ap microeconomics in class review #3. a producer’s price is derived from 3 things: 1.cost of...
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AP AP MicroeconomicsMicroeconomics
In Class Review #3In Class Review #3
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A Producer’s price is derived A Producer’s price is derived from 3 things:from 3 things:
1. Cost of Production2. Competition between firms3. Demand for product
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Total CostsTotal Costs• TC = TFC + TVC• TFC = Fixed Costs
– Constant costs paid regardless of production
• TVC = Variable Costs– Costs that vary as
production is changed
Cost
Output
TFC
TVC
TC
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Total RevenueTotal Revenue
• TR = p × q
• The money received from sale of product
Output
Cost & Revenue
TRTC
Break Even
Profit
Loss
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Profit = TR - TCProfit = TR - TC• Accounting:• Calculates actual
costs a business incurs
• Explicit!!• Ex) inputs, salaries,
rent, both fixed and variable
• Economic:• Calculates all
accounting costs plus the what if, or opportunity, costs
• Implicit!!!!• Ex) what was given
up, lost interest, “freebie” costs
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Short Run vs. Long RunShort Run vs. Long Run• Short Run
– At least one fixed factor of production, usually capital
– No Expansion– No entry/exit
industry
• Long Run– All factors are
variable– Expansion possible– Yes can enter or
leave industry
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Production ConsiderationsProduction Considerations• Total Product: the relationship btwn
inputs and outputs
• Marginal Product: the extra product gained by the change in inputs; MP = ΔTP
• Average Product: AP = TP/q
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The Production FunctionThe Production FunctionInput Total
ProductMarginal Product
Average Product
Stages of Production
1 10
2 24
3 39
4 52
5 60
6 66
7 63
8 56
+10+14+15+13+8+6-3
-7
1012
1313121197
IIIIIIIIIIIIIII
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Key Graph Parts to Key Graph Parts to Remember:Remember:
• Stages follow MP
• AP intersects MP at its high point
• MP increases, decrease & then goes negative
Output
TP
AP
MP
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Production FunctionProduction Function8. Law of Diminishing Returns• Due to limited capacity, output will
slow down and then decrease beyond a certain point
9. Choice of Technology• Capital (K) and Labor (L) are both
complements and substitutes, firms will find the combination that is the most efficient (cheapest)
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Producer’s CostsProducer’s Costs• TFC: Total Fixed
Costs• AFC: Average
Fixed Costs; TFC/q
• AVC: Average Variable Costs; TVC/q
• Marginal Costs ΔTC
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Perfect CompetitionPerfect Competition• Characteristics: many firms,
homogenous products, no barriers to entry, P = MC = MR
• Marginal Revenue: extra revenue gained with each additional unit of output; MR = ΔTR
• P = d = MR: Price Takers, each firm takes market price (or market demand) so P and MR are constant (perfectly elastic & horizontal)
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Putting it all togetherPutting it all together
Quantity Output
CostPrice
Market (Industry) Firm
S
D
PXMR
MC
QX
ATC
AVC
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More QuestionsMore Questions14. How can you tell if we are talking
about long-run or short-run?Look for multiple short run graphs, look
for LRAC, profit leads to expansion15. Profits in long run? Explain.Will lead to Long-Run Equilibrium where
firms will no longer have economic profits (characteristics of market make long run profits impossible)
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GRAPH: LRACGRAPH: LRAC
S0
D
Quantity
Price
P0
Cost
Outputs
SRMC
SRACSRMC
SRAC
LRAC
Level #1
Level #2
S1
P1
Market Firm
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Operating Profit:Operating Profit:• Minimizing losses,
it is better to produce and lose a little than it is to produce nothing and lose total fixed costs
• TR - TVCChoices: produce
with lossOutput
CostMC
ATC
AVCMRPX
QX
Losses
Op. Profit
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Shutting Down vs. Exiting Shutting Down vs. Exiting the Industry the Industry
• Shutting Down:• Short Run option• Still paying out
Total Fixed Costs but not producing
• Exiting:• Long Run option• No costs, no
production, business no longer exists
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Expanding ProductionExpanding Production• Economies of Scale
– LR, expand and more efficient (decrease costs)
• Diseconomies of Scale– LR, expand and less efficient (increase
costs)
• Constant Return to Scale– LR, expand and costs are same per unit
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Expanding ProductionExpanding Production• Increasing Returns
– LR, expand and increase production
• Diminishing Returns– LR, expand and decrease production
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Graphing ExpansionGraphing ExpansionU
nit
Co
sts
Output
Long-run ATC
Economiesof scale
Diseconomiesof scale
Constant returnsto scale
Firm
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Perfectly Competitive Perfectly Competitive Making ProfitMaking Profit
MC
MR
ATCAVC
PROFIT
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Perfectly Competitive Perfectly Competitive Minimizing LossesMinimizing Losses
Any Price btwn the average cost curves represents an economic loss but an operating profit
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Perfectly Competitive Perfectly Competitive Breaking EvenBreaking Even
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Perfectly Competitive Perfectly Competitive Shut DownShut Down
Any Price below AVC’s min point represent total loss
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• Derived Demand: the demand for labor is directly dependent on the demand for the output that labor creates
• Law of Diminishing Returns & Hiring Labor: there is a limit to how many workers a firm should hire (SR), hire as long as they are efficient
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Income vs. SubstitutionIncome vs. Substitution• Substitution EffectChoose to subs work for
leisure to get more money
Normal Supply Curve
• Income EffectChoose current income
with less work, want more leisure time
Backward Bending
QL
PL SL
SL
QL
PL
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• Marginal Product of Labor: (MPL)
• The additional output produced as one more unit of labor is added
• Marginal Revenue Product of Labor: (MRPL)
• The addition to the firm’s revenue as the result of the marginal product per labor unit– Represents the firm’s demand curve for
labor
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Marginal Resource Cost = Marginal Resource Cost = Wage of Labor = Price of LaborWage of Labor = Price of Labor
• MRC = WL = PL
• All refer to the cost of the input labor and are interchangeable.
• In a perfectly competitive labor market, the PL comes from market and is a horizontal line for the firm– It is the supply curve of labor faced by
the firm
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Example: Example: PPLL = $60 and P = $60 and PXX = $10 = $10
Labor(L)
Total Output(Q)
Marginal Product(MPL)
Marginal Revenue Product
(MRPL)
1 5
2 20
3 30
4 35
5 35
+5+15+10+5+0
MRPL = MPL × PXMPL = ΔOutput
$50$150$100$50$0
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How many workers should How many workers should be hired?be hired?
• PL = $60
• The firm will hire 3 workers; any more and the additional cost will not cover the additional revenue earned; or MRPL ≥ MRC.
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Graph:Graph:Labor Market Firm
Quantity
Price
Quantity
Cost & Rev
SL
DL
PL WL
MRPL
MRCL
QL
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Parts to Remember:Parts to Remember:#1: MRC is the labor supply curve
available to the firm#2: MRP is the labor demand curve of
the firm#3: find where they intersect and that
is the quantity of labor hired!!(MC = MR)