Presentation on theme: "Production, cost, profit and perfect competition"— Presentation transcript:
1 Production, cost, profit and perfect competition Microeconomics Unit 2Production, cost, profit and perfect competition
2 Average Product = Topic 1: PRODUCTION Total Product (TP)- total output or quantity producedMarginal Product (MP)- the additional output generated by additional inputs (workers).= change in total productAverage Product (AP)- the output per unit of inputAverage Product =Total Product# of workers2
3 Total Product(TP) PIZZAS calculate MP and AP# of Workers(Input)Total Product(TP) PIZZASMarginal Product(MP)Average Product(AP)110225345460570675783
4 Total Product(TP) PIZZAS calculate MP and AP# of Workers(Input)Total Product(TP) PIZZASMarginal Product(MP)Average Product(AP)-110225153452046057067578-54
5 Total Product(TP) PIZZAS calculate MP and AP# of Workers(Input)Total Product(TP) PIZZASMarginal Product(MP)Average Product(AP)-1102251512.53452046057014675710.718-58.755
6 Stages of ProductionIncreasing returns: workers produce more additional productsHappens because of SPECIALIZATION
7 Stages of ProductionDiminishing returns: workers produce less ADDITIONAL productsHappens because more workers are using the same fixed resources(not enough fixed resources to go around)
8 Diminishing Marginal Returns Too many cooks in the kitchen!
9 Stages of ProductionNegative returns: workers produce less total productHappens because workers get in each others way
10 Identify the three stages of returns Total Product(TP) PIZZAS # of Workers(Input)Total Product(TP) PIZZASMarginal Product(MP)Average Product(AP)-1102251512.53452046057014675710.718-58.7510
12 Stage I: increasing marginal returns Marginal and Average Product Due to SpecializationTotalProductTotal ProductQuantity of LaborMarginal and Average ProductAverage ProductQuantity of Labor12Marginal Product
13 Stage II: decreasing marginal returns Due to more workers using same fixed resourcesTotalProductTotal ProductQuantity of LaborMarginal and Average ProductAverage ProductQuantity of Labor13Marginal Product
14 Stage III: Negative Marginal Returns Marginal and Average Product TotalProductTotal ProductQuantity of LaborMarginal and Average ProductAverage ProductQuantity of Labor14Marginal Product
21 Increasing and decreasing returns???? workers TPMarginal product1428333738302313Increasing and decreasing returns????
22 EXPLICIT VS. IMPLICIT COSTS Explicit costs = out of pocket expensesAccountants only look at thisImplicit costs = opportunity costs (foregone wages, depreciation ect)Economists consider explicit AND implicit!
23 Overall costs: What is the overall cost of producing?? Must look at TOTALSFixed Costs: (FC) Costs that DON’T changeVariable Costs: (VC) Costs that DO changeTotal Costs: FC + VC
25 What happens to FC as more products are produced??? workers TPMarginal productFixed cost147028333738302313What happens to FC as more products are produced???
26 What happens to VC as more products are produced? workers TPMarginal productFixed costVariable costTotal cost147038923313837184230302762332213368What happens to VC as more products are produced?
27 What happens to TC as more products are produced??? workers TPMarginal productFixed costVariable costTotal cost1470461162892162331382083718425438230300302763462332239213368438What happens to TC as more products are produced???
29 1. Fixed cost will always be the same 2. VC will always slope up3. Total cost will always slope up* TC always > VC*Distance between TC and VC = FC
30 Additional costs of making ONE more product . Marginal Cost:Additional costs of making ONE more product .30
31 What happens to MC as more products are produced??? workers TPMarginal productFixed costVariable costTotal costMarginal cost1470461163.2928921621.64331382081.39371842541.24382303001.21302763461.53233223922.00133684383.54What happens to MC as more products are produced???
32 How much does each product cost to make? Use AVERAGES Average Fixed Cost (AFC): fixed cost PER PRODUCTAFC = FC/TP
34 What happens to AFC as more products are produced??? workers TPMarginal productFixed costVariable costTotal costMarginal costAverage fixed cost1470461163.29528921621.641.67331382081.39.93371842541.24.63382303001.21.47302763461.53.39233223922.00.34133684383.54.32What happens to AFC as more products are produced???
35 Average Variable cost (AVC): variable cost PER PRODUCT AVC = VC/TP
37 What happens to AVC as more products are produced??? workers TPMarginal productFixed costVariable costTotal costMarginal costAverage fixed costAverage variable cost1470461163.29528921621.641.672.19331382081.39.931.84371842541.24.63382303001.21.471.5330276346.39233223922.00.341.59133684383.54.321.70What happens to AVC as more products are produced???
38 Average total cost (ATC): TOTAL cost PER PRODUCT ATC = TC/TP orACT = AFC + AVC
40 What happen to ATC as more products are produced??? workers TPMarginal productFixed costVariable costTotal costMarginal costAverage fixed costAverage variable costAverage total cost1470461163.2958.2928921621.641.672.193.86331382081.39.931.842.77371842541.24.632.27382303001.21.471.53230276346.391.92233223922.00.341.591.93133684383.54.321.702.03What happen to ATC as more products are produced???
42 AFC will always get smaller as more products are produced Why??? Fixed cost are spread out among more productsAVC and ATC – always U shaped due to increasing and then diminishing returnsDistance between ATC and AVC gets smaller as more products are produced
44 MC intersects ATC at min MC intersects ATC at min. point Gap between ATC and AVC gets smaller as Q increases
45 TC VC What is the FC? At 9 units what is the: VC TC AVC ATC AFC 800 700600500400300200100What is the FC?At 9 units what is the:VC TC AVCATC AFCCosts (dollars)TC=$500FC=$400VC=$100Quantity45
46 Practice reading MC ATC AVC 12 11 10 9 8 7 6 5 4 3 Costs (dollars) 2 1 At an output of 11, what is the :AVC MC AFCATC TC VCQuantity46
47 At output Q, what area represents: Practice readingAt output Q, what area represents:TCVCFCCDQ0BEQ0AFQ0 or CDEB47
48 Relationship between ATC and MC Costs (dollars)Average product andmarginal productAPRelationship between ATC and MCMPThe MC curve intersects the ATC curve at its lowest point.Quantity of laborQuantity of outputMCWhen the marginal cost is below the average, it pulls the average down.When the marginal cost is above the average, it pulls the average up.ATCExample:The average income in the room is $50,000.An additional (marginal) person enters the room: Bill Gates.If the marginal is greater than the average it pulls it up.48
49 Things to remember about drawing cost curves: 1. Draw MC first (looks like a check mark)2. Draw ATC – start at point above MC3. Draw AVC – start at point above MC but below ATC4. MC curve always intersects ATC and AVC at their minimum points5. Distance between ATC and AVC gets smaller as output (quantity) increases6.ATC and AVC are U shaped (due to increasing and then decreasing marginal returns)
50 TOPIC 4: Long run costs of production Long run costs reflect changes in plant size
51 Definition and Purpose of the Long Run In the long run all resources are variable. Plant capacity/size can change.Why is this important?The Long-Run is used for planning. Firms use to identify which plant size results in the lowest per unit cost.3 things can happen in the long run1. Economies of scale2. Constant returns to scale3. Diseconomies of scale51
52 Long Run AVERAGE Total Cost CostsMC1ATC1$9,900,000$50,000$6,000$3,000, , ,000,0000Quantity Cars52
53 Long Run AVERAGE Total Cost Company builds new plant ATC goes down due to mass productionCostsMC1ATC1MC2$9,900,000ATC2$50,000$6,000$3,000, , ,000,0000Quantity Cars53
54 Long Run AVERAGE Total Cost Company builds new plant ATC goes down due to mass productionCostsMC1ATC1MC2$9,900,000MC3ATC2$50,000ATC3$6,000$3,000, , ,000,0000Quantity Cars54
55 Long Run AVERAGE Total Cost Company builds more plants, ATC stays the sameCostsMC1ATC1MC2$9,900,000MC3MC4ATC2$50,000ATC3ATC4$6,000$3,000, , ,000,0000Quantity Cars55
56 Long Run AVERAGE Total Cost Company builds more plants and ATC begins to increaseCostsMC1ATC1MC2$9,900,000MC5MC3ATC5MC4ATC2$50,000ATC3ATC4$6,000$3,000, , ,000,0000Quantity Cars56
57 Long Run AVERAGE Total Cost CostsMC1ATC1MC2$9,900,000MC5MC3ATC5MC4ATC2$50,000ATC3ATC4$6,000$3,000, , ,000,0000Quantity Cars57
58 Long Run AVERAGE Total Cost Where is the Long Run Average Cost Curve? CostsMC1ATC1MC2$9,900,000MC5MC3ATC5MC4ATC2$50,000ATC3ATC4$6,000$3,000, , ,000,0000Quantity Cars58
59 The LRATC curve connects the lowest points on all of the SRATC curve (envelope)
60 Economies of Scale- LRATC curve is decreasing Happens due to mass production techniques
61 Constant Returns to Scale- The ATC to produce is staying the same LRATC is flat
62 Diseconomies of Scale- LRATC is increasing Caused by a firm becoming too big “for own good”
63 Constant Returns to Scale Long Run Average Cost Curve LRATC SimplifiedThe law of diminishing marginal returns doesn’t apply in the long run because there are no FIXED RESOURCES.CostsEconomies of ScaleConstant Returns to ScaleDiseconomies of ScaleLong Run Average Cost Curve63Firm should select the size of firm that has lowest SRATCQuantity
64 Topic 5: RevenueTotal Revenue = amount of $ a firm takes in from selling a productTR = P X Q
65 Marginal revenueThe increase in revenue that results from selling ONE more unit
66 Topic 6: PROFIT Profit = financial gain TOTAL REVENUE – TOTAL COST TR>TC = PROFITTR<TC = LOSSTR = TC = BREAK EVEN (normal profit)
67 Calculate profit Total product Total cost Total revenue Profit 50 700 500808001008501,0001309001,300
68 Calculate profit Total product Total cost Total revenue Profit 50 700 500-200808001008501,0001501309001,300400
69 2 ways to improve profit1. Increase revenue2. decrease costs
72 What are the different types of costs??? FIXED and VARIABLE cost EXPLICIT cost and an IMPLICIT cost
73 Profit total cost Video clip PROFIT = total revenue – Costs???
74 Marshmallow Towers Objective: Your goal in this activity is the same goal of every business, to make PROFIT. Your assignment is to earn the most profit as you make a tower made only of toothpicks and mini-marshmallows. You will have 15 minutes
77 Variable cost – will depend upon the # of marshmallows and toothpicks you use $50.00 each$ each
78 How much will we earn for building our tower??? Revenue will be based on the HEIGHT and STRENGTH of your tower
79 HEIGHT Inches 1-4 = $1,000 in inch Every inch over 4 = $2,000 each inch
80 Strength Can stand alone for at least 10 seconds = $2,000 Can hold a sheet of paper on top for at least 10 seconds = $2,000
81 Record SheetYou will record all costs on your record sheet You may purchase as many toothpicks and marshmallows as you wish RECORD THE NUMBER EACH TIME YOU PURCHASE! Marshmallows toothpicks ______ ________ _______ ________ Total # marshmallows ___ Total # toothpicks ______
82 Before tower is judgedMarshmallows Toothpicks ______ ________ _______ ________ Total # marshmallows __ Total # toothpicks ____ X $50 = ______ X $100 = ______ Total Variable cost = ________
84 Discuss these questions as a group – answer on your record sheet We could have improved our profit by…..How did your group try to minimize your costs?How did your group try to maximize your revenue?Why is it important to consider both cost andrevenue when making business decisions?
86 Perfect Competition Number of firms: Many (thousands) of small firms Choice for Consumers: manyType of Good: identical products; perfect substitutes to each anotherMarket Entry: very easy, no barriers to entryAmount of competition: Great deal; more than any other structure
89 Characteristics of monopolistic competition Number of firms: hundreds of small companies Choice for consumers: many Type of Good: product DIFFERENTIATION Market Entry: easy, little barriers to entry Amount of competition: significant amount; non-price competition
91 OligopolyNumber of firms: Few large companies Choice for Consumers: Few Type of Good: similar or different from one another Market entry: difficult to enter; barriers exist Amount of Competition: LITTLE One firm’s actions have impact on other firms Brand name recognition important
96 ID the market structure Business 1: I’ve got plenty of competition. If I tried to raise my price, I’d lose business to the large firms that dominate our industry. I wait for them to raise prices and I follow along behind.
97 Business 2: New shops like mine are opening all the time – there are hundreds of us. I have to spend money on advertising to convince people that my shop is unique and different.
98 Business 3: I can’t afford to advertise; it would eat up what little profit I make. Besides, what good would it do? My product is the same as everyone else’s.
99 Business 4: My product is like no one else’s Business 4: My product is like no one else’s. I work hard to make sure my firm stays out in front to avoid cutthroat competition.
100 Intellectual Property Intellectual Property includes:secret formulas, ideas, inventions (products and processes), industrial designs, literary and artistic works (novels, films, music, architectural designs and web pages)Intellectual property is protected by:PatentsCopyrightsTrademarks
101 Patentslegal right to exclude anyone else from manufacturing or marketing an inventionLast for 20 years.
102 Strange patents ???Anti-eating face maskGerbil shirt
103 Copyrightsprotect written or artistic expressions - novels, poems, songs or movies.Lasts for the life of the author plus 50 years.
104 Famous copyright cases S. Victor Whitmill v. Warner Bros. Entertainment Inc. Tatoo (like Mike Tyson’s) in The Hangover Part 2. Warner Bros. and Whitmill worked out an agreement of undisclosed terms.
105 Mattel Inc. v. MGA Entertainment Inc Mattel Inc. v. MGA Entertainment Inc. MGA Entertainment filed a lawsuit against Mattel, claiming that the line of My Scene Barbies copied the big-headed and slim-bodied physique of Bratz dolls
106 The Happy Birthday Song The copyright belongs to Warner Music Group, and the company regularly charges up to $30,000 to anyone who wants to use the song for profit
107 TrademarksName, phrase, sound or symbol used in association with services or products.
111 The seller has NO control over price. Profit Topic 8: PERFECT Competition REVIEWMany small firms (thousands)Identical products (perfect substitutes)Easy for firms to enter the industryFirms are “Price Takers”The seller has NO control over price.Can only control Quantity they are producing111
112 Demand for Perfectly Competitive Firms Why are they Price Takers?If a firm charges above the market price, NO ONE will buy. Consumers will go to other firmsThere is no reason to lower price because consumers will buy the same amount at the market price.Since the price is the same at all quantities demanded, the demand curve for each firm is… Perfectly Elastic (A Horizontal straight line)112
113 The Competitive Firm is a Price Taker Price is set by the Industry $15$15DQ5000QFirm(price taker)Industry113
114 If price changes in the market, it will also change in the FIRM
115 The Competitive Firm is a Price Taker Price is set by the Industry What is the additional revenue for selling an additional unit?1st unit earns $152nd unit earns 30 (15 more)Marginal revenue is constant at $15Notice: MR=D=AR=PPDemand$15MR=D=AR=PQFirm(price taker)115115
116 For Perfect Competition: MR=D=AR=P The Competitive Firm is a Price TakerPrice is set by the IndustryWhat is the additional revenue for selling an additional unit?1st unit earns $152nd unit earns $15Marginal revenue is constant at $15Notice:Total revenue increases at a constant rateMR equal Average RevenuePDemand$15MR=D=AR=PQFirm(price taker)116116
117 Topic 9: Maximizing PROFIT in perfect competition 117
118 Short-Run Profit Maximization What is the goal of every business?To Maximize Profit!!!!!!To maximum profit firms must make the right outputHow does a firm decide the right output????MR< MC don’t produceMR> MC produce118
119 How many products should this perfect competitive firm produce??? Price of item is $20.00TP TC MC MR
120 How many products should this perfect competitive firm produce??? What is the firm’s profit at this point???TR-TCPrice of item is $20.00TP TC MC MR$20.00
121 *Profit would still be made at TP of 5, but profit not maximized Price of item is $20.00TP TC MC MRProfit at TP of 4 = $20Profit at TP of 5 = $10
123 # of workersTPMPFCVCTCAFCAVCATCMCTRMRprofit114401002.867.142302001.336.676.2533007.510445400.898.89543500.9311.63-50
124 Increasing, diminishing and negative returns??? # of workersTPMPFCVCTCAFCAVCATCMCTRMRprofit114401002.867.14230162001.336.676.253103007.54455400.898.8943-2500.9311.63-50Increasing, diminishing and negative returns???
125 # of workersTPMPFCVCTCAFCAVCATCMCTRMRprofit114401001402.867.14230162002401.336.676.253103003407.54455400440.898.8943-2500540.9311.63-50
126 # of workersTPMPFCVCTCAFCAVCATCMCTRMRprofit114401001402.867.1410230162002401.336.6786.2533003407.58.54455400440.898.899.7843-2500540.9311.6312.56-50
127 # of workersTPMPFCVCTCAFCAVCATCMCTRMRprofit114401001402.867.1410230162002401.336.6786.2530033407.58.54004455440.898.899.7845043-2500540.9311.6312.56-50430
128 In PC, Marginal revenue = price of product (remember MR=D=AR=P) # of workersTPMPFCVCTCAFCAVCATCMCTRMRprofit114401001402.867.1410230162002401.336.6786.2530033407.58.54004455440.898.899.7845043-2500540.9311.6312.56-50430In PC, Marginal revenue = price of product (remember MR=D=AR=P)
129 In PC, Marginal revenue = price of product (remember MR=D=AR=P) # of workersTPMPFCVCTCAFCAVCATCMCTRMRprofit114401001402.867.1410230162002401.336.6786.2530033407.58.54004455440.898.899.7845043-2500540.9311.6312.56-50430In PC, Marginal revenue = price of product (remember MR=D=AR=P)
130 # of workersTPMPFCVCTCAFCAVCATCMCTRMRprofit114401001402.867.1410230162002401.336.6786.253006033407.58.54004455440.898.899.782045043-2500540.9311.6312.56-50430-110
131 # of workersTPMPFCVCTCAFCAVCATCMCTRMRprofit114401001402.867.1410230162002401.336.6786.253006033407.58.54004455440.898.899.782045043-2500540.9311.6312.56-50430-110How many products should this firm produce to maximize its profits ????
132 # of workersTPMPFCVCTCAFCAVCATCMCTRMRprofit114401001402.867.1410230162002401.336.6786.253006033407.58.54004455440.898.899.782045043-2500540.9311.6312.56-50430-110
133 MC in Perfect competition Upward sloping part of MC curve = Supply of firmMC=S
134 MR = MC in perfect competition Firm will produce the Q where MR=MC to maximize profit
135 Topic 10: Perfectly competitive firm in the short run 1. It can make a profit2. Break even NORMAL PROFIT3. Have a lossFirm will produce where MR=MC
139 Shut Down RuleA firm should continue to produce as long as the price is above the AVCWhen the price falls below AVC then the firm should minimize its losses by shutting downWhy? If the price is below AVC the firm is losing more money by producing than they would have to pay to shut down.
140 If price changes in the market, it will also change in the FIRM and the firm should adjust their output Example: increase in S lowers P
147 In the long-run, what happens when economic profits are made? When firms make profits, other firms enter the industry – this causes supply to increase which causes prices to go downWhen prices go down, profits go down
148 In the long-run, what happens when losses are made? When firms incur a loss, firms start to leave the industry – this causes supply to decrease which causes prices to go upWhen prices go up, profit goes up
149 Topic 12: Efficiency Perfectly competitive markets are perfectly efficient They have BOTH productive and allocative efficiency in the long run149
150 Productive Efficiency The production of a good in a least costly way.Graphically it is where…Price = Minimum ATC150
151 Long-Run Equilibrium MC ATC Price D=MR Notice that the product is being made at the lowest possible cost (Minimum ATC)QQuantity151
152 Allocative Efficiency Producers are making the products most wanted by society.Graphically it is where…Price = MC152
153 Optimal amount being produced Long-Run EquilibriumMCMRPPriceOptimal amount being producedQQuantity153
154 Long-Run Equilibrium P = Minimum ATC = MC EXTREMELY EFFICIENT!!!! MC PriceD=MRPP = Minimum ATC = MCEXTREMELY EFFICIENT!!!!QQuantity154