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Deadweight Loss (definition)
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Fall in total surplus that results from a market distortion (like a tax)
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How do price elasticities of supply and demand impact deadweight loss of a tax?
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Greater elasticities of supply and demand means greater DWL (so it's better to tax things with more inelastic supply and demand)
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Does changing a tax cause the DWL to change at the same rate?
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No, DWL changes at a different rate. Makes it so that when tax rates are low, raising them doesn't cause much harm and decreasing them doesn't cause much benefit and so that when tax rates are high, raising them is very harmful, and cutting them is very beneficial
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Laffer Curve
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When a tax is small, increasing it causes tax revenue to increase; when a tax is larger, increasing it causes tax revenue to decrease
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How to calculate profit
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Profit = Total Revenue (PxQ) - Total Cost
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Explicit Costs (definition)
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Require an outlay of money (ex. wages paid to workers, rent)
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Implicit Costs (definition)
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Don't require a cash outlay (ex. opportunity cost of owner's time)
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Total Cost formula
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Explicit Costs + Implicit Costs
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Accounting Profit formula
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Total Revenue - Explicit Costs
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Economic Profit formula
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Total Revenue - Total Costs
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Is accounting or economic profit higher?
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Accounting profit is higher (because it doesn't take implicit costs into account)
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Production Function (definition)
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Relationship between quantity of inputs used to produce a good and the quantity produced of the good (gets flatter as production rises)
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Marginal Product (definition)
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Increase in output that arises from an additional unit of input (with other inputs held constant) (slope of production function)
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Marginal Product of Labor (MPL)
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MPL = Change in Q / Change in L
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Diminishing MPL
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As the quantity of the input increase, the marginal product of an input decreases (why production function gets flatter)
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Why is MPL important?
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When a firm is deciding whether or not to hire a new worker, they have to determine if the wage paid to the worker is less than the MPL of his labor
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Why does MPL decrease?
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Limited fixed resources mean that with each additional worker, the fixed resources are spread between more people and each worker will be less productive (Too many cooks in the kitchen)
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Can MPL be negative?
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Yes, after a certain point adding labor is counterproductive
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Marginal Cost (MC) (definition)
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Increase in total cost, arising from an extra unit of production
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Marginal Cost formula
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MC = Change in Total Cost / Change in Quantity
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How does considering marginal cost help firms?
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If the additional MC is less than the revenue a firm would get from selling the good, then the firm's profits will increase if the produce more
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Fixed Costs (FC) (definition)
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Don't vary with quantity produced (cost of equipment, loan payments, rent, etc)
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Variable Costs (VC) (definition)
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Vary with quantity produced (material costs, wages, etc)
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Total Cost formula (VC/FC)
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VC + FC
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Fixed Cost curve
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Blue Line (Downward sloping because of spreading effect)
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Marginal Cost Curve
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Purple Line (Upwards sloping because of diminishing returns)
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Variable Cost Curve
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Red Line (upwards sloping, but flatter than marginal cost curve)
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Total Cost Curve
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Black Line
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Where do MC and ATC curves intersect?
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MC curve intersects the ATC curve from below at its lowest point
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Why is the intersection of MC and ATC curves important?
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It shows the minimum cost output (at an output less than minimum cost output, MC is less than ATC and ATC is decreasing; at an output more than minimum cost output, MC is more than ATC and ATC is increasing)
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Short Run Costs (definition)
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Inputs like factories and land are fixed costs, other costs like wages are variable costs
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Long Run Costs (definition)
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All costs are variable costs
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Economies of Scale (How ATC changes as the scale of production changes)
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(LR)ATC decreases as Q increases
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Constant Returns to Scale (How ATC changes as the scale of production changes)
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(LR)ATC stays the same as Q increases (specialization)
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Diseconomies of Scale (How ATC changes as the scale of production changes)
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(LR)ATC increases at Q increases (Growing pains)
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What is the Goal of Firms?
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To maximize profit
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3 Factors of a Perfectly Competitive Market
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1. Market with many buyers and sellers
2. Trading identical products
3. Firms can freely enter or exit the market
(Because of 1 & 2, each buyer and seller is a price taker and takes the price as given)
2. Trading identical products
3. Firms can freely enter or exit the market
(Because of 1 & 2, each buyer and seller is a price taker and takes the price as given)
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Total Revenue formula
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TR = PxQ
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Average Revenue formula
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AR = TR/Q
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Marginal Revenue formula
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MR = Change TR/Change Q (Change in TR from an additional unit sold)
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AR and MR for competitive firms is equal to what?
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Price (AR = P = MR) (ONLY true for firms in competitive markets)
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Why does MR = P?
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A competitive firms can continuously increase its output without affecting the market price, so each one-unit increase in Q makes revenue increase by the market price
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What Q maximizes a firm's profit?
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MR = MC (if MR > MC, increasing Q increases profit; if MR < MC, decreasing Q increases profit)
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What curve is a firm's supply curve equal to in a perfectly competitive market?
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MC curve
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Shutdown (definition)
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A short-run decision to not produce anything because of market conditions
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Exit (definition)
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A long-run decision to leave a market
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Difference between shutdowns and exits
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If a firm shuts down in SR, they still have to pay the fixed costs; if a firm exits in LR, they have no costs
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When should a firm shut down in the short run?
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If VC > TR or AVC > P (If a firm shuts down, they save the VC, and their cost of shutting down = TR)
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If P > AVC, what Q should a firm produce?
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The firm should produce where P = MC
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What is a firm's short run supply curve?
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The portion of the firm's MC curve that's above the AVC
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Sunk Cost (definition)
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A cost that has already been committed and can't be recovered (need to be paid regardless of what choice you make; in SR, FC are sunk costs, so they don't matter in a decision to shut down)
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When should a firm exit in the long run?
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If TC > TR or ATC > P (if a firm exits, they lose TR but save TC)
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What is a firm's long run supply curve?
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The portion of its MC curve above the LRATC
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3 Assumptions for Market Supply
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1. All existing firms and potential entrants have identical costs
2. Each firm's costs do not change as other firms enter or exit the market
3. The #firms in the market is fixed in SR, variable in LR (because fixed costs become variable)
2. Each firm's costs do not change as other firms enter or exit the market
3. The #firms in the market is fixed in SR, variable in LR (because fixed costs become variable)
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