Costs of Production and Perfect Competition

Unit 3: Costs of Production and Perfect Competition

Per-Unit Costs

• Total Cost (TC), Variable Cost (VC), and Fixed Cost (FC) are calculated based on output (Q).
• Different areas represent these costs in a graphical context:
  • 0CDQ: Typically indicates Total Cost.
  • 0BEQ: Generally refers to Variable Cost.
  • 0AFQ or BCDE can represent Fixed Cost or specific cost analysis.

Perfect Competition Basics

• Perfect competiton features many firms, each a price taker, meaning they cannot set prices above the market equilibrium.
• The firm’s demand curve (D) is perfectly elastic at the market price set by industry supply and demand.

Cost and Revenue Analysis

• Break-even occurs when Total Revenue (TR) = Total Cost (TC).
• Important points from the graph:
  • The profit maximization point is where Marginal Revenue (MR) = Marginal Cost (MC).
  • Firms produce where MR is equal to MC to maximize their profit, leading to a point where the profits can be determined by subtracting TC from TR.
  • Shutdown point occurs when TR is less than VC; the firm should not continue production.

Calculating Costs

• Average Total Cost (ATC), Average Variable Cost (AVC), and Average Fixed Cost (AFC) can be calculated using:
  ext{ATC} = rac{TC}{Q}, ext{AFC} = rac{FC}{Q}, ext{AVC} = rac{VC}{Q} .
• Marginal Cost (MC) is the change in total costs that arises when the quantity produced changes by one unit.
  ext{MC} = rac{ ext{Change in TC}}{ ext{Change in Q}} .

Perfect Competition in Long Run

• In the long run, firms will enter the market if economic profits are available and exit if they incur losses.
• Long run equilibrium is achieved when firms earn normal profits, represented graphically where:
  • Price (P) = MC = Minimum ATC.
• Graphically, the equilibrium is shown at the intersection of industry supply and demand.

Firm Behavior in Response to Market Changes

• If demand increases, leading to short-run profits, firms will enter the market, increasing supply and leading to price decrease.
• Conversely, if firms incur losses, they will exit, decreasing supply and increasing prices until equilibrium is restored.

Price Elasticity and Market Dynamics

• Price Adjustment: In response to shifting demand, the market price may temporarily rise or fall, but eventually return to the equilibrium price in the long run due to firm entry and exit.

Short Run Total Costs

• Review the short-run total cost function, noting that:
  • Total Fixed Cost (TFC) can be derived from total costs even at zero output.
    ext{TFC} = ext{Total Cost at } Q=0 .
  • To calculate Marginal Costs at various output levels, note the change in total costs for each additional unit produced.

Special Case: Tariffs and Domestic Market Effects

• In situations where imports and tariffs affect domestic markets:
  • Tariffs increase domestic price and may alter the level of domestic production and consumer surplus.
  • Example calculations for consumer surplus and tariff revenue highlight the impacts of such trade policies on domestic economics.