i. economic costs economic costs are opportunity costs explicit costs –resource payments like...
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I. ECONOMIC COSTSI. ECONOMIC COSTS• Economic Costs are Opportunity Costs
• Explicit Costs – Resource payments like rent, labor, trucks,
vendors, fuel
• Implicit Costs– self-owned resources– lost value from investing in business
rather than alternative
II. ECONOMIC PROFITII. ECONOMIC PROFIT
• Total Revenue MINUS Economic Costs
• AKA Pure profit
EconomicProfit
Implicit costs(including a
normal profit)
ExplicitCosts
Accountingcosts (explicit
costs only)
AccountingProfit
Ec
on
om
ic (
op
po
rtu
nit
y) C
os
ts
TOTAL
REVENUE
Profits to anEconomist
Profits to anAccountant
III. SHORT RUN & LONG RUNIII. SHORT RUN & LONG RUN
• Short Run – FIXED PLANT– Brief period of time to alter plant capacity– Output can be varied by adding larger/smaller
amounts of resources
• Long Run – VARIABLE PLANT– Enough time to change Q of ALL resources
employed including plant capacity– Firms can enter or exit industry
Inputs Total Product
Marginal Product
Average Product
0 0 Remember: Plot Between Input Points!
1 10 10 10
2 25 15 12.5
3 37 12 12.33
4 47 10 11.75
5 55 8 11
6 60 5 10
7 63 3 9
8 63 0 7.875
9 62 -1 6.88
Law of Diminishing ReturnsLaw of Diminishing Returns
SHORT-RUN PRODUCTIONRELATIONSHIPS
To
tal P
rod
uct
, TP
Quantity of Labor
Ave
rag
e P
rod
uct
, AP
, an
dM
arg
inal
Pro
du
ct, M
P
Quantity of Labor
Total Product
MarginalProduct
AverageProduct
IncreasingMarginalReturns
Law of Diminishing Returns
SHORT-RUN PRODUCTIONRELATIONSHIPS
To
tal P
rod
uct
, TP
Quantity of Labor
Ave
rag
e P
rod
uct
, AP
, an
dM
arg
inal
Pro
du
ct, M
P
Quantity of Labor
Total Product
MarginalProduct
AverageProduct
DiminishingMarginalReturns
Law of Diminishing Returns
SHORT-RUN PRODUCTIONRELATIONSHIPS
To
tal P
rod
uct
, TP
Quantity of Labor
Ave
rag
e P
rod
uct
, AP
, an
dM
arg
inal
Pro
du
ct, M
P
Quantity of Labor
Total Product
MarginalProduct
AverageProduct
NegativeMarginalReturns
IV. Short Run Costs• Fixed Cost:
– Constant and must be paid no matter the output• Variable Cost
– Change with level of output• Total Cost
– FC + VC• Marginal Cost
– additional cost of producing one more unit of output
• Average Fixed Cost– TFC/Q
• Average Variable Cost – TVC/Q
• Average Total Cost – AFC + AVC– Or TC/Q
Output
Total
Fixed
Cost
Total
Variable
Cost
Total
Cost
Marginal
Cost
Average
Fixed
Cost
Average
Variable
Cost
Average
Total
Cost
0 $500 $0 $500PLOT BETWEEN OUTPUT LEVELS
100 500 700 1200 $7.00 $5.00 $7.00 $12.00
200 500 1300 1800 6.00 2.50 6.50 9.00
300 500 1800 2300 5.00 1.67 6.00 7.67
400 500 2400 2900 6.00 1.25 6.00 7.25
500 500 3100 3600 7.00 1.00 6.20 7.20
600 500 3820 4320 7.20 0.83 6.37 7.20
700 500 4700 5200 8.80 0.71 6.71 7.42
Total
Product
Fixed
Cost
Variable
Cost
Total
Cost
Marginal
Cost
Average
Fixed
Cost
Average
Variable
Cost
Average
Total
Cost
0 $100.00 $0 $100.00 ------- -------- ------- --------
1 100.00 10.00 110.00 $10.00 $100.00 $10.00 $110.00
2 100.00 16.00 116.00 6.00 50.00 8.00 58.00
3 100.00 21.00 121.00 5.00 33.33 7.00 40.33
4 100.00 26.00 126.00 5.00 25.00 6.50 31.50
5 100.00 30.00 130.00 4.00 20.00 6.00 26.00
6 100.00 36.00 136.00 6.00 16.67 6.00 22.67
7 100.00 45.50 145.50 9.50 14.29 6.50 20.79
8 100.00 56.00 156.00 10.50 12.50 7.00 19.50
9 100.00 72.00 172.00 16.00 11.11 8.00 19.11
10 100.00 90.00 190.00 18.00 10.00 9.00 19.00
11 100.00 109.00 209.00 19.00 9.09 9.90 19.00
12 100.00 130.00 230.00 21.00 8.33 10.83 19.16
13 100.00 160.00 260.00 30.00 7.69 12.31 20.00
V. Perfect Competition• Price Taker (determined by industry)• Total Revenue = Price x Quantity• Marginal Revenue = Change TR / Change
Quantity• Average Revenue = TR/Q• Firms will produce where MR = MC
– Perfectly elastic demand for the firm– Maximize profits or minimize losses
• Economic Profit if MR=MC is greater than ATC• Economic Loss if MR=MC is below ATC• Firm will stay open as long as it can cover its
AVC• Firm will shut down if MR=MC is below AVC
Co
st a
nd
Rev
enu
eMC
MR
AVCATC
Economic Profit
MARGINAL REVENUE-MARGINAL COST APPROACH
Profit Maximization Position
Output Q
Co
st a
nd
Rev
enu
eMC
MRAVCATC
Economic Loss
MARGINAL REVENUE-MARGINAL COST APPROACH
Loss Minimization Position
OutputQ
Co
st a
nd
Rev
enu
eMC
MR
AVC
ATC
MARGINAL REVENUE-MARGINAL COST APPROACH
Short-Run Shut Down Point
Minimum AVCis the Shut-Down
Point
OutputQ
Co
st a
nd
Rev
enu
e, (
do
llar
s) MC
MR1
AVC
ATC
Quantity Supplied
MR2
MR3
MR4
MR5
P1
P2
P3
P4
P5
Q2 Q3 Q4 Q5
Marginal Cost & Short-Run Supply
Do notProduce –
Below AVC
Break-even(Normal Profit)Point
Co
st a
nd
Rev
enu
e, (
do
llar
s)MC
MR1
Quantity Supplied
MR2
MR3
MR4
MR5
P1
P2
P3
P4
P5
Q2 Q3 Q4 Q5
Yields theShort-Run
Supply Curve
Supply
NoProductionBelow AVC
Marginal Cost & Short-Run Supply
AVC2
MC2
Higher Costs Move theSupply Curve to the LeftC
ost
an
d R
even
ue,
(d
oll
ars)
MC1
AVC1
Quantity Supplied
S1
S2
Marginal Cost & Short-Run Supply
AVC2
MC2
Lower Costs Movethe Supply Curve
to the Right
Co
st a
nd
Rev
enu
e, (
do
llar
s)MC1
AVC1
Quantity Supplied
S1
S2
Marginal Cost & Short-Run Supply
Price
Quantity
S=MC
AVC
ATC
Q
D
Quantity
Q
D
S= MC’s
IndustryFirm
(price taker)
EconomicProfit
P
SHORT-RUN COMPETITIVE EQUILIBRIUM
The Competitive Firm “Takes” itsPrice from the Industry Equilibrium
P
Q
S=MC
AVC
ATC
8
D
P
Q8000
D
S= MC’s
IndustryFirm(price taker)
EconomicProfit
$111$111
SHORT-RUN COMPETITIVE EQUILIBRIUM
The Competitive Firm “Takes” itsPrice from the Industry Equilibrium
How about thelong-run?
PROFIT MAXIMIZATION IN THE LONG RUN
Assumptions...• Entry and Exit Only• Identical Costs• Constant-Cost IndustryGoal of the AnalysisPrice = Minimum ATCLong-Run Equilibrium - TheZero Economic Profit Model
Temporary profits and the reestablishmentof long-run equilibrium
S1
MCATC
P
Q100
P
Q100,000
IndustryFirm(price taker)
$60
50
40
$60
50
40
PROFIT MAXIMIZATION IN THE LONG-RUN
MR
D1
An increase in demand increases profits.
MR
D1
MCATC
P
Q100
P
Q100,000
IndustryFirm(price taker)
$60
50
40
$60
50
40
PROFIT MAXIMIZATION IN THE LONG RUN
D2
EconomicProfits
S1
New competitors increase supply and lowerprices decrease economic profits.
MR
D1
MCATC
P
Q100
P
Q100,000
IndustryFirm(price taker)
$60
50
40
$60
50
40
PROFIT MAXIMIZATION IN THE LONG RUN
D2
Zero EconomicProfits
S1
S2
Decreases in demand, Losses, and the Reestablishment of Long-Run Equilibrium
S1
MCATC
P
Q100
P
Q100,000
IndustryFirm(price taker)
$60
50
40
$60
50
40
PROFIT MAXIMIZATION IN THE LONG RUN
D1
MR
A decrease in demand creates losses.
MR
D1
MCATC
P
Q100
P
Q100,000
IndustryFirm(price taker)
$60
50
40
$60
50
40
PROFIT MAXIMIZATION IN THE LONG RUN
D2
EconomicLosses
S1
MR
D1
MCATC
P
Q100
P
Q100,000
IndustryFirm(price taker)
$60
50
40
$60
50
40
PROFIT MAXIMIZATION IN THE LONG RUN
D2
Return to ZeroEconomic Profits
S1
S3
Competitors with losses decrease supply andprices return to zero economic profits.
LONG-RUN SUPPLY IN ACONSTANT COST INDUSTRY
Perfectly Elastic Long-Run Supply
P
Q
=$50 S
D1
Z1
Q1
D2
Z2
Q2Q3
D3
Z3
100,000 110,00090,000
LONG-RUN SUPPLY IN ACONSTANT COST INDUSTRY
P1
P2
P3
P
Q
=$50 S
D1
Z1
Q1
D2
Z2
Q2Q3
D3
Z3
100,000 110,00090,000
LONG-RUN SUPPLY IN ACONSTANT COST INDUSTRY
P1
P2
P3
P
Q
$555045
S
D1
Y1
Q1
D2
Y2
Q2Q3
D3
Y3
100,000 110,00090,000
LONG-RUN SUPPLY IN ANINCREASING COST INDUSTRY
P1
P2
P3
P MR
Q
MCATC
Quantity
Pri
ce
Price = MC = Minimum ATC(normal profit)
LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRM
PURE COMPETITION AND EFFICIENCY
Productive EfficiencyPrice = Minimum ATC
Allocative EfficiencyPrice = MC
UnderallocationPrice > MC
OverallocationPrice < MC
PURE COMPETITION AND EFFICIENCY
Productive EfficiencyPrice = Minimum ATC
Allocative EfficiencyPrice = MC
UnderallocationPrice > MC
OverallocationPrice < MC
Resources are
efficiently allocated
under competition.
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