the range of different market structures, which we will explore in Perfect Competition, Monopoly, and Monopolistic Competition and Oligopoly.
First let’s take a look at how firms determine their costs and desired profit levels. Then, we will discuss costs in the short run and long run and the factors that may influence each.