Microeconomics Unit 3 Costs of Production and Perfect Competition

Unit 3: Costs of Production and Perfect Competition Production and the Law of Diminishing Marginal Returns Calculate MP. Plot TP and MP on Graph Output Stage 1 Stage 2 Number of Total Marginal Workers Product Product 20 0 1 2 3 4 5 6 0 5 15 19 20 20 18 5 10 4 1 0 -2 Stage 3 TP 15 10 Define the Law of Diminishing Marginal Returns As variable resources are added to fixed resources, the additional output from each new worker will eventually fall. 5 0 1 2 3 4 5 MP Workers After which worker does diminishing marginal returns set in? After the 2nd Worker Identify the three stages of returns: increasing, decreasing, and negative marginal returns Revenue and Costs (Define the following) Total RevenueFixed Cost (FC)- Costs that DONÕT change as you Price x Quantity produce more (ex: rent, insurance, etc.) Accounting ProfitVariable Cost (VC)- Costs that DO change as you Total Revenue Ð Explicit Costs produce more (wages to workers, raw materials, etc.) Economic ProfitTotal Cost (TC)- Fixed Costs + Variable Costs Total Revenue Ð Explicit and Implicit Costs Normal ProfitMarginal Cost (MC)- Additional cost to produce one additional output. Zero Economic Profit (breaking even) Short Run Cost Curves (at least one fixed resource) Draw and Label ATC, AVC, and MC MC Costs Long-Run Cost Curves (all resources are variable) Costs LRATC ATC AVC Output Vertical distance between ATC and AVC is AFC Output Economies of Scale- Long run average total cost (LRATC) falls because mass production techniques are used. Diseconomies of Scale- Long run average total cost (LRATC) increase as the firm gets too big and difficult to manage. Calculating ATC, AVC, AFC, and MC Fill in the blanks for a firm producing boxes of oranges: Assume this firm is in a perfectly competitive market and the price is $35 Output Variable Total AVC AFC ATC MC for each box. (boxes) Cost Cost 1. How many boxes should they 0 $0 $10 produce? Why? 3 Boxes of Oranges, 1 20 $30 $20 $10 $30 $20 Firms should produce as long as the 2 30 $40 $15 $5 $20 $10 additional revenue of a unit is greater 3 60 $70 $20 $3.3 $23 $30 than the additional cost. To maximize 4 100 $110 $25 $2.5 $27 $40 profit, produce where MR = MC 2. Calculate the profit at that quantity TR= $105 and TC =$70, Profit = $35 Shut Down Point Per-Unit vs. Lump-Sum Characteristics of Perfect Competition Shut Down Rule: A firm 1. A per unit tax shifts _MC, 1. Many small firms should shut down if the price AVC, and ATC_ so quantity will 2. Identical products fall below the minimum AVC _____Change (decrease)____. 3. No barriers to entry Short-Run Supply Curve: The 2. A lump sum tax shifts __AFC 4. No control over the price MC curve above minimum and ATC__ so quantity will 5. No economic profit in long run AVC NOT change . 6. Efficient Graphing Perfect Competition Draw side-by-side graphs showing a perfectly competitive market and firm. Draw the firm making profit Price Market Price Firm Firms are price S MC takers and produce where MR= MC PM Profit QM Price D Quantity ATC QF MR=D=AR=P Quantity Draw a perfectly competitive market and a firm with the firm making a loss Market Price Firm S MC ATC Loss PM QM D Quantity MR=D=AR=P QF Quantity Calculation Practice Assume the price is $14 and the firm produces the profit maximizing quantity. Identify the following: 1. Quantity- 10 units (MR=MC) 2. Total revenue- $140 = $14 x 10 units 3. Total cost- $100 = $10 x 10 units 4. Economic profit- $40 = $140 - $100 5. What will happen to the number of firms in the market in the long run? Increase, firms will enter Assume the market adjust to the long run. Identify: 6. Price- $9 (No economics profit, minimum ATC) 7. Quantity- 7 Units (MR=MC) 8. What will happen to number of firms in the market? Not change. No incentive to enter or leave If the price was $5, should the firm shut down in the short run? CanÕt tell, need an AVC curve to know Perfect Competition in the Long Run Draw side-by-side graphs showing a perfectly competitive market and firm in long run equilibrium Price Market Price Firm S MC ATC PM MR=D=AR=P QM D Quantity QF Quantity From Short Run to Long Run Draw what happens to each graph in the long run Draw what happens to each graph in the long run Market: Price_↓_ Quantity _↑_ Firm: Market: Firm: Price_↓_ Quantity_↓_ Price ↑ Quantity ↓ Price ↑ Quantity ↑ Efficiency in the Long Run In the long run, perfectly competitive firms have both types of efficiency: 1.Productive Efficiency: they produce the quantity that is the lowest cost (Minimum ATC) 2.Allocative Efficiency: they produce the optimal quantity that society wants (Price = MC)