Unit 3: Production, Costs, and the Perfect Competition Model

Production Function

  • Allocative efficiency - when D/P = MC

  • Efficiency in production - when factors of supply are used to maximize production

    • MPK/r = MPL/w

    • MPK = marginal product of capital

    • r = rental rate of capital

    • MPL = marginal product of labor

    • w = wage

  • Marginal product (MP) - additional output when one more unit of input is added

  • Law of diminishing marginal returns - as the amount of one input is increased, marginal returns (increase in output) will eventually decrease

  • Fixed costs - don’t change with more output

  • Variable costs - change with more output

  • Total costs = Fixed Costs + Variable Costs

  • Marginal cost - the amount by which costs increase when one more unit of output is produced

Short and Long Run Production Costs

  • Short run - time frame when at least one factor of production is held constant, and firms can neither enter nor exit the market

  • Long run - all factors of production are variable and there are no fixed costs

  • Economies of scale - exist over the range of output where the long run average cost curve slopes downward, meaning cost per unit is falling

    • When you learned it - where ATC slopes downward

Profit Maximization

  • MR = MC

  • Profit = Total revenue - Total Cost

Perfect Competition

  • Characteristics

    • Many sellers

    • No product differentiation

    • Firms are price takers

  • Economic profits = Total Revenue - (Explicit + Implicit Costs)

  • Accounting profits = Total Revenue - Explicit Costs