Microeconomics - Costs of Production & Market Structures

Economic Profit vs. Accounting Profit

• Explicit Costs: Actual money spent.

• Implicit Costs: Value of opportunities lost.

• Accounting Profit: Revenue minus explicit costs.

• Economic Profit: Revenue minus explicit and implicit costs.

• Normal Profit: Zero economic profit, indicating resources are optimally employed.

Production Function: Short Run vs. Long Run

• Long Run: All resources are variable.

• Short Run: At least one input is fixed.

Short Run Production Schedule

• Total Product of Labor (TPL): Total output at a given labor quantity.

• Average Product of Labor (APL): TPL divided by the amount of labor employed.

• Marginal Product of Labor (MPL): Change in TPL from a change in labor input.

• Stage One: MPL is rising: Increasing Marginal Returns.

• Stage Two: MPL is falling: Decreasing Marginal Returns.

• Stage Three: MPL is negative: Negative Marginal Returns.

• If MP > 0, then TP increases.

• If MP < 0, then TP decreases.

• If MP > AP, then AP is rising.

Law of Diminishing Marginal Returns

• As variable input is added to fixed inputs, production increases at a decreasing rate.

Relationship Between Production and Costs

• Total Fixed Costs (TFC): Costs that do not vary with output.

• Total Variable Costs (TVC): Costs that vary with output.

• Total Cost (TC): TFC + TVC

• Marginal Cost (MC): Change in total cost from producing one more unit.

• As MPL is falling, MC is rising.

• As APL is falling, AVC is rising.

Various Types of Cost

• $TC = TFC + TVC$

• $AFC = \frac{TFC}{Q}$

• $AVC = \frac{TVC}{Q}$

• $ATC = \frac{TC}{Q}$

• $MC = \frac{\Delta TC}{\Delta Q}$

• $TFC + TVC = TC$

• $AFC + AVC = ATC$

• $\sum MC = TVC$

Short-Run Cost Table

• Marginal cost (MC) initially decreases, then increases.

Tax and Shifting Cost Curves

• Per-Unit Tax: Increases variable costs, shifting MC, AVC, and ATC upward.

• Lump-Sum Tax: Increases fixed costs, shifting TC, AFC, and ATC upward.

Long-Run ATC

• Firms have more flexibility in the long run.

Economies and Diseconomies of Scale

• Economies of Scale: Long-run average total cost falls as output increases.

• Diseconomies of Scale: Long-run average total cost rises as output increases.

• Constant Returns to Scale: Long-run average total cost stays the same as output changes.

Perfect Competition

• Many buyers and sellers.

• Same products.

• No entry or exit barrier.

• Firms are price takers.

• $MR = D = AR = P$

Competitive Market Characteristics

• Many buyers and sellers; goods are largely the same; firms can freely enter or exit.

Profit-Maximization

• Maximize profit where $MR = MC$.

Short-Run Shutdown

• Shutdown if TR - TVC < 0

Temporary Shutdown vs. Permanent Exit

• Shutdown: Short-run decision to not produce due to market conditions. Fixed costs are unavoidable.

• Exit: Long-run decision to leave the market. All costs are avoidable.

Long-Run Equilibrium

• If economic profit > 0: New firms enter, increasing market supply and decreasing prices until economic profit is zero.

• If economic profit < 0: Existing firms exit, decreasing market supply and increasing prices until economic profit is zero.

Long-Run Market (Industry) Supply Curve

• Constant-Cost Industry: Horizontal long-run supply curve.

• Increasing-Cost Industry: Upward-sloping long-run supply curve.

• Decreasing-Cost Industry: Downward-sloping long-run supply curve.

Efficiency and Perfect Competition

• Allocative Efficiency: $P = MC$

• Productive Efficiency: $P = \text{minimum } ATC$

Monopoly

• Single firm in the industry with no close substitutes and high barriers to entry.

• Price maker.

Key Characteristics of Monopoly

• One firm.

• No substitutes.

• Price maker.

• Strong barriers to entry.

Profit-Maximization of Monopoly

• Maximize profit where $MR = MC$.

Welfare Cost of Monopoly

• Monopolies produce less and charge higher prices than socially efficient levels.

• Causes Deadweight Loss.

• Not allocatively or productively efficient.

Government Regulations to Monopolists

• Antitrust laws.

• Price regulations.

• Granting per-unit subsidies.

Price Discrimination

• Selling the same goods to different customers for different prices.