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Economic Profit
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1. TR - total opportunity costs
2. Total opportunity costs include both explicit and implicit costs
3. Is never larger than accounting profit
2. Total opportunity costs include both explicit and implicit costs
3. Is never larger than accounting profit
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TR > TC
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Earning a positive economic profit
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TR < TC
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Earning a negative economic profit (loss)
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TR = TC
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Earning 0 economic profit
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Accounting profit
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takes into account explicit costs only
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Marginal product of labor
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1. The additional output produced by the last worker hired
2. Change in Q / change in L
3. Firm's demand curve of labor
2. Change in Q / change in L
3. Firm's demand curve of labor
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The slope of the production function
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1. Is marginal product, when marginal product falls, the marginal cost rises
2. Shows the relationship b/t the quantity of inputs used in production (labor) and the quantity of output produced
2. Shows the relationship b/t the quantity of inputs used in production (labor) and the quantity of output produced
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List some variable cost to a firm that produces bagels
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1. Cost of flour
2. Electricity bills
3. Wages paid to employees
2. Electricity bills
3. Wages paid to employees
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What does the marginal cost curve look like
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It is U shaped and intersects ATC and AVC at their minimum points
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AFC calculation
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FC/Q
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AVC calculation
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VC / Q
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Average product of labor calculation
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Q / L
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If a firm expands output and the long run ATC falls, this firm is experiencing
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Economies of scale
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Norman's bagel shop sold 3m bagels last year, half were plain and sold for $.50 each, the remaining were cinnamon raisin bagels and sold for $.80 each. Last year Norman's TR = ?
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TR = $1.95M
$.50 x 1.5M + .$80 x 1.5M
$.50 x 1.5M + .$80 x 1.5M
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Fixed costs
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1. Costs that do not vary as output changes
2. In the short run a firm must pay fixed costs whether they are producing or not
2. In the short run a firm must pay fixed costs whether they are producing or not
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Economies of scale can result from
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1. Increased specialization
2. When long run ATC falls as Q rises
2. When long run ATC falls as Q rises
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Increasing returns to scale or economies of scale
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1. An increase in a firm's scale of production leading to lower costs per unit produced
2. Bigger firms with larger amount of capital can produce more goods at a lower cost
3. In the long run doubling inputs will result in more that doubling the output and the LRAC curve in downward sloping
2. Bigger firms with larger amount of capital can produce more goods at a lower cost
3. In the long run doubling inputs will result in more that doubling the output and the LRAC curve in downward sloping
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Constant returns to scale
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1. An increase in a firm's scale of production has no effect on costs per unit produced
2. In the long run doubling inputs will result in doubling the output and the LRAC curve is horizontal
2. In the long run doubling inputs will result in doubling the output and the LRAC curve is horizontal
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Decreasing returns to scale or diseconomies of scale
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1. An increase in a firm's scale of production leads to higher costs per unit produced
2. Bureaucratic inefficiencies is considered to be a cause
2. Bureaucratic inefficiencies is considered to be a cause
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LRAC
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A given point on the LRAC tells us the average cost of producing the associated level output
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Derived demand curve
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A bagel producer decides to supply more bagels to the market and as a result her demand for bagel workers increases
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Marginal revenue product of labor
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1.The additional revenue earned by the last worker hired
2. Equivalent to labor demand curve
2. Equivalent to labor demand curve
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W = MRPL is the same as
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P = MC
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MRPL > W
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Firm will increase more workers
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MRPL < W
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Firm will decrease workers, this will increase the firms profit due to reduction in cost
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A profit maximizing firm that has labor as the only factor of production as a demand curve that is
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Equal to the marginal revenue product of labor
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Marginal profit is equal to
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MRP of labor minus the wage
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A firm will hire workers up to the point where
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The wage = the MRP of labor
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A profit maximizing firm will continue to hire labor inputs as long as
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MRP > wage rate
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Diminishing marginal returns to labor
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1. When each additional worker hired contributes less than the previous worker hired to total output
2. Labor demand curve closes downward due to diminishing marginal returns
3. Implies increasing marginal costs
2. Labor demand curve closes downward due to diminishing marginal returns
3. Implies increasing marginal costs
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If the opportunity cost of leisure rises and people take fewer hours of leisure, we know that their labor supply curve is
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Upward sloping
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When a landowner in a competitive market rents out his land, he is paid the
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Marginal revenue product of the land
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What should you do if MP per dollar for capital > your marginal product per dollar of labor to increase profit?
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Reduce the amount of labor and increase the amount of capital
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Your bagel shop uses both capital and labor, and in this process they are complements. You install a new oven and the marginal product of capital increases, as a result
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Labor becomes more productive
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In a perfectly competitive market the absence of barrier to entry and exit implies that
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Firms can enter or leave the industry without significant obstacles
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If a firm is a price taker
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The firm's demand curve is horizontal / perfectly elastic at the competitive price
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MC curve of a PC firm shows
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The firm's short run supply curve
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If a perfectly competitive firm chooses output such that MR<MC
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1. It could decease output to make a profit
2. The extra revenue that the firm gained by producing the last unit was less than the extra cost, therefore the firm should cut output, there are not profit maximizing
2. The extra revenue that the firm gained by producing the last unit was less than the extra cost, therefore the firm should cut output, there are not profit maximizing
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P*=d=MR
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1. Always true for a perfectly competitive firm
2. The market price always equals marginal revenue, which always corresponds to the demand curve that the firm faces
2. The market price always equals marginal revenue, which always corresponds to the demand curve that the firm faces
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If the market price is < AVC then the firm should
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Shut down, the firm will not cover its variable costs
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The firm's MR curve is where at the market price
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Horizontal
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Normal rate of return
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1. Where MC and ATC intersect
2. Firms are making 0 economic profit, in the short run they should not shut down because they are making exactly the normal rate of return
2. Firms are making 0 economic profit, in the short run they should not shut down because they are making exactly the normal rate of return
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In the long run perfectly competitive markets will have
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P*=SRMC=SRAC=LRAC
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In a perfectly competitive industry P=MC, what is not an implication of this
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1.The product will be produced at the minimum average total cost in the long run
2. In the long run a PC firm will produce at a minimum average total cost, however, this is not an implication of marginal cost pricing
2. In the long run a PC firm will produce at a minimum average total cost, however, this is not an implication of marginal cost pricing
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Characteristics of a PC market
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1. Homogeneous products
2. No barriers to entry
3. Many firms
2. No barriers to entry
3. Many firms
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The PC firm faces what type of demand curve
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Perfectly elastic
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What is the slope of a PC industry demand curve
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Downward sloping
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If a PC firm chooses output such as MR > MC than
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1. It could expand output and make more profit
2. The extra revenue of producing an additional output is > the extra cost of producing the extra unit, the firm could expand an make more profit, this firm is not profit maximizing
2. The extra revenue of producing an additional output is > the extra cost of producing the extra unit, the firm could expand an make more profit, this firm is not profit maximizing
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A PC firm will produce
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1. P*=MC
2. For a PC firm P=d=MR, and profit maximizing occurs at MR = MC, we will have P = MC
3. P = MC > AVC
2. For a PC firm P=d=MR, and profit maximizing occurs at MR = MC, we will have P = MC
3. P = MC > AVC
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a PC firm will shutdown
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P = MC < AVC
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Why do PC firms in the long run always make 0 economic profit
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1. There are no barriers to entry or exit in PC industries
2. When firms are making a positive economic profit, entry will occur and firms profit level will decrease
3. When firms are making a negative economic profit, exit will occur and remaining firms profit level will increase
2. When firms are making a positive economic profit, entry will occur and firms profit level will decrease
3. When firms are making a negative economic profit, exit will occur and remaining firms profit level will increase
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In a PC industry P=MC, which of the is not an implication of this
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The product will be produced at the minimum average total cost in the long run
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Relative to a competitively organized industry, a monopoly
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Produces less output and charges a higher price
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A natural monopoly refers to
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An industry with large economies of scale
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Suppose the price elasticity of demand for a monopolist is -1, P = $10, then MR =
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0
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Suppose the price elasticity of demand for a monopolist is -2, P = $20 then MR =
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$10
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Which of the following is the best example of price discrimination
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Selling movie tickets to students at a lower price than those sold to non students
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Which of the following will lead to Pareto Efficient outcome
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A PC market
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A supply curve of a monopolist is
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Non- existent
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A demand curve of a monopolist is
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Downward facing
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Which of the following is not necessary to engage in price discrimination
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The firm must know the willingness to pay for every consumer
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Price discrimination
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1. Good must be difficult to re-sell
2. Demand for the good must be downward sloping
3. The firm must be able to identify at least two different types of consumers with different elasticies of demand
2. Demand for the good must be downward sloping
3. The firm must be able to identify at least two different types of consumers with different elasticies of demand
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Pareto efficiency
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No economic agent can be made better off without making some other economic agent worse off
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Pareto improvement
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Make some people better off w/out making someone worse off
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Substitution effect
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1. Upward sloping labor supply curve
2. W increases, QSL increases
3. Positive relationship w/ wage and labor supply
4. When wage increases it becomes more costly to consume leisure = more people work.
5. Typically dominates income effect
2. W increases, QSL increases
3. Positive relationship w/ wage and labor supply
4. When wage increases it becomes more costly to consume leisure = more people work.
5. Typically dominates income effect
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Income effect
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1. Downward sloping labor supply curve
2. W decreases, QSL decreases
3. Negative relationship w/ wage and labor supply
4. When wage increases, worked income increases,if leisure is a normal good, people consume more leisure = more people work less.
2. W decreases, QSL decreases
3. Negative relationship w/ wage and labor supply
4. When wage increases, worked income increases,if leisure is a normal good, people consume more leisure = more people work less.
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Point where MC curve intersects ATC curve
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Break even point
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As MPL increases what happens to MC
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MC decreases
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As MPL decreases what happens to MC
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MC increases
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If the margin > average
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the average is rising
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If the margin < average
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the average is falling
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What is the general relationship between AVC, ATC and MC?
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The are all valley shaped, MC intersects each of the average functions at their minimum
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Labor demand curve will shift to right when
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there is an increased demand for output
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If capital and labor are complements in production and there is a decrease in the quality off capital, how will this effect the labor demand curve?
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it will shift to the left
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If capital and labor are substitutes in production and the cost of capital increases greatly, what will happen to labor?
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The labor demand will shift to the right
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LeatherTown sells wallets for a price of $50 each, the firms pays its workers $100 per day, how many workers should they hire?
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Not enough information to answer this question
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MC curve is = AVC when
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AVC is minimized
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MC curve intersects the AVC curve at the
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minimum value of the AVC curve
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TVC always
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increase with output
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In the short run where YVC is increasing
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at a decreasing rate, MC is positive and increasing
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In the short run as output increases
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the difference b/t the ATC and AVC decreases
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Firms that are breaking even
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are earning 0 economic profits
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If a firms economic profit is 0 then
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TR = TC
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A profit maximizing strategy becomes a loss minimization strategy when a firm in a PC industry is producing where
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AVC < P < ATC
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A firm will choose to operate rather than shut down as long as
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P >AVC
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A firm suffering economic losses decides whether or not to produce in the short run on the basis of whether
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revenues cover VC
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Pet shop operates in a PC industry, firm is producing P = MC, the shop's TR > VC < TC, the firm should
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produce in the short run to minimize loss but exit the industry in the long run
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Pet shop operates in a PC industry, firm is producing P = MC, the P < AVCm the firm should
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cease production immediately because it is not covering its variable costs of production
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A firm that is earning profits in the short run has incentive to
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expand its scale of production in the long run
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A PC firm can minimize its losses by shutting down when revenues are = or <
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VC
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If a PC firm is producing where P = MC and is earning a normal rate of return. The firm employs wage workers and the government just raised the wage, in the short run this firm will most likely
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reduce the amount of output it produces because its cost curves have shifted up
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A PC firm will continue to operate at a loss
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from the range where MC interests AVC and ATC
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