AP

Microeconomics
In Class Review #3
A Producer’s price is derived
from 3 things:

1. Cost of Production
2. Competition between firms
3. Demand for product
 Total Costs
• TC = TFC + TVC TC
• TFC = Fixed Costs TVC
Cost
– Constant costs paid
regardless of
production
• TVC = Variable
Costs
– Costs that vary as
production is TFC
changed
Output
 Total Revenue
Cost &
• TR = p × q Revenue
TC
TR

Break

• The money Even

received
from sale of Profit

product
Loss

Output
 Profit = TR - TC
• Accounting: • Economic:
• Calculates actual • Calculates all
costs a business accounting costs
incurs plus the what if, or
• Explicit!! opportunity, costs
• Ex) inputs, salaries, • Implicit!!!!
rent, both fixed • Ex) what was given
and variable up, lost interest,
“freebie” costs
 Short Run vs. Long Run
• Short Run • Long Run
– At least one fixed – All factors are
factor of variable
production, usually – Expansion possible
capital – Yes can enter or
– No Expansion leave industry
– No entry/exit
industry
 Production Considerations
• Total Product: the relationship btwn
inputs and outputs

• Marginal Product: the extra product

gained by the change in inputs; MP
= ΔTP
• Average Product: AP = TP/q
 The Production Function
Input Total Marginal Average Stages of
Product Product Product Production
1 10 +10 10 I
2 24 +14 12 I
3 39 +15 13 I
4 52 +13 13 II
5 60 +8 12 II
6 66 +6 11 II
7 63 -3 9 III
8 56 -7 7 III
 Key Graph Parts to
Remember:
• Stages follow Output

MP TP
• AP intersects
MP at its high
point
• MP increases,
decrease &
then goes AP
negative
MP
 Production Function
8. Law of Diminishing Returns
• Due to limited capacity, output will
slow down and then decrease
beyond a certain point
9. Choice of Technology
• Capital (K) and Labor (L) are both
complements and substitutes, firms
will find the combination that is the
most efficient (cheapest)
 Producer’s Costs
• TFC: Total Fixed
Costs
• AFC: Average
Fixed Costs;
TFC/q
• AVC: Average
Variable Costs;
TVC/q
• Marginal Costs
ΔTC
 Perfect Competition
• Characteristics: many firms,
homogenous products, no barriers to
entry, P = MC = MR
• Marginal Revenue: extra revenue
gained with each additional unit of
output; MR = ΔTR
• P = d = MR: Price Takers, each firm
takes market price (or market
demand) so P and MR are constant
(perfectly elastic & horizontal)
 Putting it all together
Market (Industry) Firm

Price Cost MC
S

ATC
PX MR
AVC

Quantity
QX Output
 More Questions
14. How can you tell if we are talking
about long-run or short-run?
Look for multiple short run graphs, look
for LRAC, profit leads to expansion
15. Profits in long run? Explain.
Will lead to Long-Run Equilibrium where
firms will no longer have economic
profits (characteristics of market
make long run profits impossible)
 GRAPH: LRAC
Market Firm
Price S0 Cost

S1 SRMC

SRMC
P0 SRAC

SRAC

P1 LRAC

D
Level Level
Quantity #1 #2 Outputs
 Operating Profit:
• Minimizing losses,
Cost
it is better to MC
produce and lose a ATC
little than it is to
Losses
produce nothing PX MR
Op. Profit
and lose total fixed AVC
costs
• TR - TVC
Choices: produce QX Output
with loss
 Shutting Down vs. Exiting
the Industry
• Shutting Down: • Exiting:
• Short Run option • Long Run option
• Still paying out • No costs, no
Total Fixed Costs production,
but not producing business no longer
exists
 Expanding Production
• Economies of Scale
– LR, expand and more efficient (decrease
costs)
• Diseconomies of Scale
– LR, expand and less efficient (increase
costs)
• Constant Return to Scale
– LR, expand and costs are same per unit
 Expanding Production
• Increasing Returns
– LR, expand and increase production

• Diminishing Returns
– LR, expand and decrease production
 Graphing Expansion
Firm

Economies Constant returns Diseconomies

of scale to scale of scale
Unit Costs

Long-run ATC

Output
Perfectly Competitive
Making Profit

MC

MR
PROFIT
ATC
AVC
Perfectly Competitive
Minimizing Losses

Any Price btwn the average

cost curves represents an
economic loss but an
operating profit
Perfectly Competitive
Breaking Even
Perfectly Competitive
Shut Down

Any Price below

AVC’s min point
represent total loss
• Derived Demand: the demand for
labor is directly dependent on the
demand for the output that labor
creates

• Law of Diminishing Returns & Hiring

Labor: there is a limit to how many
workers a firm should hire (SR), hire
as long as they are efficient
 Income vs. Substitution
• Substitution Effect • Income Effect
Choose to subs work for Choose current income
leisure to get more with less work, want
money more leisure time

Normal Supply Curve Backward Bending

SL
PL
PL SL

QL
QL
• Marginal Product of Labor: (MPL)
• The additional output produced as
one more unit of labor is added
• Marginal Revenue Product of
Labor: (MRPL)
• The addition to the firm’s revenue as
the result of the marginal product
per labor unit
– Represents the firm’s demand curve for
labor
 Marginal Resource Cost =
Wage of Labor = Price of Labor
• MRC = WL = PL

• All refer to the cost of the input labor

and are interchangeable.
• In a perfectly competitive labor
market, the PL comes from market
and is a horizontal line for the firm
– It is the supply curve of labor faced by
the firm
 Example:
PL = $60 and PX = $10
Labor Total Output Marginal Product Marginal Revenue
(L) (Q) (MPL) Product
(MRPL)

1 5 +5 $50
2 20 +15 $150
3 30 +10 $100
4 35 +5 $50
5 35 +0 $0
MPL = ΔOutput MRPL = MPL × PX
 How many workers should
be hired?
• PL = $60

• The firm will hire 3 workers; any

more and the additional cost will
not cover the additional revenue
earned; or MRPL ≥ MRC.
 Graph:
Labor Market Firm

Price Cost & Rev

SL

PL WL MRCL

DL
MRPL

Quantity QL Quantity
 Parts to Remember:
#1: MRC is the labor supply curve
available to the firm
#2: MRP is the labor demand curve of
the firm
#3: find where they intersect and that
is the quantity of labor hired!!
(MC = MR)