Transcript MC - Ms. Lane AP Government/Economics Class WEbsite

Unit 3:
Costs of Production and
Perfect Competition
Revenue and Profit
3.1
Revenue = Price x Quantity
Accountants vs. Economists
Accountants look at only EXPLICIT COSTS
•Explicit costs (out of pocket costs) are payments
paid by firms for using the resources of others.
•Example: Rent, Wages, Materials, Electricity Bills
Accounting
Profit
Total
Revenue
Accounting Costs
(Explicit Only)
Economists examine both the EXPLICIT COSTS and
the IMPLICIT COSTS
•Implicit costs are the opportunity costs that firms
“pay” for using their own resources
•Example: Forgone Wage, Forgone Rent, Time
Economic
Profit
Total
Revenue
Economic Costs
(Explicit + Implicit)
Accountants vs. Economists
Accountants look at only EXPLICIT COSTS
•Explicit costs (out of pocket costs) are payments
paid by firms for using the resources of others.
•Example: Rent, Wages, Materials, Electricity Bills
From now
on, all costs
Total
Accounting Costs
Revenue will be
we discuss
(Explicit Only)
Economists ECONOMIC
examine both the EXPLICIT
COSTSCOSTS and
Accounting
Profit
the IMPLICIT COSTS
•Implicit costs are the opportunity costs that firms
“pay” for using their own resources
•Example: Forgone Wage, Forgone Rent, Time
Economic
Profit
Total
Revenue
Economic Costs
(Explicit + Implicit)
Practice
Assume the following:
• David left his job as a lawyer earning $8,000 a month to open up
an ice cream shop
• Last month he sold 5,000 sundaes for $2 each and 8,000 cones
for $1 each
• His rent is $1000 per month
• His other expenses like labor, ice cream, cones, etc. add up to
$9,000 per month
• Last month he took a family vacation that cost $5000
1. Calculate David’s accounting profit
2. Calculate David’s economic profit
3. Should David go back to being a lawyer?
4. What must be true for accounting profit if economic profit is
zero?
No Economic Profit = Normal Profit
Normal Profit
In an efficient competitive market, firms that have
identical products will make a normal profit.
They will break even and make no economic profit
Traffic Analogy
When there is heavy traffic,
why do all lanes go the same
slow speed?
Cars leave slower lanes and
enter faster lanes.
Similarly, what happens in
perfectly competitive markets
if firms earn excessive profit?
Maximizing
PROFIT!
1. Assume every unit can be sold for $10. Which
unit maximizes profit?
2. Use marginal analysis to explain why you
should never produce 5 units
Marginal
Cost
Price
$12
$10
$8
$6
Marginal
Revenue
1
2
3
4
5
Quantity
Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
•To maximum profit firms must make the right
output
•Firms should continue to produce until the
additional revenue from each new output
equals the additional cost.
Example (Assume the price is $10)
• Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11
Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
•To maximum profit firms must make the right
output
•Firms should continue to produce until the
additional revenue from each new output
equals the additional cost.
Example (Assume the price is $10)
• Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11
Profit Maximizing Rule
MR=MC
Production = Converting
inputs into output
Widget
Production Simulation
Production Simulation
Overview
• The class will be divided into two firms.
• There will be several rounds in which each firm will produce chains out
of paper.
• Each round last exactly 1 minute
• Each firm is going to hire one more worker at the start of each round.
Resources
• 1 stapler, 1 scissors, 1 table, and plenty of staples and paper
Rules
• Workers cannot stockpile slips of paper. No extras
• Workers cannot cut more than one paper at a time
• Workers can only add links to one side of the chain
• Each link must pass inspection
• If links don’t meet specifications they won’t count
Responsibilities
• The manager will hire the workers.
• The inspector will check to make sure each product is made to
specifications
Production Simulation
Step 1: Cut
paper down
the middle into
two piece
Step 2: Fold
piece down the
middle
Step 3: Wrap
ends around
and staple
Step 4: Add
more links
to one end
Fill out this chart based on your firm’s production
# of Workers
(Input)
0
1
2
3
4
5
6
# of Links
(Output)
Marginal
Product
Inputs and Outputs
• To earn profit, firms must make products (output)
• Inputs are the resources used to make outputs.
• Input resources are also called FACTORS.
•Total Physical Product (TP)- total output or quantity
produced
•Marginal Product (MP)- the additional output
generated by additional inputs (workers).
Marginal Product =
Change in Total Product
Change in Inputs
•Average Product (AP)- the output per unit of input
Total Product
Average Product =
Units of Labor
Fixed vs. Variable
• Fixed Resources- Resources that don’t
change with the quantity produced
• Ex: Table, scissors, and stapler
• Variable Resources- Resources that do
change with the quantity produced
• Ex: Workers, paper, and staples
Identify three fixed resources and
three variable resources for a pizza
restaurant
Production Analysis
•What happens to marginal product as you hire
more workers?
•Why does this happens?
The Law of Diminishing Marginal Returns
As variable resources (workers) are added to
fixed resources (ovens, machinery, tool, etc.), the
additional output produced from each additional
worker will eventually fall.
Too many cooks in
the kitchen!
Notice that as you hire
more workers the
additional links each
additional worker
creates begins to
decrease
This is because of the
fixed resources and the
Law of Diminishing
Marginal Returns
Graphing Production
Unit 3:
Costs of Production and
Perfect Competition
3.2
22
Three Stages of Returns
Stage I: Increasing Marginal Returns
MP rising. TP increasing at an increasing rate.
Why? Specialization.
Total
Product
Total
Product
Quantity of Labor
Marginal
and
Average
Product
Average Product
Marginal Product
Quantity of Labor
Three Stages of Returns
Stage II: Decreasing Marginal Returns
MP Falling. TP increasing at a decreasing rate.
Why? Fixed Resources. Each worker adds less and less.
Total
Product
Total
Product
Quantity of Labor
Marginal
and
Average
Product
Average Product
Marginal Product
Quantity of Labor
Three Stages of Returns
Stage III: Negative Marginal Returns
MP is negative. TP decreasing.
Workers get in each others way
Total
Product
Total
Product
Quantity of Labor
Marginal
and
Average
Product
Average Product
Marginal Product
Quantity of Labor
With your partner calculate MP and AP then discuss
what the graphs for TP, MP, and AP look like.
Remember quantity of workers goes on the x-axis.
# of Workers Total Product(TP)
PIZZAS
(Input)
0
1
2
3
4
5
6
7
8
0
10
25
45
60
70
75
75
70
Marginal
Product(MP)
Average
Product(AP)
With your partner calculate MP and AP then discuss
what the graphs for TP, MP, and AP look like.
Remember quantity of workers goes on the x-axis.
# of Workers Total Product(TP)
PIZZAS
(Input)
0
1
2
3
4
5
6
7
8
0
10
25
45
60
70
75
75
70
Marginal
Product(MP)
Average
Product(AP)
-
-
10
15
20
15
10
5
0
-5
27
With your partner calculate MP and AP then discuss
what the graphs for TP, MP, and AP look like.
Remember quantity of workers goes on the x-axis.
# of Workers Total Product(TP)
PIZZAS
(Input)
0
1
2
3
4
5
6
7
8
0
10
25
45
60
70
75
75
70
Marginal
Product(MP)
Average
Product(AP)
-
-
10
10
15
12.5
20
15
15
15
10
14
5
12.5
0
10.71
-5
8.75
Identify the three stages of returns
# of Workers Total Product(TP)
PIZZAS
(Input)
0
1
2
3
4
5
6
7
8
0
10
25
45
60
70
75
75
70
Marginal
Product(MP)
Average
Product(AP)
-
-
10
10
15
12.5
20
15
15
15
10
14
5
12.5
0
10.71
-5
8.75
Identify the three stages of returns
# of Workers Total Product(TP)
PIZZAS
(Input)
0
1
2
3
4
5
6
7
8
0
10
25
45
60
70
75
75
70
Marginal
Product(MP)
Average
Product(AP)
-
-
10
10
15
12.5
20
15
15
15
10
14
5
12.5
0
10.71
-5
8.75
More Examples of the Law of Diminishing
Marginal Returns
Example #1: Learning curve when studying for an exam
Fixed Resources-Amount of class time, textbook, etc.
Variable Resources-Study time at home
Marginal return1st hour-large returns
2nd hour-less returns
3rd hour-small returns
4th hour- negative returns (tired and confused)
Example #2: A Farmer has fixed resource of 8 acres
planted of corn. If he doesn’t clear weeds he will get 30
bushels. If he clears weeds once he will get 50 bushels.
Twice -57, Thrice-60. Additional returns diminishes each
time.
Tony’s Hat Store
Worksheet
Unit 3:
Costs of Production and
Perfect Competition
3.3
Short-Run
Production Costs
Definition of the “Short-Run”
• We will look at both short-run and long-run production costs.
• Short-run is NOT a set specific amount of time.
• The short-run is a period in which at least one resource is fixed.
• Plant capacity/size is NOT changeable
• In the long-run ALL resources are variable
• NO fixed resources
• Plant capacity/size is changeable
Today we will examine short-run costs
Different Economic Costs
Total Costs
FC = Total Fixed Costs
VC = Total Variable Costs
TC = Total Costs
Per Unit Costs
AFC = Average Fixed Costs
AVC = Average Variable Costs
ATC = Average Total Costs
MC = Marginal Cost
Fixed Costs:
Definitions
Costs for fixed resources that DON’T change
with the amount produced
Ex: Rent, Insurance, Managers Salaries, etc.
Average Fixed Costs = Fixed Costs
Quantity
Variable Costs:
Costs for variable resources that DO change as
more or less is produced
Ex: Raw Materials, Labor, Electricity, etc.
Variable Costs
Average Variable Costs =
Quantity
Definitions
Total Cost:
Sum of Fixed and Variable Costs
Average Total Cost =
Total Costs
Quantity
Marginal Cost:
Additional costs of an additional output.
Ex: If the production of two more output
increases total cost from $100 to $120, the MC
$10
is _____.
Change in Total Costs
Marginal Cost =
Change in Quantity
Calculating Costs
Variable Fixed
Output
Cost
Cost
0
1
2
3
4
5
6
$0
$10
$17
$25
$40
$60
$110
Total
Cost
$10 $10
$10 $20
$10 $27
$10 $35
$10 $50
$10 $70
$10 $120
Marginal
Cost
$10
$7
$8
$15
$20
$50
Fill out the chart then
calculate:
1.
2.
3.
4.
5.
6.
7.
ATC of 6 Units
AFC of 2 Units
AVC of 4 Units
ATC of 1 Unit
AVC of 5 Units
AFC of 5 Units
ATC of 5 Units
Notice that the AVC + AFC = ATC
For 5 Units: AVC ($12) + AFC ($2) = ATC ($14)
Is this is true for 4 Units?
Calculating Costs
Variable Fixed
Output
Cost
Cost
0
1
2
3
4
5
6
$0
$10
$17
$25
$40
$60
$110
Total
Cost
$10 $10
$10 $20
$10 $27
$10 $35
$10 $50
$10 $70
$10 $120
Marginal
Cost
-
$10
$7
$8
$15
$20
$50
AVC AFC ATC
$10
$10
$20
$8.50
$5 $13.50
$8.33 $3.33 $11.66
$10 $2.50 $12.50
$12
$2
$14
$18.33 $1.67
$20
Notice that the AVC + AFC = ATC
Calculating Costs
AVC AFC ATC
$10
$10
$20
$8.50
$5 $13.50
$8.33 $3.33 $11.66
$10 $2.50 $12.50
$12
$2
$14
$18.33 $1.67
$20
MC
ATC
Costs
$20
$18
$16
$14
$12
$10
$8
$6
$4
$2
AVC
ATC and AVC get
closer and closer but
NEVER touch
Average
Fixed Cost
AFC
1
2
3
4
5
6 Quantity
MC
ATC
Costs
$20
$18
$16
$14
$12
$10
$8
$6
$4
$2
AVC
Calculate TC,
VC, and FC of
the 5th Unit
AFC
1
2
3
4
5
6 Quantity
Total Cost Curves
TC
Costs
FC + VC = TC
VC
Fixed Cost
$10
FC
Quantity
Practice
2008 Audit Exam
1.
2.
Calculating Costs Practice
Output
0
1
2
3
4
5
6
Variable Fixed
Cost
Cost
$0
$12
$22
$27
$40
$60
$100
$20
Total
Cost
Marginal
Cost
-
Fill out the chart then
calculate:
1.
2.
3.
4.
5.
6.
7.
8.
ATC of 6 Units
AFC of 2 Units
AVC of 3 Units
ATC of 5 Units
AVC of 2 Units
AVC of 4 Units
AFC of 4 Units
ATC of 4 Units
How much does the 10th unit
costs?
Costs
$30
25
20
15
10
5
0
MC
ATC
AVC
Calculate TC,
VC, and FC
AFC
7 8 9 10 11
Quantity
Per-Unit Costs (Average and Marginal)
At output Q, what
area represents:
TC 0CDQ
VC 0BEQ
FC 0AFQ or BCDE
More
Practice
Additional Practice
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
TC
MC
AVC AFC ATC
Calculating TC, VC, FC, ATC, AFC, and
MC
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
MC
AVC AFC ATC
Calculating TC, VC, FC, ATC, AFC, and
MC
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
AVC AFC ATC
Per Unit Costs
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
-
AVC AFC ATC
Per Unit Costs
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
Per Unit Costs
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
8
7
6.5
6
6
6.6
Per Unit Costs
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
8
50
7
33.3
6.5
25
6
20
6
16.67
6.6
14.3
Asymptote
Per Unit Costs
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 40.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
Per Unit Costs
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 40.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
Calculate A-E
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
A
58
B
33.3 40.3
6.5
25
31.5
6
D
E
C
16.67 22.67
6.6
14.3 20.9
Calculating TC, VC, FC, ATC, AFC, and
MC
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 40.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
Calculating TC, VC, FC, ATC, AFC, and
MC
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 40.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
Marshmallow Towers Activity
https://youtu.be/Ho8lqhsF1B8
*WATCH THIS VIDEO!*
Shapes of
Cost Curves
Costs
Why does marginal cost always go
down then up?
MC
Quantity
Relationship between Production and Cost
Output
As more workers are hired, their
marginal product increases and
then eventually decreases
because of the law of
diminishing marginal returns
MP
Costs
Quantity of labor
The additional costs (MC) of the
units they produce fall when MP
MC
goes up, but eventually increase
as additional workers produce
less and less output
MP and MC are mirror
images of each other
Quantity of output
Why is the MC curve U-shaped?
•The MC curve falls and then rises because of diminishing
marginal returns.
•Example:
•Assume the fixed cost is $20 and the ONLY variable cost is the
cost for each worker (Wage = $10)
Workers Total Prod Marg Prod Total Cost Marginal Cost
0
0
1
5
2
13
3
19
4
23
5
25
6
26
Why is the MC curve U-shaped?
•The MC curve falls and then rises because of diminishing
marginal returns.
•Example:
•Assume the fixed cost is $20 and the ONLY variable cost is the
cost for each worker (Wage = $10)
Workers Total Prod Marg Prod Total Cost Marginal Cost
0
0
1
5
5
2
13
8
3
19
6
4
23
4
5
25
2
6
26
1
Why is the MC curve U-shaped?
•The MC curve falls and then rises because of diminishing
marginal returns.
•Example:
•Assume the fixed cost is $20 and the ONLY variable cost is the
cost for each worker (Wage = $10)
Workers Total Prod Marg Prod Total Cost Marginal Cost
0
0
$20
1
5
5
$30
2
13
8
$40
3
19
6
$50
4
23
4
$60
5
25
2
$70
6
26
1
$80
Why is the MC curve U-shaped?
•The MC curve falls and then rises because of diminishing
marginal returns.
•Example:
•Assume the fixed cost is $20 and the ONLY variable cost is the
cost for each worker (Wage = $10)
Workers Total Prod Marg Prod Total Cost Marginal Cost
0
0
$20
1
5
5
$30
10/5 = $2
2
13
8
$40
10/8 = $1.25
3
19
6
$50
10/6 = $1.6
4
23
4
$60
10/4 = $2.5
5
25
2
$70
10/2 = $5
6
26
1
$80
10/1 = $10
Why is the MC curve U-shaped?
•The additional cost of the first 13 units produced falls
because workers have increasing marginal returns.
•As production continues, each worker adds less and
less to production so the marginal cost for each unit
increases.
Workers Total Prod Marg Prod Total Cost Marginal Cost
0
0
$20
1
5
5
$30
10/5 = $2
2
13
8
$40
10/8 = $1.25
3
19
6
$50
10/6 = $1.6
4
23
4
$60
10/4 = $2.5
5
25
2
$70
10/2 = $5
6
26
1
$80
10/1 = $10
Costs
Relationship between Production and Cost
Why does ATC go down
MC
then
up?
ATC
Quantity
•When the marginal cost is
below the average, it pulls
the average down.
•When the marginal cost is
above the average, it pulls
the average up.
MC intersects the ATC curve at ATC’s lowest point
Example:
•The average income in the room is $50,000.
•An additional (marginal) person enters the room: Bill Gates.
•If the marginal is greater than the average it pulls it up.
•Notice that MC can increase but still pull down the average.
2008 Audit Question 23
2010 Question 18
When in
doubt, graph
it out
Costs
MC
ATC
$12
AVC
$10
$8
AFC
$2
100
Quantity
1.
2.
Shifting Cost
Curves
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
3
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
What if Fixed
Costs increase to
$200
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
200
200
200
200
200
200
200
200
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
200
200
200
200
200
200
200
200
TC
200
210
216
221
226
230
236
246
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
Which Per Unit Cost Curves Change?
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
200
200
200
200
200
200
200
200
TC
200
210
216
221
226
230
236
246
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
ONLY AFC and ATC Increase!
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
200
200
200
200
200
200
200
200
TC
200
210
216
221
226
230
236
246
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
200
110
8
100
58
7
66.6 30.3
6.5
50
31.5
6
40
26
6
33.3 22.67
6.6
28.6 20.9
ONLY AFC and ATC Increase!
Shifting Costs Curves
If fixed costs change ONLY AFC and ATC Change!
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
200
200
200
200
200
200
200
200
TC
200
210
216
221
226
230
236
246
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
200
210
8
100
108
7
66.6 73.6
6.5
50
56.5
6
40
46
6
33.3 39.3
6.6
28.6 35.2
MC and AVC DON’T change!
Shift from an increase in a Fixed Cost
MC
Costs (dollars)
ATC1
ATC
AVC
AFC1
AFC
Quantity
Shift from an increase in a Fixed Cost
MC
Costs (dollars)
ATC1
AVC
AFC1
Quantity
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
What if the cost for
variable resources
increase
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
VC
0
11
18
24
30
35
43
55
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
VC
0
11
18
24
30
35
43
55
FC
100
100
100
100
100
100
100
100
TC
100
111
118
124
130
135
143
155
MC
10
6
5
3
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
Which Per Unit Cost Curves Change?
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
VC
0
11
18
24
30
35
43
55
FC
100
100
100
100
100
100
100
100
TC
100
111
118
124
130
135
143
155
MC
11
7
6
6
5
8
12
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
MC, AVC, and ATC Change!
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
VC
0
11
18
24
30
35
43
55
FC
100
100
100
100
100
100
100
100
TC
100
111
118
124
130
135
143
155
MC
11
7
6
6
5
8
12
AVC AFC ATC
11
100
110
9
50
58
8
33.3 30.3
7.5
25
31.5
7
20
26
7.16 16.67 22.67
7.8
14.3 20.9
MC, AVC, and ATC Change!
Shifting Costs Curves
If variable costs change MC, AVC, and ATC Change!
TP
0
1
2
3
4
5
6
7
VC
0
11
18
24
30
35
43
55
FC
100
100
100
100
100
100
100
100
TC
100
111
118
124
130
135
143
155
MC
11
7
6
6
5
8
12
AVC AFC ATC
11
100
111
9
50
59
8
33.3 41.3
7.5
25
32.5
7
20
27
7.16 16.67 23.83
7.8
14.3 22.1
Shift from an increase in a Variable Costs
MC1
Costs (dollars)
MC
ATC1
AVC1
ATC
AVC
AFC
Quantity
Shift from an increase in a Variable Costs
MC1
Costs (dollars)
ATC1
AVC1
AFC
Quantity
Long-Run Costs
2010 Question 19
Definition of the “Short-Run”
• We will look at both short-run and long-run production costs.
• Short-run is NOT a set specific amount of time.
• The short-run is a period in which at least one resource is fixed.
• Plant capacity/size is NOT changeable
• In the long-run ALL resources are variable
• NO fixed resources
• Plant capacity/size is changeable
Today we will examine LONG-run costs.
Definition and Purpose of the Long Run
In the long run all resources are variable.
Plant capacity/size can change.
Why is this important?
The Long-Run is used for planning. Firms use to identify
which plant size results in the lowest per unit cost.
Ex: Assume a firm is producing 100 bikes with a fixed
number of resources (workers, machines, etc.).
If this firm decides to DOUBLE the number of
resources, what will happen to the number of bikes it
can produce?
There are only three possible outcomes:
1. Number of bikes will double (constant returns to scale)
2. Bikes will more than double (increasing returns to scale)
3. Bikes will less than double (decreasing returns to scale)
Long Run ATC
What happens to the average total costs of a
product when a firm increases its plant capacity?
Example of various plant sizes:
•I make looms out of my garage with one saw
•I rent out building, buy 5 saws, hire 3 workers
•I rent a factor, buy 20 saws and hire 40 workers
•I build my own plant and use robots to build looms.
•I create plants in every major city in the U.S.
Long Run ATC curve is made up of all the
different short run ATC curves of various plant
sizes.
ECONOMIES OF SCALE
Why does economies of scale occur?
• Firms that produce more can better use Mass
Production Techniques and Specialization.
Example:
• A car company that makes 50 cars will have a very
high average cost per car.
• A car company that can produce 100,000 cars will
have a low average cost per car.
• Using mass production techniques, like robots, will
cause total cost to be higher but the average cost for
each car would be significantly lower.
Long Run AVERAGE Total Cost
MC1
Costs
ATC1
$9,900,000
$50,000
$6,000
$3,000
0
1
100
1,000
100,000
1,000,0000
Quantity Cars
Long Run AVERAGE Total Cost
MC1
Costs
ATC1
MC2
Economies of Scale- Long
Run Average Cost falls
because mass production
techniques are used.
$9,900,000
ATC2
$50,000
$6,000
$3,000
0
1
100
1,000
100,000
1,000,0000
Quantity Cars
Long Run AVERAGE Total Cost
Economies of Scale- Long
Run Average Cost falls
because mass production
techniques are used.
MC1
Costs
ATC1
MC2
$9,900,000
MC3
ATC2
$50,000
ATC3
$6,000
$3,000
0
1
100
1,000
100,000
1,000,0000
Quantity Cars
Long Run AVERAGE Total Cost
Constant Returns to ScaleThe long-run average total
cost is as low as it can get.
MC1
Costs
ATC1
MC2
$9,900,000
MC3
MC4
ATC2
$50,000
ATC3
ATC4
$6,000
$3,000
0
1
100
1,000
100,000
1,000,0000
Quantity Cars
Long Run AVERAGE Total Cost
MC1
Costs
ATC1
Diseconomies of ScaleLong run average costs
increase as the firm gets too
big and difficult to manage.
MC2
$9,900,000
MC3
MC5
MC4
ATC5
ATC2
$50,000
ATC3
ATC4
$6,000
$3,000
0
1
100
1,000
100,000
1,000,0000
Quantity Cars
Long Run AVERAGE Total Cost
These are all short run
average costs curves.
Where is the Long Run
Average Cost Curve?
MC1
Costs
ATC1
MC2
$9,900,000
MC3
MC5
MC4
ATC5
ATC2
$50,000
ATC3
ATC4
$6,000
$3,000
0
1
100
1,000
100,000
1,000,0000
Quantity Cars
Long Run AVERAGE Total Cost
Costs
Economies of
Scale
Constant
Returns to
Scale
Diseconomies
of Scale
Long Run
Average Cost
Curve
0
1
100
1,000
100,000
1,000,0000
Quantity Cars
LRATC Simplified
The law of diminishing marginal returns doesn’t apply in
the long run because there are no FIXED RESOURCES.
Costs
Economies of
Scale
Constant
Returns to Scale
Diseconomies
of Scale
Long Run
Average Cost
Curve
Quantity
Unit 3:
Costs of Production and
Perfect Competition
4 Market
Structures
Candy Markets Simulation
https://youtu.be/KGrmnynjHjI
WATCH THIS VIDEO
*see folder activities and simulation*
11
3
Four Market Structures
Perfect
Competition
Monopolistic
Competition
Oligopoly
Monopoly
Every product is sold in a market that can be
considered one of the above market
structures.
For example:
1. Fast Food Market
2. Cars Manufactures
3. Market for Operating Systems (Microsoft)
4. Strawberry Market
5. Cereal Market
Four Market Structures
Perfect
Competition
Monopolistic
Competition
Oligopoly
Monopoly
Imperfect Competition
Characteristics of Perfect Competition:
Examples: Corn, Strawberries, Milk, etc.
• Many small firms
• Identical products (perfect substitutes)
• Low Barriers- Easy for firms to enter and
exit the industry
• Seller has no need to advertise
• Firms are “Price Takers”
The seller has NO control over price.
Four Market Structures
Perfect
Competition
Monopolistic
Competition
Oligopoly
Monopoly
Characteristics of Monopoly:
Examples: The Electric Company, De Beers,
• One large firm (the firm is the market)
• Unique product (no close substitutes)
• High Barriers- Firms cannot enter the
industry
•Monopolies are “Price Makers”
Barriers to Entry
A monopoly wouldn’t last long if there were not high
barriers to keep other firms from entering.
Types of Barriers to Entry
1. Economies of Scale
• Ex: There is only one electric company because they are the
only ones that can make electricity ay the lowest cost. This is
a “natural monopoly”
2. Superior Technology
3. Geography or Ownership of Raw Materials
4. Government Created Barriers
• The government issues patents to protect inventors and
forbids others from using their invention
Four Market Structures
Perfect
Competition
Monopolistic
Competition
Oligopoly
Monopoly
Characteristics of Oligopolies:
Examples: Cell Phones, Service Providers, Cars
• A Few Large Producers (Less than 10)
• Identical or Differentiated Products
• High Barriers to Entry
• Control Over Price (Price Maker)
• Mutual Interdependence
•Firms must worry about the decisions of
their competitors and use strategy
Four Market Structures
Perfect
Competition
Monopolistic
Competition
Oligopoly
Monopoly
Characteristics of Mono. Comp:
Examples: Fast food, furniture, shoe stores
• Relatively Large Number of Sellers
• Differentiated Products
• Some control over price
• Low Barriers- easy for firms to enter
• A lot of non-price competition
(Advertising)
Perfect
Competition
FOUR MARKET STRUCTURES
Perfect
Competition
Monopolistic
Competition
Oligopoly
Monopoly
Imperfect Competition
Characteristics of Perfect Competition:
Examples: Corn, Strawberries, Milk, etc.
• Many small firms
• Identical products (perfect substitutes)
• Low Barriers- Easy for firms to enter and
exit the industry
• Seller has no need to advertise
• Firms are “Price Takers”
The seller has NO control over price.
Demand for Perfectly Competitive
Firms
Why are they Price Takers?
•If a firm charges above the market price, NO
ONE will buy. They will go to other firms
•There is no reason to price low because
consumers will buy just as much at the market
price.
Since the price is the same at all quantities
demanded, the demand curve for each firm is…
Perfectly Elastic
(A Horizontal straight line)
The Competitive Firm is a Price Taker
Price is set by the Industry
Industry
(all firms)
P
Firm
S
P
$10
$10
Demand
D
5000
Q
Q
The Competitive Firm is a Price Taker
Price is set by the Industry
What is the additional
revenue for selling an
additional unit?
1st unit earns $10
2nd unit earns $10
Marginal revenue is
constant at $10
Notice:
Firm
P
$10
• Total revenue increases
at a constant rate
• MR equal Average
Revenue
Demand
MR=D=AR=P
Q
The Competitive Firm is a Price Taker
Price is set by the Industry
What is the additional
revenue for selling an
Firm
additional
unit? Competition:
P
For
Perfect
1st unit earns $10
= MR
2nd unit earnsDemand
$10
Marginal revenue is
(Marginal
Revenue)
constant at
$10
Demand
$10
Notice:
MR=D=AR=P
• Total revenue increases
at a constant rate
• MR equal Average
Revenue
Q
Maximizing
PROFIT!
Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
•To maximum profit firms must make the right
output
•Firms should continue to produce until the
additional revenue from each new output
equals the additional cost.
Example (Assume the price is $10)
• Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11
Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
•To maximum profit firms must make the right
output
•Firms should continue to produce until the
additional revenue from each new output
equals the additional cost.
Example (Assume the price is $10)
• Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11
Profit Maximizing Rule
MR=MC
Lets put costs and revenue together
to calculate profit.
Firm
Industry
P
S
P
(price taker)
MC
$7
$7
Demand
ATC
D
10,000
Q
Q
•How much output should be produced?
•How much is Total Revenue? How much is Total Cost?
•Is there profit or loss? How much?
P
$9
MC
8
7
6
5
4
3
2
1
MR=D=AR=P
Profit = $18
Total Cost=$45
Total Revenue =$63
1 2 3 4 5 6 7 8 9 10 Q
ATC
Suppose the market demand falls. What
would happen if the price is lowered from
$7 to $5?
The MR=MC rule still applies but now the
firm will make an economic loss.
The profit maximizing rule is also the
loss minimizing rule!!!
Cost and Revenue
•How much output should be produced?
•How much is Total Revenue? How much is Total Cost?
•Is there profit or loss? How much?
MC
$9
8
ATC
7
6
Loss =$7
5
MR=D=AR=P
4
3
2 Total Cost = $42
Total Revenue=$35
1
1 2 3 4 5 6 7 8 9 10 Q
The Shut Down
Rule
Assume the market demand falls even
more. If the price is lowered from $5 to $4
the firm should stop producing.
Shut Down Rule:
•A firm should continue to produce as long
as the price is above the AVC
•When the price falls below AVC then the
firm should minimize its losses by shutting
down
•Why? If the price is below AVC the firm is
losing more money by producing than they
would have to pay to shut down.
SHUT DOWN! Produce Zero
Price
$9
8
7
6
5
4
3
2
1
MC
ATC
AVC
Minimum AVC
is shut down
point
1 2 3 4 5 6 7 8 9 10 Q
P<AVC. They should shut down
Producing nothing is cheaper than staying open.
Price
$9
8
7
6
5
4
3
2
1
MC
ATC
Fixed Costs=$10
AVC
TC=$35
MR=D=AR=P
TR=$20
1 2 3 4 5 6 7 8 9 10 Q
Profit Maximizing Rule
MR = MC
Three Characteristics of MR=MC Rule:
1. Rule applies to ALL markets
structures (PC, Monopolies, etc.)
2. The rule applies only if price is
above AVC
3. Rule can be restated P = MC for
perfectly competitive firms (because
MR = P)
Practice
#1
1. Should the firm produce? Yes
2. What output should the firm produce? 10
3. What is the TR and TC at that output? TR=$140
4. How much profit or loss?
TC=$100
Profit=$40
Price
MC
$16
15
14
MR=D=AR= P
ATC
10
9
5
0
3
7
10
12
Quantity
What output should the firm produce? 6
What is TR at that output? $90
What is TC? $120
How much profit or loss? Loss= $30
#2
Price
MC
24
ATC
20
18
AVC
15
MR=D=AR=P
12
0
3
6
8
10
Quantity
#3
1. What output should the firm produce? Zero Shutdown
2. What is TR at MR=MC point? $45
(Price below AVC)
3. What is TC at MR=MC point? $55
4. How much profit or loss? Loss=Only Fixed Cost $5
MC
Price
ATC
AVC
$12
11
10
MR=D=AR=P
9
0
5
6
7
8
Quantity
#4
1. Should the firm produce? Yes
2. What output should the firm produce? 10
3. What is the TR and TC at that output? TR=$100
4. How much profit or loss?
TC=$60
Profit=$40
Price
MC
$12
11
10
MR=D=AR= P
ATC
6
5
3
0
3
7
10
12
Quantity
2007 Form B FRQ
2007 Form B FRQ
Maximizing Profit
Output
0
1
2
3
4
5
6
Variable Fixed
Cost
Cost
$0
$12
$22
$27
$40
$60
$100
$20
Total
Cost
Marginal
Cost
-
Assume the firm can
sell each unit at a
price of $30
1. How many units
should the firm
produce to
maximize profit?
2. What is the total
revenue at that
quantity?
3. How much is the
profit?
Notice that at 6 units the firm is still making
profit. It’s just not maximizing profit
Maximizing Profit
Output
0
1
2
3
4
5
6
Variable Fixed
Cost
Cost
$0
$12
$22
$27
$40
$60
$100
$20
Total
Cost
Marginal
Cost
-
TR MR Profit
$30
$60
$90
$120
$150
$180
$30
$30
$30
$30
$30
$30
-$2
$18
$43
$60
$70
$60
Notice that at 6 units the firm is still making
profit. It’s just not maximizing profit
2006 FRQ
2006 FRQ
149
Short-run
Supply Curve
Marginal Cost and Supply
Cost and Revenue
As price increases, the quantity
increases
$5
0
45
40
35
30
25
20
15
10
5
0
MC
ATC
MR5
AVC
MR4
MR3
MR2
MR1
1
2
3
4
5
6
7
9
Q
Marginal Cost and Supply
Cost and Revenue
When price increases, quantity increases
When price decrease, quantity decreases
$5
0
45
40
35
30
25
20
15
10
5
0
MC = Supply
ATC
Short-run
Supply Curve:
AVC
MC above AVC
1
2
3
4
5
6
7
9
Q
Marginal Cost and Supply
Cost and Revenue
If variable costs increase (ex: per unit tax)
$5
0
45
40
35
30
25
20
15
10
5
0
MC2=Supply2
MC1=Supply1
AVC
AVC
When MC increases, SUPPLY decrease
1
2
3
4
5
6
7
9
Q
Marginal Cost and Supply
Cost and Revenue
What if variable costs decrease (ex: subsidy)?
$5
0
45
40
35
30
25
20
15
10
5
0
MC1=Supply1
MC2=Supply2
AVC
AVC
When MC decreases, SUPPLY increases
1
2
3
4
5
6
7
9
Q
Marginal Cost and Supply
What happens to quantity if fixed costs
increase?
Price
MC
MR=D=AR= P
ATC1
ATC
PF
Quantity stays
the same because
MC/Supply
doesn’t change
QF
Quantity
Per Unit vs. Lump Sum
A PER UNIT tax or subsidy only effects
the VARIABLE COSTS so MC, AVC,
and ATC will shift.
This WILL effect the quantity produced
A LUMP SUM tax or subsidy only
effects FIXED COSTS so only AFC and
ATC will shift. MC stays the same.
This WILL NOT effect the quantity produced
2008 Audit Exam
Unit 3:
Costs of Production and
Perfect Competition
Perfect
Competition
1.
2.
3.
4.
5.
6.
7.
8.
9.
Review
Identify the 4 Market Structures
Identify the characteristics of perfect competition
Why is a perfectly competitive firm a “price taker”?
Explain why perfectly competitive firms make little
profit
How do ALL firms determine what output to
produce?
Draw a perfectly competitive firm producing 10
units at a price of $10 making a profit of $30
Draw and label a perfectly competitive firm
making a loss.
On your graph, identify the shut down point
List 10 words that rhyme with the word “great”
Drawing side-by-side graph for perfectly
completive industry and firm
Is the firm making a profit or a loss? Why?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
Industry
Q
8
Firm
(price taker)
Q
Which of the following is a
correctly labeled graph for
firm making economic
profit?
162
P
ATC
MC
#1
P
MC
#3
ATC
MR=D
PF
MR=D
Q
P
#2
Q
QF
P
MC
#4
QF
ATC
ATC
MC
MR=D
MR=D
Q
QF
Q
QF
P
MC
#1
ATC
P
MC
#3
ATC
MR=D
PF
MR=D
Q
Q
They
are all wrongQ
P #4
#2
ATC
MC
for different reasons
F
P
F
ATC
MC
MR=D
MR=D
Q
QF
Q
Q
QF
P
ATC
MC
#1
P
MC
#3
ATC
MR=D
PF
MR=D
Profit
too big
ATC>P
Q
P
#2
Q
QF
P
MC
ATC
MC
MR=D
MR=D
MC&ATC
Wrong
Q
MR > MC
Q
QF
#4
QF
ATC
QF
Where is the profit maximization point? How do you know?
What output should be produced? What is TR? What is TC?
How much is the profit or loss? Where is the Shutdown Point?
Cost and Revenue
$25
MC
20
Profit
15
MR=P
ATC
AVC
10
Total Revenue Total Cost
0
1 2 3 4 5 6 7 8 9 10
Perfect Competition
in the Long-Run
You are a wheat farmer. You learn that
there is a more profit in making corn.
What do you do in the long run?
In the Long-run…
•Firms will enter if there is profit
•Firms will leave if there is loss
•So, ALL firms break even, they make
NO economic profit
(No Economic Profit = Normal Profit)
•In long run equilibrium a perfectly
competitive firm is EXTREMELY
efficient.
Side-by-side graph for perfectly completive
industry and firm in the LONG RUN
Is the firm making a profit or a loss? Why?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
Industry
Q
8
Firm
(price taker)
Q
Firm in Long-Run Equilibrium
Price = MC = Minimum ATC
Firm is making NO economic profit
Firm is making positive accounting profit
P
MC
ATC
$15
MR=D
There is no incentive to
enter or leave the
industry 17
TC = TR
8
0
Q
Going from Short-Run
to Long-Run
1.
2.
3.
4.
Is this the short or the long run? Why?
What will firms do in the long run?
What happens to P and Q in the industry?
What happens to P and Q in the firm?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000 6000 Q
Industry
8
Firm
Q
Firms enter to earn profit so supply
increases in the industry
Price decreases and quantity increases
P
S
P
MC
S1
ATC
$15
MR=D
$15
$10
D
5000 6000 Q
Industry
8
Firm
Q
Price falls for the firm because they are
price takers.
Price decreases and quantity decreases
P
S
P
MC
S1
ATC
$15
$15
MR=D
$10
$10
MR1=D1
D
5000 6000 Q
Industry
5 8
Firm
Q
New Long Run Equilibrium at $10 Price
Zero Economic Profit
P
P
MC
S1
ATC
$10
MR1=D1
$10
D
5000 6000 Q
Industry
5
Firm
Q
1.
2.
3.
4.
Is this the short or the long run? Why?
What will firms do in the long run?
What happens to P and Q in the industry?
What happens to P and Q in the firm?
P
S
P
$15
MC
MR=D
$15
D
4000 5000
Industry
Q
ATC
8
Firm
Q
Firms leave to avoid losses so supply
decreases in the industry
Price increases and quantity decreases
P
S1
S
P
MC
ATC
$20
$15
MR=D
$15
D
4000 5000
Industry
Q
8
Firm
Q
Price increase for the firm because they
are price takers.
Price increases and quantity increases
P
S1
S
P
$20
MC
$20
$15
$15
MR1=D1
MR=D
D
4000 5000
Industry
Q
ATC
89
Firm
Q
New Long Run Equilibrium at $20 Price
Zero Economic Profit
S1
P
P
$20
MC
$20
MR1=D1
D
4000
Industry
Q
ATC
9
Firm
Q
Going from Long-Run to
Long-Run
Constant Cost Industry- New firms entering the
market does not increase the costs for the firms
already in the market.
Currently in Long-Run Equilibrium
If demand increases, what happens in the short-run
and how does it return to the long run?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
Industry
Q
8
Firm
Q
Demand Increases
The price increases and quantity increases
Profit is made in the short-run
P
S
P
MC
ATC
$20
$20
$15
$15
MR1=D1
MR=D
D1
D
5000
Industry
Q
8 9
Firm
Q
Firms enter to earn profit so supply
increases in the industry
Price Returns to $15
P
S S1
P
MC
ATC
$20
$20
$15
$15
MR1=D1
MR=D
D1
D
5000 7000 Q
Industry
8 9
Firm
Q
Back to Long-Run Equilibrium
The only thing that changed from long-run to
long-run is quantity in the industry
S1
P
P
MC
ATC
$15
MR=D
$15
D1
D
7000 Q
Industry
8
Firm
Q
What if demand falls?
If demand decreases, what happens in the shortrun and how does it return to the long run?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
Industry
Q
8
Firm
Q
Demand Decreases
The price increases and quantity increases
Profit is made in the short-run
P
S
P
MC
ATC
$15
$10
MR=D
$15
$10
5000
D1 D
Q
Industry
MR1=D1
7 8
Firm
Q
Demand Decreases
The price increases and quantity increases
Profit is made in the short-run
P
S1
S
P
MC
ATC
$15
$10
MR=D
$15
$10
3000 5000
D1 D
Q
Industry
MR1=D1
7 8
Firm
Q
Demand Decreases
The price increases and quantity increases
Profit is made in the short-run
S1
P
P
MC
ATC
$15
MR=D
$15
D1
3000
Industry
Q
8
Firm
Q
Practice
2012 Multiple Choice #23
2012 Multiple Choice #38
2010 FRQ #1
Going from Long-Run to
Long-Run
Increasing Cost Industry- New firms entering
the market increase the costs for the firms
already in the market.
(Only asked once on a FRQ- 2011 Form B)
Currently in Long-Run Equilibrium
If demand increases, what happens in the short-run
and how does it return to the long run?
P
S
P
MC
ATC
$15
MR=D
$15
D
Q
Industry
Q
Firm
INCREASING COST Industry
The price increases and quantity increases
Profit is made in the short-run
P
S
P
MC
$25
$25
ATC
$15
$15
MR=D
D1
D
Q
Industry
Q
Firm
Firms enter to earn profit but fight for
resources causing costs to increase
Price Falls to $20
$25
$25
MC1
MC ATC1
ATC
$20
$15
$15
MR=D
P
S
P
S1
D1
D
Q
Industry
Q
Firm
Firms enter to earn profit but fight for
resources causing costs to increase
Price Falls to $20
P
S1
MC1
P
ATC1
MR1
$20
D1
Q
Industry
Q
Firm
2008 Audit Exam
Unit 3:
Costs of Production and
Perfect Competition
NAME THAT CONCEPT
1.Law of Demin.
Marginal Returns
2.Fixed Cost
3.Low Barriers
4.Price Taker
5.MR = MC
NAME THAT CONCEPT
1.Variable Costs
2.Shut Down Rule
3.MR=D=AR=P
4.Normal Profit
5.Economies of Scale
(Mr. Darp)
1.
2.
3.
4.
5.
6.
7.
8.
9.
Review
Draw and label a perfectly competitive firm making a profit
Draw and label a perfectly competitive firm making a loss
Why is that firm considered a “price taker”?
How do firms determine what output to produce?
On your graph, identify the shut down point
On your graph, identify the firms supply curve
What happens in the industry if there is a profit?
What happens in the industry if there is a loss?
List 10 rides at Disneyland
20
4
Four Market Structures
Perfect
Competition
Monopolistic
Competition
Oligopoly
Monopoly
Imperfect Competition
Characteristics of Perfect Competition:
Examples: Corn, Strawberries, Milk, etc.
• Many small firms
• Identical products (perfect substitutes)
• Low Barriers- Easy for firms to enter and
exit the industry
• Seller has no need to advertise
• Firms are “Price Takers”
The seller has NO control over price.
Shifting Cost
Curves
A change in fixed costs change ATC
and AFC (but not MC)
A change in variable costs change
ATC, AVC, and MC
Changes in fixed
costs don’t
change output
Changes in variable costs change
output
Efficiency
In general, efficiency is the optimal use
of societies scarce resources
•Perfect Competition forces producers to use
limited resources to their fullest.
•Inefficient firms have higher costs and are the
first to leave the industry.
•Perfectly competitive industries are extremely
efficient
There are two kinds of efficiency:
1. Productive Efficiency
2. Allocative Efficiency
Productive Efficiency- Producing at the
lowest possible cost (minimum amount
of resources are being used)
Graphically it is where price equals the
minimum ATC
Allocative Efficiency- Producing at the
amount most desired by society
(allocating resources towards the
products society wants)
Graphically it is where price equals
marginal cost
Short-Run Profit
P
Not Productively Efficient
MC
MR=D=AR=P
ATC
$10
Q1
Notice that Q1 is NOT
being made at the
lowest possible cost
(ATC not at lowest
Q
point).
Short-Run Loss
P
Not Productively Efficient
MC
ATC
MR=D=AR=P
$5
Q2
Notice that Q2 is NOT
being made at the
lowest possible cost
(ATC not at lowest
Q
point).
Long-Run Equilibrium
P
Productively Efficient in the Long-Run
MC
ATC
$8
MR=D=AR=P
Q3
In the long-run, Q2 IS
being made at the
lowest possible cost
(ATC at lowest point)
Q
Short-Run Profit
P
Allocatively Efficient
MC
MR=D=AR=P
ATC
$10
Q1
Notice that the price
people are willing to
pay equals the
additional cost to
Q
produce Q1
(Price = MC)
Short-Run Profit
P
NOT Allocatively Efficient
MC
MR=D=AR=P
ATC
$10
$5
At Q2, the price is greater
than the MC so society
wants more output
produced
Q2
Q
Long-Run Equilibrium
P
MC
ATC
$8
MR=D=AR=P
Q3
A perfectly
competitive profit
maximizing firm is
always allocatively
Q
efficient
Summary
Perfectly competitive firms are
allocatively and productively
efficient in the long-run
In the short-run, they are always
allocatively efficient, but they are
not productively efficient.