(312) Microeconomics Unit 3 COMPLETE Summary - Production & Perfect Competition

Overview of Microeconomics Unit Three

Focuses on production, perfectly competitive markets, and firms. Supplemented by a review booklet available for purchase.

Production Function

Definition: Describes the relationship between labor quantity and output quantity.

  • Chart Example:

    • 1 worker = 10 units of output

    • 2 workers = 25 units of output

    • 3 workers = 36 units of output

    • 4 workers = 46 units of output

    • 5 workers = 50 units of output

    • 6 workers = 48 units of output

Marginal Product of Labor

Definition: The additional output produced as a result of adding one more worker.

  • Calculation: Change in total product divided by change in labor quantity.

  • For 1st worker: 10 units (from 0 to 10).

  • For 2nd worker: 15 units (from 10 to 25).

  • Observed trends:

    • Increasing returns (specialization).

    • Diminishing returns (marginal product falls).

    • Negative returns (total product decreases).

Marginal Cost of Labor

Definition: The cost of hiring one additional worker.

  • Calculation: Wage paid divided by marginal product.

  • Relationship to marginal product curve:

    • Downward sloping during increasing returns.

    • Upward sloping during diminishing returns.

Types of Costs for Businesses
  • Fixed CostsDefinition: Unchanging costs regardless of output level (e.g. land, capital).

  • Variable CostsDefinition: Costs that vary with output level (e.g. labor, electricity).

  • Total CostsComposition: Fixed costs + Variable costs.Graph Representation: Fixed costs are horizontal; variable costs start steep and can plateau.

  • Marginal CostCalculation: Change in total cost divided by change in quantity.Resembles a Nike Swoosh in graph form (initially decreasing then increasing).

Average Variable Cost (AVC) and Average Total Cost (ATC)

Average Variable Cost: Calculated by dividing total variable costs by quantity. Average Total Cost: Calculated by dividing total costs by quantity.

  • Graph relationships:

    • AVC intersects marginal cost at its minimum point.

    • ATC intersects marginal cost at its minimum point, indicating productively efficient production.

Long-Run Costs vs. Short-Run Costs
  • Long-Run: All costs are variable; firms can expand plants and production facilities.

  • Short-Run: Limited adjustments—can hire more workers or change production rates.

  • Economies of Scale: Decreasing average costs with increased production (increasing returns of scale).

  • Constant Returns to Scale: Average costs remain constant as inputs double.

  • Diseconomies of Scale: Increasing average costs as production expands beyond efficient capacity.

Profit Calculations
  • Accounting ProfitDefinition: Actual profit calculated as total revenue - explicit costs.

  • Economic ProfitDefinition: Includes both explicit and implicit costs, calculated as total revenue - (explicit costs + implicit costs).

    • Normal profit: occurs when economic profit is zero.

Firm Production Decisions

Key Principle: Marginal Revenue = Marginal Cost.

  • Marginal Revenue: Change in total revenue divided by change in quantity.

  • Economic profits lead to firm entry; economic losses lead to exit, impacting market supply.

Perfect Competition

Market Characteristics

  • Many firms with identical products.

  • Low barriers to entry.

  • Firms are price takers (cannot influence market price).

Market Graphs

  • Interaction of demand, supply, and firm graphs leading to profit maximization at intersection of marginal cost and marginal revenue curves.

  • Economic profit occurs when ATC < market price.

  • Economic loss occurs when ATC > market price.

  • Long-run equilibrium happens at zero economic profit.

Efficiency in Perfect Competition
  • Allocative efficiency: Price = Marginal Cost.

  • Productive efficiency: Firms produce at minimum average total cost in the long run.

Supply Curves in Perfect Competition
  • Firm supply curve is the marginal cost curve above AVC minimum.

  • Impact of changes in demand on long-run supply curves:

    • Increasing demand leads to higher prices and more firms entering the market (shifting supply right).

    • Decreasing demand causes firms to exit, resulting in supply shifting left.

  • Long-Run Supply Curve: Typically horizontal at the minimum ATC for firms, indicating perfect elasticity at long-run equilibrium.

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