MicroEco Ch12 13 14 15 16

Opening Video

1) What was the first task of the new employee at the pizza shop in the video? Chopping onions. 2) Which of the following costs did the pizza shop owner NOT include in his accounting books? The owner's talent and effort.

In the graph, what is the marginal product of the fourth worker?

2 gallons per hour -When the fourth worker is hired, output increases from 6 gallons per hour to 8 gallons per hour, so the increase in output marginal product is 2 gallons per hour.

Why doesn't a craft brewery use an efficient automated plant like those used by Anheuser Busch to produce its 3,200 barrels of beer per year?

A craft brewery uses a small scale plant rather than an automated plant like those of Anheuser Busch because the larger automated plant has a higher average total cost at small outputs and a lower average total cost at large outputs.

If a firm's total fixed cost is $25, its total variable cost is $40, and it produces 5 units out output, what is the firm's average total cost?

A firm's average total cost is: Total Cost / Output and Total Total cost = Total fixed cost + Total variable cost. So total cost is $25 + $40 = $65 Average total cost is $65/5 = $13

What is a firm's total cost of production?

A firm's cost of producing goods and services is the sum of the costs of all the resources used whether bought or owned by the firm. -The firm's total cost of production is the sum of all explicit costs and implicit costs of all resources used in production.

MARGINAL COST

A firm's marginal cost is the change in total cost that results from a one unit increase in output. In the graph above: Total variable cost and total cost increase at a decreasing rate at small outputs and then begin to increase at an increasing rate as output increases. The concept of marginal cost enables us to understand these patterns in the changes in total cost.

A FIRM'S PROFIT MAXIMIZING CHOICES

A firm's objective is to maximize its economic profit, which is equal to total revenue (TR) minus total cost (TC) That is: Economic profit = TR - TC Normal profit, the return that the firm's entrepreneur can obtain on average, is part of the firm's total cost. In perfect competition, a firm achieves its objective by deciding the quantity to produce. We'll illustrate perfect competition with the market for maple syrup and the decisions of one firm, Dave's Maple Syrup. We begin our exploration of Dave's decision and their implications for the way a competitive market works by defining some revenue concepts.

AVERAGE PRODUCT

AVERAGE PRODUCT (AP) is the total product per worker employed. It is calculated as: Total product Average product = --------------------- Quantity of labor Another name for average product is PRODUCTIVITY. Average product and marginal product are related, and both increase at a small quantity of labor and eventually decreases as the quantity of labor increases.

What are accountants' measure of cost and profit used for? The accountant's measures are used to ensure that a firm pays the correct amount of income tax.

Accountants measure cost and profit to ensure that the firm pays the correct amount of income tax and to show the bank how the firm has used its bank loan.

The market in which real estate is sold is called OLIGOPOLY. The market in which mouthwash is sold is called MONOPOLISTIC COMPETITION.

An oligopoly is a market in which a small number of firms compete. Real estate is sold in an oligopolistic market. Monopolistic competition is a market in which a large number of firms compete by making similar but slightly different products. Mouthwash is sold in a monopolistically competitive market.

Why doesn't Anheuser Busch use a large enough number of small plants like those used by craft brewery to produce its 125 million barrels of beer per year?

Anheuser Busch uses 32 large scale plants rather than many small plants because a smaller plant has a lower average total cost at small outputs and a higher average total cost at large outputs.

In the long run, which costs are fixed? Does falling average fixed cost bring economies of scale?

In the long run, No costs are fixed and All costs are variable. Economies of scale result from greater specialization of both labor and capital.

LONG RUN COST

In the long run, a firm can vary both the quantity of labor and its plant size. A small firm like Sam's Smoothies can increase its plant size by moving into a larger building and installing more machines. -Costs vary in the long run when a firm varies its plant size along with the quantity of labor it uses. -The first thing that happens is that the distinction between fixed cost and variable cost disappears. All costs are variable in the long run.

What is the distinction between the short run and the long run?

In the short run, the quantities of some resources are fixed. In the long run, the quantities of all resources can be varied.

Graph to show Sam's total product schedule and total product curve.

- A total product schedule shows the maximum quantity that can be produced at each quantity of labor. - This total product schedule shows the maximum quantity of smoothies that Sam's can produce at six different quantities of labor employed. - In column C, Sam's employs 2 workers and can produce 3 gallons of smoothies an hour. - The total product curve, TP, graphs the data in the table. Points A through F on the curve correspond to the columns of the table. The total product curve separates attainable outputs from unattainable outputs. -Points below the TP curve are inefficient and points on the TP curve efficient.

AVERAGE AND MARGINAL PRODUCT COST Graph illustrates link between the average and marginal product curves and between the average and marginal cost curves.

-A firm's MC curve is linked to its MP curve. If, as the firm hires more labor up to 2.5 workers a day: -the firm's marginal product rises -its marginal cost falls. If marginal product is at a maximum, marginal cost is at a minimum. If, as the firm hires more labor, -ts marginal product diminishes -it's marginal cost rises.

Graph illustrates the distinction between the firm's accounting cost and profit and its opportunity cost and economic profit.

-Both economists and accounts measure a firm's total revenue the same way. It equals the price multiplied by the quantity sold of each item. -Accountants measure profit as total revenue minus explicit costs - costs paid in money. They spread cost of capital over its life as depreciation. -Economists measure economic profit as total revenue minus opportunity cost. -Opportunity cost includes explicit costs and implicit costs. Normal profit is an implicit cost.

SHORT RUN PRODUCTION

To increase the output of a fixed plant, a firm must increase the quantity of labor it employs. We describe this relationship between output and the quantity of labor employed by using three related concepts: 1) TOTAL PRODUCT 2) MARGINAL PRODUCT 3) AVERAGE PRODUCT TOTAL PRODUCT - Total Product (TP) is the total quantity of a good produced in a given period. -Total product is an output rate - the number of units produced per unit of time (for example, per hour, day, or week) Total product changes as the quantity of labor employed increases and we illustrate this relationship as a total product schedule and total product curve.

OPPORTUNITY COST & ECONOMIC PROFIT

To produce it's output, Sam's Smoothies employs land, labor, capital, and entrepreneurship that could have been used by another firm to produce other goods or services. The opportunity cost of Sam's production is the highest valued alternative production forgone. This opportunity cost can be broken down into the opportunity cost of each of the factors of production that Sam's Smoothies employs. (See spreadsheet)

NORMAL PROFIT

is the profit that Sam could earn supplying her entrepreneurship to another firm. So normal profit is part of Sam's Smoothies' opportunity cost because it is the cost of a forgone alternative - running another firm.

ECONOMIC PROFIT

is the reward for her entrepreneurship over and above normal profit and equals total revenue (row 1) minus opportunity cost (row 11)

Suppose a student takes three courses and has a GPA at 2.0. If the student takes an additional course and earns an A (worth 4 points) what is the student's new GPA?

The student's new GPA is

COST CURVES AND PRODUCT CURVES In the graph, what is the relationship between the TP curve and the TVC curve? The TVC curve is DERIVED from the TP curve. The quantity of labor that determines total product is multiplied by the wage rate to determine the total variable cost of producing that total product. (The TVC curve and the TP curve are closely related. The quantity of labor that determines total product is multiplied by the wage rate to determine total variable cost of producing that total product.)

The technology that a firm uses determines its cost. A firm's cost curves comes directly from its product curves, its fixed costs, and the wage rate. Total Product and Total Variable Cost Graph that shows link between the total product curve and the total variable cost curve. -A firm's cost curves are linked to its product curves. The easiest link to see is between the total variable cost (TVC) curve and the total product (TP) curve. -The TP curve shows how total product changes when the quantity of labor changes. -The TVC curve shows how total variable cost changes when output (total product) changes. -The x-axis in the TVC graph is the same as the y-axis in the TP graph. -If we multiply the quantity of labor by the wage rate, we get TVC. -If we replace the labor axis with the TVC axis, the TP curve becomes the TVC curve. Flip the axes and the graph is now the TVC graph.

What does a firm do to increase its output?

To increase its output, the firm must ________ in the short run, and in the long run, the firm ________. increase the quantity of a variable factor of production; is able to change its plant as well as the quantity of labor it hires.

Graph that shows average product schedule and average product curve and see the relationship between average product and marginal product. 1) In the graph, what is the relationship between the average product curve and the marginal product curve? Average product increases when marginal product exceeds average product. -When marginal product exceeds average product, the higher marginal value pulls the average value upward, so average product increases.

-Calculate and graph average product. -Average product equals total product divided by the quantity of labor. -When the quantity of labor is 3 workers, total product is 6 gallons an hour. (So average product is 6/3=2 gallons per worker) -Point B through F in the graph correspond to the average product values in the table. -The average product curve is AP. -For the quantity of labor at which marginal product exceeds average product, average product is increasing and the AP curve is upward sloping. -For the quantity of labor at which marginal product is less than average product, average product is decreasing and the AP curve is downward sloping. -At the quantity of labor at which marginal product equals average product, average product is at its maximum.

Spreadsheet of Dav's total revenue, total cost, and economic profit schedules. 1) When Dave produces 5 cans of syrup per day, what is his total revenue, total cost, and economic profit? Total revenue is $40 Total cost is $33 Economic profit is $7

-Dave starts his spreadsheet with a list of the quantities that he knows he can produce. -Dave knows that he can sell his syrup for $8 a can, so he lists his total revenue by multiplying each quantity by $8. -Dave knows his fixed costs and also knows how much labor he must hire to produce each quantity, so he can calculate his total cost of producing each quantity. -Dave can now calculate his economic profit at each quantity of syrup produced as total revenue minus total cost.

Graph of the MR = MC profit maximizing rule. What is the profit that Dave makes on the 10th can of syrup? Zero -The marginal cost of the 10th can is $8. -The marginal revenue is $8, so the profit earned on the 10th can is nothing (zero)

-Dave's marginal revenue is constant at $8 per can. -Dave's marginal cost increases as output increases. -Dave maximizes profit by producing 10 cans per day, where marginal revenue equals marginal cost. -If Dave produces 9 cans per day, he misses out on the profit from the 10th can. -If Dave produces 11 cans per day, he incurs a loss on the 11th can.

The relationship between the marginal product and the quantity of labor employed using a marginal product schedule and marginal product curve. 1) What are the marginal returns, and below what output level does the firm in the graph experience increasing marginal returns? Marginal returns are the changes in total product that result from a one unit increase. The firm in the graph experiences increasing marginal returns below 6 gallons of smoothies per hour. (Marginal returns is another name for marginal product - the change in the total product when the quantity of labor increases by one unit.) (In the graph, increasing marginal returns end when 6 gallons of smoothies per hour are produced.)

-Graph that calculates marginal product. -Marginal product is the change in total product that results from a one unit increase in the quantity of labor employed. -For example, when labor increases from 2 to 3 workers, total product increases from 3 gallons to 6 gallons of smoothies an hour. So marginal product is 3 gallons per worker. -The orange bars illustrate marginal product, and the bar when labor increases from 2 to 3 workers is highlighted. -The marginal product curve passes through the midpoint of these bars. -Marginal product increases to a maximum (when 3 workers are employed in this example.) -Where marginal product is rising total product is increasing at an increasing rate. -As more workers are added, marginal product decreases - diminishing marginal product. -Where marginal product is falling, total product is increasing at a decreasing rate

Graph illustrates cost concepts with the Average Cost Curves and Marginal Cost Curve. 1) In the graph, at what output is Sam's average total cost at its minimum, and at what output does average total cost equal marginal cost? Sam's ATC is at its minimum when output is 8 gallons per hour. Sam's ATC equals marginal cost when output is 8 gallons per hour. (The ATC curve has a minimum at 8 gallons per hour and MC = ATC at minimum ATC.)

-Measure output on the x axis and average and marginal cost on the y axis. -AFC decreases as output increases because the fixed cost, a constant, is being divided by output. -AVC is U shaped because the gains from specialization lower it, and after reaching a minimum (at 7 gallons an hour), diminishing returns increase it. -ATC is the sum of AFC + AVC. The ATC curve, too, is U shaped and is at its minimum just less than 8 gallons an hour. (The vertical distance between the ATC curve and the AVC curve is AFC, as illustrated by the two arrows. The two curves becomes closer together as output increases because AFC decreases.) -The initial gains from specialization followed by diminishing returns make the marginal cost curve U shaped. (MC) (MC) curve reaches a minimum at a smaller output than the minimum average costs. -The MC curve intersects the two average cost curves at their minimum points. When a marginal value is below an average value, the average is pulled down. And when a marginal value is above an average value, the average is pulled up.

Sam's smoothie's marginal cost of production and its three average costs.

-Sam's total fixed costs are $20/hour. -The average fixed cost is $20 an hour divided by output. -For example, when Sam produces 6 galls per hour, the AFC is $20 divided 6 gallons: $20/6 = $3.33 per gallon ---------------------------------------- -Total variable cost is total minus the $20 total fixed cost. -Average variable cost is total variable cost divided by output. -For example, when Sam produces 6 gallons per hour, the average variable cost is $36 divided by 6 gallons, which equals $6 per gallon. $36/6 = $6 per gallon --------------------------------------- Average total cost = Average fixed cost + average variable cost Or... ATC = AFC + AVC For example, when Sam produces 6 gallons per hour, average total cost equals average fixed cost of $3.33 plus average variable cost of $6, which equals $9.33. $9.33 = $3.33 + $6 ATC = AFC +AVC

Sam's total cost curve In the graph, what is Sam's total cost when she hires 4 workers and produces 8 gallons of smoothies per hour? $68 per hour -When Sam hires 4 workers at $12/hour, her total variable cost is $48 per hour. -Her total cost is $48 variable cost plus $20 fixed cost, for a total of $68 per hour.

-She measures output on the x axis and total cost on the y axis. -Total fixed cost (TFC) is constant - it graphs as a horizontal line at $20. -Total variable cost (TVC) increases as output increases. -Total cost (TC) is the sum of TFC and TVC. -The vertical distance between the total cost curve and the total variable cost curve is total fixed cost, as illustrated by the two arrows.

The graph shows a firm's average product curve. On the graph, draw the firm's marginal product curve and label it MP. 1) When your marginal grade exceeds your GPA, how does your GPA change? -Your GPA rises (The relationship between your marginal grade and your average grade GPA is similar to the relationship between marginal product and average product. When your marginal grade exceeds your GPA, your GPA rises.)

-The marginal product curve intersects the average product curve at the point of maximum average product. -When marginal product exceeds average product, average product is increasing. -When marginal product is less than average product, average prodcuc is decreasing.

The graph illustrates the profit maximizing rule: produce the quantity at which marginal revenue equals marginal cost.

-The table shows Dave's total revenue (TR), total cost (TC), and economic profit, (TR - TC) for quantities produced ranging from 8 to 12 cans per day. -Dave maximizes economic profit by producing 10 cans per day. -Add two columns to the table and calculate marginal revenue (MR) and marginal cost (MC) -Marginal revenue is a constant $8 per can. -Marginal cost increases as output increases. -If Dave produces 9 cans per day, marginal revenue ($8) exceeds marginal cost ($4), so an increase in output increases economic profit. -If Dave produces 11 cans per day, marginal revenue ($8) is less than marginal cost ($9) so a decrease in output increases economic profit. -If Dave produces 10 cans per day, marginal revenue ($8) equals marginal cost (midway between $7 and $9) so economic profit is maximized.

Dave's profit maximizing output with a pair of graphs. Graph of Dave's total revenue and total cost, measured on the y axis, at each quantity produced, measured on the x axis. (Graph 1) 1) In the graph, what is Dave's economic profit if he produces 13 cans per day? ZERO -When Dave produces 13 cans per day, his TR curve intersects his TC curve (like it does when he produces 4 cans per day), so his economic profit is zero.

-The total revenue curve is a graph of the TR schedule. -The total cost curve is a graph of the TC schedule. -Economic profit equals TR - TC and is shown by the gap between the TR and TC curves. -We can illustrate Dave's economic profit by changing the y axis variable to economic profit, TR - TC -Dave's economic profit is maximized when he produces 10 cans per day.

Graph to illustrate Sam's long run average cost curve. 1) In the graph, over what range of output does Sam's experience economies of scale? -Up to 14 gallons of smoothies per hour.

-This ATC curve shows the average total costs with the current plant size. ATC1 -If Sam installs more blenders and other equipment, she can produce a larger output with fewer workers. She now operates on ATC2 -ATC2 is higher than ATC 1 at small outputs because the larger plant has a higher fixed cost. But at large outputs, ATC2 is lower than ATC1. -If she installs even more blenders and other equipment, she can produce a larger output for a similar ATC as before and she now operates on ATC3. -If she installs even more blenders and equipment, her shop gets overcrowded and while she can produce a larger output, the ATC increases and she now operates on ATC4. -The long run average cost curve traces the lowest attainable average total cost of producing each output. -The dark blue curve is Sam's long run average cost curve LRAC. -Sam's experience economies of scale as output increases up to 14 gallons an hour. -Sam's experience constant returns to scale for outputs between 14 gallons and 19 gallons an hour. (Sam's experiences diseconomies of scale for outputs that exceed 19 gallons an hour.)

Sam's Total Cost of Production and illustrate it with the total cost curves.

-To find its total cost of production at each output level, a firm starts with its total product schedule. -Sam hires workers for only part of an hour to produce some output levels. -Sam's fixed costs are $20 an hour, and she pays these costs regardless of how much labor she hires. -Sam can hire labor for $12 an hour and her total variable cost is her cost of labor. -Sam's total cost equals her total fixed cost plus her total variable cost. -The highlighted row shows that to produce 6 gallons of smoothies, Sam's hires 3 workers. -Total fixed cost is $20/hour. -total variable cost is $36: The cost of 3 workers at $12/hour. -Sam's total cost of producing 6 gallons an hour is $20 plus $36, which equals $56.

Graph illustrate Dave's marginal revenue and total revenue. In the graph you've just made, why is Dave's total revenue curve linear (a straight line)? Dave's total revenue curve is linear because he sells every can he produces at the same market price. Dave's total revenue equals price multiplied by the quantity sold, or: TR = P x Q (The TR curve graphs TR on the y axis and Q on the x axis, so the slope of the TR curve is P. In perfect competition, Dave sells every can he produces at the constant market price, so the TR curve is linear.

-Total revenue is equal to the price multiplied by the quantity sold. So if Dave sells 10 cans, his total revenue is $8 x 10, which equals $80. -If the quantity sold increases from 10 cans to 11 cans, total revenue increases from $80 to $88, so marginal revenue is $8 a can, the same as the price. -In perfect competition, market demand and market supply determine the price. -Dave is a price taker, so he sells his syrup for the market price. The demand curve for Dave's syrup is a horizontal line at the market price. -Because price equals marginal revenue, the demand curve for Dave's syrup is Dave's marginal revenue curve (MR) -The total revenue curve (TR) shows the total revenue at each quantity sold. Because Dave sells each can for the market price, the total revenue curve is an upward sloping straight line.

Fuel is an airline's biggest single expense. When the price of jet fuel rocketed in 2008, airlines switched to newer airplanes with more fuel-efficient engines. How does a technological advance that makes airplane engines more fuel efficient change an airline's total product, marginal product, and average product?

A technological advance that makes an airplane engine more fuel efficient ________ an airline's total product and ________ an airline's marginal product. increases; increases

MARGINAL ANALYSIS AND THE SUPPLY DECISION

Another way to find the profit maximizing output is to use marginal analysis, which compares marginal revenue, MR, and marginal cost, MC. As output increases, marginal revenue is constant but marginal cost eventually increases. If marginal revenue exceeds marginal cost (MR > MC), then the revenue from selling one more unit exceeds the cost of producing that unit, so an increase in output will increase economic profit. If marginal revenue is less than marginal cost (MR < MC), then the revenue from selling one more unit is less than the cost of producing that unit, so a decrease in output will increase economic profit. If marginal revenue equals marginal cost (MR = MC), then the revenue from selling one more unit equals the cost incurred to produce that unit. Economic profit is maximized and either an increase or a decrease in output will decrease economic profit. -A firm's profit maximizing output is its quantity supplied. Dave's quantity supplied at a price of $8 a can is 10 cans a day. If the price were higher than $8 a can, he would increase production. If the price were lower than $8 a can, he would decrease production. These profit maximizing responses to different prices are the foundation of the law of supply. Other things remaining the same, as the price of a good rises, the quantity supplied of that good increases.

PROFIT MAXIMIZING OUTPUT

As output increases, total revenue increases, but total cost also increases. Marginal return decreases, and eventually total cost increases faster than total revenue. There is one output level that maximizes economic profit where the difference between TR and TC is largest, and a perfectly competitive firm chooses this output level. One way to find the profit maximizing output is to make a spreadsheet.

WHY THE AVERAGE TOTAL COST CURVE IS U SHAPED.

Average total cost (ATC) - is the sum of Average fixed cost (AFC) and the average variable cost (AVC) So, the shape of the ATC curve combines the shapes of the AFC and AVC curves. The U Shape of the ATC curve arises from the influence of two opposing forces: 1) Spreading total fixed cost over a larger output. -When output increases, the firms spreads its total fixed costs more thinly over a larger output. -When Sam's fixed plant cost $20/hour is divided by larger and larger outputs, AFC gets smaller and smaller - the AFC slopes downward. 2) Decreasing marginal returns. -Decreasing marginal returns means that as output increases, larger amounts of labor are needed to produce an additional unit of output. -So average variable cost eventually increases, and the AVC curve eventually slopes upward. -------------------------------------------- (The shape of the average total cost curve combines these two effects.) -Initially, as output increases, both AFC and AVC decrease, so ATC decreases and the ATC curve slopes downward.) (But as output increases farther and decreasing marginal returns set in, average variable cost begins to increase.) -Eventually, AVC increases more quickly than AFC decreases, so ATC increases and the ATC curve slopes upward.

The graph shows a firm's average fixed cost curve and average variable cost curve. Draw a curve that is approximately the firm's average total cost curve. Label it.

Average total cost is the sum of average fixed cost and average variable cost. Initially, as output increases, both average fixed cost and average variable cost decrease, so average total cost decreases, and the ATC curve slopes downward. As output increases further, decreasing marginal returns set in and average variable cost begins to increase. With average fixed cost decreasing more quickly than average variable cost is increasing, the ATC curve continues to slope downward. Eventually, average variable cost increases more quickly than average fixed cost decreases, so average total cost increases and the ATC curve slopes upward.

Last year, Bob earned $35k selling real estate, but he now sells art supplies. The return to entrepreneurship in the art supplies industry is $14k/year. During this year, Bob bought $12k of art supplies from manufacturers and sold them for $59k. Bob rents a shop for $9k/year and spends $1,200 on utilities and office expenses. Bob owns a cash register, which he bought for $1,800 with funds from his savings account. The bank pays 2% a year on savings accounts. At the end of the year, Bob was offered $1,600 for his cash register. Calculate the: 1) Explicit Cost 2) Implicit Cost 3) Economic Profit

Bob has explicit costs of $22,200 Bob's explicit cost includes cost of supplies, rent, and utilities: $12,000 + $9,000 + $1,200 = $22,200 ----------------------------------------- Bob has implicit costs of $49,236 Bob's implicit cost includes: 1) Salary forgone $35,000 2) Return to Entrepreneurship $14,000 3) Economic Depreciation $1,800 - $1,600 = $200 4) Interest Forgone $1,800 x 0.02 = 36 $35,000 + $14,000 + $200 + $36 = $49,236 ------------------------------------------- Bob's economic profit is: Revenue - Explicit $- Implicit $ $59,000 - $22,200 - $49,236 = (-$12,436) Loss

ECONOMIC DEPRECIATION

Economic depreciation is part of the opportunity cost of the firm using capital that it owns (row 7). The alternative to using owned capital is to sell it, so the opportunity cost of using capital includes the change in its market value - the market price of the capital at the beginning of the period minus its market price at the end of the period.

Think about a local farmers market. Lots of farmers are willing to sell whatever quantity of apples they have available and lots of visitors are happy to buy apples from any of the farmers who sell apples of the same quality at the same price. What do economists call this type of market?

PERFECT COMPETITION

Graph to explore the effects of changes in fixed cost and the cost of labor on Sam's total cost curves.

In the graph, what happens to Sam's total cost curves when the wage rate rises from $12 per hour to $20 per hour? Sam's TFC curve does not change and her TVC curve rotates upward. -The wage rate is variable cost, so when the wage rate changes the TVC curve changes, but the TFC curve does not change. -The TVC curve rotates upward because TVC increases by the increase in the wage rate multiplied by the number of workers hired.

Joel hires students to paint houses. The table shows Joel's total product schedule.

How does the marginal product of a student change as Joel hires more students? When Joel hires the fifth and sixth students, the marginal product decreases. -Marginal product is the change in the total product when an additional student is hired. -For example, when Joel increases the number of students from 1 to 2, total product increases from 3 to 7 houses a week. -So the marginal product of the second student is 4 houses a week. The table shows that the marginal product decreases when Joel hires the 5th and 6th students.

In the graph, what is Dave's economic profit if he produces 12 cans of maple syrup per day, and is 12 cans per day his profit maximizing output?

If Dave produces 12 cans of maple syrup per day, his economic profit is $20 and he is NOT MAXIMIZING PROFIT. -In the graph, when the quantity produced is 12 cans per day, economic profit equals $96 minus $76, which is $20. The profit maximizing output is 10 cans per day with an economic profit of $29.

Lizzie leases ladders and then hires students to paint houses. If Lizzie hires twice as many students and leases twice as many ladders, what do you know about her long run average cost curve?

If Lizzie experiences diseconomies of scale, her long run average cost curve SLOPES UPWARD.

In the graph, what is the relationship between the MP curve and the AVC curve? When MP equals AP, the AVC is at its minimum.

If as the firm hires more labor its average product diminishes, its average variable cost rises.

What is the relationship between a firm's short-run average cost and its marginal cost?

If marginal cost exceeds average total cost and output increases, average total cost ________ and average variable cost ________. increases; increases

Why does marginal revenue equal price in perfect competition? Marginal revenue equals price in perfect competition because the firm can sell any quantity it chooses at the going market price.

If the firm sells one more unit, it sells it for the market price, and total revenue increases by that amount. This increase in total revenue is marginal revenue.

In the graph, what is Dave's marginal revenue if the market price is $10 per can, and what is his total revenue if he produces 10 cans per day?

If the market price is $10 per can, Dave's marginal revenue is $10. If he produces 10 cans per day, his total revenue is $100. -In perfect competition, marginal revenue equals the market price. Total revenue equals the quantity produced multiplied by the market price.

REVENUE CONCEPTS

In perfect competition, market demand and market supply determine the price. A firm in perfect competition cannot influence the market price: It is a price taker. Dave can sell any quantity of syrup he chooses at the going price but none above that price. He faces a perfectly elastic demand because syrup from Harlow's Sugar House, Casper Sugar Shack, and all the other maple farms in North America are perfect substitutes for Dave's Syrup. A firm's total revenue (TR) equals the market price (P) multiplied by the quantity sold (Q). That is: TR = P x Q A firm's MARGINAL REVENUE is the change in total revenue that results from a one unit increase in the quantity sold. In perfect competition, marginal revenue equals price. The reason is that the firm can sell any quantity it chooses at the going market price. So, if the firm sells one more unit, it sells it for the market price, and total revenue increases by that amount. This increase in total revenue is marginal revenue.

Is it possible for a firm to experience simultaneously an increasing average product and diminishing marginal product?

It is possible because when marginal product exceeds average product and marginal product is decreasing, each additional worker is producing more than the average worker, so average product is increasing.

MARGINAL PRODUCT

MARGINAL PRODUCT (MP) is the change in the total quantity of a good produced that results from one unit increased in the quantity of labor employed. -Marginal product changes as the quantity of labor increases and all production processes in firms as different as the Ford Motor Company and Sam's Smoothies share a common feature: -INCREASING MARGINAL RETURNS INITIALLY -DECREASING MARGINAL RETURNS EVENTUALLY INCREASING MARGINAL RETURNS - Increasing marginal returns occur when the marginal product of an additional worker exceeds the marginal product of the previous worker. The source of increasing marginal returns is increased specialization and greater division of labor in the production process. -The marginal product of the second worker is greater than the marginal product of the first worker. Marginal returns are increasing -Most production processes experience increasing marginal returns initially. DECREASING MARGINAL RETURNS - All production processes eventually reach a point of decreasing marginal returns. Decreasing marginal returns occur when the marginal product of an additional worker is less than the marginal product of the previous worker. -Decreasing marginal returns arise from the fact that more and more workers use the same equipment and workspace. As more workers are employed, there is less that is productive for the additional worker to do. -Decreasing marginal returns are so pervasive that they qualify for the status of a law: The Law of Decreasing Returns, which states that: -As a firm uses more of a variable factor of production, with a given quantity of fixed factors of production, the marginal product of the variable factor eventually decreases.

In the marginal cost and average cost calculations you've just made, what is Sam's marginal cost when she increases output from 5 gallons to 6 gallons per hour, and what is her average fixed cost when her output is 6 gallons per hour?

Marginal cost = $4.20 AFC = $3.33 When output increases from 5 gallons to 6 gallons, total cost increases from $51.80 to $56.00, an increase of $4.20. (The marginal cost of the 6th gallon is $4.20) Sam's total fixed costs are $20 an hour. (The AFC cost is $20/hour divided by the output.) -Sam produces 6 gallons per hour. (The AFC is $20/6 = $3.33 per gallon)

Think about the market in which you buy your sports shoes. What do economists call this type of market?

MONOPOLISTIC COMPETITION

Which market types produce differentiated products, and which have no close substitutes?

MONOPOLISTIC competition produce differentiated products and oligopoly; monopoly has no close substitutes.

OTHER MARKET TYPES

MONOPOLY - arises when one firm sells a good or service that has no close substitutes and a barrier blocks the entry of new firms. In some places, the phone, gas, electricity, and water suppliers are local monopolies - monopolies that are restricted to a given location. For many years, a global firm called DeBeers had a near international monopoly in diamonds. Your eyeglasses were most likely supplied to the shop that sold them to you by an Italian global monopoly called Luxottica. MONOPOLISTIC COMPETITION - arises when many firms compete by making similar but slightly different products. Each firm is the sole producer of its own version of the good in question. For example, in the market for running shoes, Nike, Reebok, Fila, Asics, New Balance, and many others make their own versions of the perfect shoe. The term "monopolistic competition" reminds us that each firm has a monopoly on its own brand, but the firms compete. OLIGOPOLY - arises when a small number of interdependent firms compete. If a market has only two firms, it is a duopoly. Boeing and Airbus are duopoly in large commercial airplane manufacture. Apple's iOS and Google's Android are a duopoly in smartphone operating systems. Firms in oligopoly might produce almost identical products, like Duracell and Energizer batteries, or they might produce differentiated products, like the different cola products produce by Coke and Pepsi.

Businesses operate in four different market types. They are: -Perfect Competition -Monopoly -Monopolistic Competition -Oligopoly

PERFECT COMPETITION Perfect competition exists when: -Many firms sell an identical product to many buyers. -There are no barriers to entry into (or exit from) the market. -Established firms have no advantage over new firms. -Sellers and buyers are well informed about prices. These conditions that define perfect competition arise when the market demand for the product is large relative to the output of a single producer. This situation arises when economies of scale are absent, so the efficient scale of each firm is small. Firms in perfect competition all look the same to the buyer. The markets for pizzas, tshirts, fruits and vegetables, hot dogs, and hamburger meat are examples of highly competitive markets.

When do the conditions that define perfect competition arise? The conditions that define perfect competition arise when the market demand for the product is large relative to the output of a single producer.

Perfect competition arises when the market demand for the product is large relative to the output of a single producer, when economies of scale are absent, when the efficient scale of each firm is small, and when all firms look the same to buyers.

Lee, a songwriter, earned $45,000 in 2019, but in 2020, he opened a landscaping business. After one year, he submitted the following information to his accountant. Question Facts 1) He stopped renting out his cottage for $4,500/year and used it as his business premisses. The market value of the cottage increased from $76,000 to $80,000. 2) He spent $30,000 on materials, phone, utilities, etc. 3) He leased machines for $3,000/year. 4) He paid $12,500 in wages. 5) He used $5,000 from his savings account, which earns 2 percent a year interest. 6) He borrowed $20,000 at 10 percent a year from the bank. 7) He sold $220,000 worth of landscaping. 8) Normal profit is $25,000 a year.

Question A) The accountant recorded the depreciation on Lee's cottage during 2020 as $6,000. According to the accountant, what was Lee's profit in 2020? Answer A) $166,500 Explanation The accountant measures Lee's profit as total revenue minus explicit costs minus depreciation. Total Revenue: $220,000 Explicit Costs: $47,500 Depreciation: $6,000 (given in question) According to the accountant, Lee's profit was: $220,000 - $47,500 - $6,000 = $166,500

Samantha supplies some of the firm's labor, and the opportunity cost of the time she spends working for the firm is the wage income she forgoes by not working in the best alternative job.

ROW 8

Sam provides some of the funds that buy capital, and the opportunity cost of these funds is the interest that Sam forgoes by not using them in the best alternative way. Sam also supplies entrepreneurship, the factor of production that organizes the business and bears the risk of running it. The return to entrepreneurship is profit, and it has two parts, normal profit (row 10) and economic profit (row 12)

ROW 9

Ray hires students to sell magazine subscriptions at $450/week and leases business equipment that costs $350/week. The table shows Ray's total product and total cost schedules. At what output is Ray's average total cost at a minimum?

Ray's average total cost is at a minimum when he sells 16 subscriptions. ATC = TC/Q Quantity produced is total product. So, ATC = TC / Q 2150/16 = 134.37 The lowest/minimum of all.

Why is the average total cost curve U shaped?

The ATC curve slopes downward at low output levels because average fixed costs (AFC) FALLS. It slopes upward at high output levels because MARGINAL RETURNS DECREASE.

Explore changes in the fixed cost and the wage rate on the firm's average and marginal cost curves. In the graph, what happens to Sam's average total cost curve and marginal cost curve when total fixed cost increases from $20 per hour to $30 per hour?

Sam's MC curve DOES NOT CHANGE and her ATC curve shifts upward.

Why do marginal returns increase at first but eventually diminish?

Specialization of labor increases marginal returns and Overcrowding decreases marginal returns.

Which of the following are examples of short run and long run decisions?

Starbucks has hired more labor to meet increasing demand. (Short Run) Starbucks has opened another shop to meet the increasing demand. (Long Run)

THE LONG RUN AVERAGE COST CURVE

THE LONG RUN AVERAGE COST CURVE shows the lowest average total cost at which it is possible to produce each output when the firm has had enough time to change both its plant size and its labor force.

The table shows a firm's fixed and variable cost schedules. The firm produces 13 tote bags per day. What is the firm's average total cost of producing a tote bag?

The average total cost of producing 13 tote bags per day is ________. $7.31 20 + 75 = 95 95/13 = 7.31

What does a firm in perfect competition do if marginal cost exceeds marginal revenue?

The firm decreases its output. -If marginal revenue is less than marginal cost (MR < MC), then the revenue from selling one more unit is less than the cost of producing that unit, so the firm decreases its output to increase economic profit.

What is the manufacturer's economic profit?

The manufacturer's economic profit is $175/day. Revenue of 50 jeans = $1,650 Cost of workers = $275 Material cost = $900 Company owned equipment and depreciation cost = 300 (Implicit cost) Economic profit can be calculated by subtracting explicit cost and implicit cost from revenue. Profit = $1,650 - $900 - $275 - $300 Economic profit = $175 (Answer) The economic profit for 50 jeans is $175.

The graph shows the average variable cost curve and average total cost curve for a firm that produces candles. On the graph, draw the firm's marginal cost curve and label it MC. What is the relationship between these short run cost curves? When the firm produces an output at which marginal cost exceeds the average variable cost but is less than average total cost, the average variable cost is increasing while the average total cost is decreasing.

The marginal cost curve intersects the ATC curve and the AVC curve at their minimum points. When the marginal cost exceeds average total cost, average total cost is increasing. When the marginal cost is less than average total cost, average total cost is falling. -When marginal cost exceeds average variable cost, average variable cost is increasing. -When marginal cost curve is less than average variable cost, average variable cost is falling.

Consider the market for pickles, jeans, real estate, mouthwash, and dental services in a town with one dentist. In what type of market is each good or service sold?

The market in which pickles are sold is called PERFECT COMPETITION. The market in which jeans are sold is called MONOPOLISTIC COMPETITION.

When the firm produces the quantity at which average product is at its maximum, which variable is at its minimum?

The output at which average product is a maximum is the same output at which average variable cost is a minimum.

EXPLICIT COST

The opportunity cost of a factor of production is an explicit cost, if the firm makes a direct money payment for its use. In Sam's Smoothies' economic accounting spreadsheet, the cost of fruit, yogurt, and honey (row 3), wages that Samantha pays for labor (row 4), and the interest she pays the bank (row 5), are explicit costs.

IMPLICIT COSTS

The opportunity cost of a factor of production is an implicit cost if the firm does not make a direct money payment for its use. Sam's has two implicit costs: -Economic depreciation -Cost of the resources provided by Sam.

What is the opportunity cost of the entrepreneurship supplied by a firm's owner?

The opportunity cost of entrepreneurship is NORMAL PROFIT. -Normal profit is the opportunity cost of entrepreneurship because it is the cost of the forgone alternative of running another firm.

In the graph, what are the components of a firm's opportunity cost of production?

The opportunity cost of production includes both explicit costs and implicit costs, including normal profit and economic depreciation. (See graph)

Matt's factory rents equipment and hires students to produce sports bags. Compare the outputs at which Matt's AVC and ATC curves are at their minimum points.

The output at which Matt's AVC curve is a minimum is SMALLER the output at which his ATC curve is a minimum. This is because initially when decreasing marginal returns set in average fixed cost is decreasing at a faster rate than average variable cost is increasing.

AVERAGE COST

There are three average cost concepts: -AVERAGE FIXED COST -AVERAGE VARIABLE COST -AVERAGE TOTAL COST AVERAGE FIXED COST (AFC) is the total fixed cost per unit of output. AVERAGE VARIABLE COST (AVC) is total cost per unit of output. The average cost concepts are calculated from the total cost concepts as follows: TC = TFC + TVC Divide each total cost by quantity produced, Q, TO GET: TC/Q = TFC/Q + TVC/Q or ATC = AFC + AVC

Think about the market in which the water you use when you take a shower is sold. There is only one supplier. What do economists call this type of market?

This type of market is called? MONOPOLY

ACCOUNTING COST & PROFIT

To calculate Sam's Smoothie's profit in 2020. Sam makes a spreadsheet. Her number of total revenue comes from -The sales of smoothies -Invoices she paid -Cost of fruit, yogurt, and honey -The wages total comes from her payroll records -Bank interest comes from the bank statement Depreciation for her shop during 2020 was $10k (equipment and tools) Accountants measure cost and profit to ensure that a firm pays the correct amount on income tax and to show the bank how the firm used its loan. Economists have a different purpose: -To predict the firm's decision. These decisions respond to opportunity cost and economic profit.

THE SHORT RUN AND THE LONG RUN

To study the relationship between a firm's output decision and its costs, we distinguish between the two decision time frames: 1) The short run 2) The long run THE SHORT RUN: FIXED PLANT -The short run is the time frame in which the quantities of some resources are fixed. -For most firms, the fixed resources are land and capital. The collection of fixed resources is called the firm's plant. -Sam's Smoothies plant is its blenders, refrigerators, and shop. -To increase output in the short run, a firm must increase the quantity of variable factors it uses. Labor is usually the variable factor of production. To produce more smoothies, Sam must hire more labor. -Short run decisions are easily reversed. A firm can increase or decrease output in the short run by increasing or decreasing the number of labor hours it hires. THE LONG RUN: VARIABLE PLANT -The long run is the time frame in which the quantities of all resources can be varied. That is, the long run is a period in which the firm can change its plant. -To increase output in the long run, a firm can increase the size of its plant. Sam's Smoothies can install more blenders and refrigerators and increase the size of its shop. Once a firm buys a new plant, its resale value is usually much less than the amount the firm paid for it. The fall in value is economic depreciation. It is called a sunk cost to emphasize that it is irrelevant to the firm's short run decisions. Only the short run cost of changing its labor inputs and the long run cost of changing its plant size are relevant to a firm's decisions.

A bakery hires workers to produce cakes. Construct the bakery's total product curve. On the graph, draw a point to show that with 2 workers, the bakery can produce 4 cakes a day. Label the point 1. Draw a point to show that with 5 workers, the bakery can produce 16 cakes a day. Label the point 2. Draw the bakery's total product curve over the range of 0 to 5 workers. Show both increasing and decreasing marginal returns and label the curve.

Total product increases as the number of workers increases. Initially, as more workers are employed, the curve becomes steeper because the marginal product of an additional worker exceeds the marginal product of the previous worker. As the number of workers increases more, the curve becomes less steep because each additional worker adds less to total product than the previous worker. The total product curve begins at the origin and passes through the points (2,4) and (5,16).

Kim hires students to do house cleaning at $450 a week. To run the business, Kim leases equipment that cost $550 a week. The table shows Kim's total product schedule.

What is the gap between her total cost and total variable cost of doing business in the short run? The gap between total cost and total variable cost is constant as output increases because the gap equals total fixed cost. -In the short run, total cost minus total variable cost equals total fixed cost. -The gap between total cost and total variable cost is constant at all outputs because in the short run, total fixed cost is constant.

PLANT SIZE AND COST

When a firm changes its plant size, its cost of producing a given output changes. Samantha wonders what would happen to the average total cost of a smoothie if she increased the size of the plant by renting a bigger building and installing a larger number of blenders and refrigerators. Will the average total cost of producing a gallon of smoothies fall, rise, or remain the same? Each of these three outcomes is possible, and they arise because when a firm changes the size of its plant, it might experience. -ECONOMIES OF SCALE -DISECONOMIES OF SCALE -CONSTANT RETURNS OF SCALE ECONOMIES OF SCALE - Are features of a firm's technology that make average total cost fall as the output rate increases. The main source of economies of scale is greater specialization of both labor and capital. -At a small output rate, Sam's Smoothies uses regular blenders like the one in your kitchen. But if Sam's produces hundreds of gallons an hour, it uses commercial blenders that fill, empty, and clean themselves. The result is that the output rate is larger and the average total cost of producing a gallon of smoothies is lower. DISECONOMIES OF SCALE - Diseconomies of scale are features of firm's technology that make average total cost rise as output increases. Diseconomies of scale arise from difficulty of coordinating and controlling a large enterprise. CONSTANT RETURNS TO SCALE - Constant returns to scale are features of a firm's technology that keep average total cost constant as output increases. Constant returns to scale occur when a firm can replicate its existing production facility on a larger scale.

What is the relationship between the average product and the marginal product?

When marginal product exceeds average product, average product increases.

What is the relationship between marginal values and average values?

When the marginal value is above the average value, the average value rises.

An Indian clothing manufacturer pays its workers $275 to make 50 pairs of jeans a day. Workers use company owned equipment that costs $300 in forgone interest and economic depreciation. Materials cost $900. The manufacturer sells the 50 pairs of jeans for $1,650.

Which of the manufacturer's costs are explicit costs, and which are implicit? The explicit costs are wages and materials. The implicit costs are forgone interest and economic depreciation.

SHORT RUN AND LONG RUN COST

Wwe being by looking at a firm's cost of production in the short run, when its plant size is fixed. To produce more output (total product) in the short run, a firm must employ more labor, which means that it must increase its costs. We describe the relationship between output and cost using three cost concepts: -Total Cost -Marginal Cost -Average Cost A firm's TOTAL COST (TC) is the cost of all the factors of production used by the firm. Total cost divides into two parts: -Total fixed Cost -Total Variable Cost Total Fixed Cost (TFC) is the cost of a firm's fixed factors of production: its plant size. -In the short run, the plant size doesn't change as output changes, so total fixed cost doesn't change as output changes and fixed cost is incurred even at zero output. Total Variable Cost TVC - is the cost of a firm's variable factor of production - labor. To change its output in the short run, a firm must change the quantity of labor it employs, so total variable cost changes as output changes. Total cost is the sum of total fixed cost and total variable cost. That is, Total Cost = TFC + TVC TC = TFC + TVC