(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.