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I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned.

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Presentation on theme: "I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned."— Presentation transcript:

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3 I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned resources –lost value from investing in business rather than alternative

4 II. ECONOMIC PROFIT Total Revenue MINUS Economic Costs AKA Pure profit

5 Economic Profit Implicit costs (including a normal profit) Explicit Costs Accounting costs (explicit costs only) Accounting Profit Economic (opportunity) Costs TOTALREVENUETOTALREVENUE Profits to an Economist Profits to an Accountant

6 III. SHORT RUN & LONG RUN Short Run – FIXED PLANT –Brief period of time to alter plant capacity –Output can be varied by adding larger/smaller amounts of resources Long Run – VARIABLE PLANT –Enough time to change Q of ALL resources employed including plant capacity –Firms can enter or exit industry

7 InputsTotal Product Marginal Product Average Product 00 Remember: Plot Between Input Points!

8 Law of Diminishing Returns SHORT-RUN PRODUCTION RELATIONSHIPS Total Product, TP Quantity of Labor Average Product, AP, and Marginal Product, MP Quantity of Labor Total Product Marginal Product Average Product Increasing Marginal Returns

9 Law of Diminishing Returns SHORT-RUN PRODUCTION RELATIONSHIPS Total Product, TP Quantity of Labor Average Product, AP, and Marginal Product, MP Quantity of Labor Total Product Marginal Product Average Product Diminishing Marginal Returns

10 Law of Diminishing Returns SHORT-RUN PRODUCTION RELATIONSHIPS Total Product, TP Quantity of Labor Average Product, AP, and Marginal Product, MP Quantity of Labor Total Product Marginal Product Average Product Negative Marginal Returns

11 IV. Short Run Costs Fixed Cost: –Constant and must be paid no matter the output Variable Cost –Change with level of output Total Cost –FC + VC Marginal Cost –additional cost of producing one more unit of output Average Fixed Cost –TFC/Q Average Variable Cost –TVC/Q Average Total Cost –AFC + AVC –Or TC/Q

12 Output Total Fixed Cost Total Variable Cost Total Cost Marginal Cost Average Fixed Cost Average Variable Cost Average Total Cost 0$500$0$500 PLOT BETWEEN OUTPUT LEVELS $7.00$5.00$7.00 $

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14 Total Product Fixed Cost Variable Cost Total Cost Marginal Cost Average Fixed Cost Average Variable Cost Average Total Cost 0$100.00$0$ $10.00$100.00$10.00$

15 V. Perfect Competition Price Taker (determined by industry) Total Revenue = Price x Quantity Marginal Revenue = Change TR / Change Quantity Average Revenue = TR/Q Firms will produce where MR = MC –Perfectly elastic demand for the firm –Maximize profits or minimize losses Economic Profit if MR=MC is greater than ATC Economic Loss if MR=MC is below ATC Firm will stay open as long as it can cover its AVC Firm will shut down if MR=MC is below AVC

16 Cost and Revenue MC MR AVC ATC Economic Profit MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position Output Q

17 Cost and Revenue MC MR AVC ATC Economic Loss MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position Output Q

18 Cost and Revenue MC MR AVC ATC MARGINAL REVENUE-MARGINAL COST APPROACH Short-Run Shut Down Point Minimum AVC is the Shut-Down Point Output Q

19 Cost and Revenue, (dollars) MC MR 1 AVC ATC Quantity Supplied MR 2 MR 3 MR 4 MR 5 P1P1 P2P2 P3P3 P4P4 P5P5 Q2Q2 Q3Q3 Q4Q4 Q5Q5 Marginal Cost & Short-Run Supply Do not Produce – Below AVC Break-even (Normal Profit) Point

20 Cost and Revenue, (dollars) MC MR 1 Quantity Supplied MR 2 MR 3 MR 4 MR 5 P1P1 P2P2 P3P3 P4P4 P5P5 Q2Q2 Q3Q3 Q4Q4 Q5Q5 Yields the Short-Run Supply Curve Supply No Production Below AVC Marginal Cost & Short-Run Supply

21 AVC 2 MC 2 Higher Costs Move the Supply Curve to the Left Cost and Revenue, (dollars) MC 1 AVC 1 Quantity Supplied S1S1 S2S2 Marginal Cost & Short-Run Supply

22 AVC 2 MC 2 Lower Costs Move the Supply Curve to the Right Cost and Revenue, (dollars) MC 1 AVC 1 Quantity Supplied S1S1 S2S2 Marginal Cost & Short-Run Supply

23 PricePrice Quantity S=MC AVC ATC Q D Quantity Q D S=  MC’s Industry Firm (price taker) Economic Profit P SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm “Takes” its Price from the Industry Equilibrium

24 P Q S=MC AVC ATC 8 D P Q 8000 D S=  MC’s Industry Firm (price taker) Economic Profit $111 SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm “Takes” its Price from the Industry Equilibrium How about the long-run?

25 PROFIT MAXIMIZATION IN THE LONG RUN Assumptions... Entry and Exit Only Identical Costs Constant-Cost Industry Goal of the Analysis Price = Minimum ATC Long-Run Equilibrium - The Zero Economic Profit Model

26 Temporary profits and the reestablishment of long-run equilibrium S1S1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $ $ PROFIT MAXIMIZATION IN THE LONG-RUN MR D1D1

27 An increase in demand increases profits. MR D1D1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $ $ PROFIT MAXIMIZATION IN THE LONG RUN D2D2 Economic Profits S1S1

28 New competitors increase supply and lower prices decrease economic profits. MR D1D1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $ $ PROFIT MAXIMIZATION IN THE LONG RUN D2D2 Zero Economic Profits S1S1 S2S2

29 Decreases in demand, Losses, and the Reestablishment of Long-Run Equilibrium S1S1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $ $ PROFIT MAXIMIZATION IN THE LONG RUN D1D1 MR

30 A decrease in demand creates losses. MR D1D1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $ $ PROFIT MAXIMIZATION IN THE LONG RUN D2D2 Economic Losses S1S1

31 MR D1D1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $ $ PROFIT MAXIMIZATION IN THE LONG RUN D2D2 Return to Zero Economic Profits S1S1 S3S3 Competitors with losses decrease supply and prices return to zero economic profits.

32 LONG-RUN SUPPLY IN A CONSTANT COST INDUSTRY Perfectly Elastic Long-Run Supply

33 P Q =$50 S D1D1 Z1Z1 Q1Q1 D2D2 Z2Z2 Q2Q2 Q3Q3 D3D3 Z3Z3 100,000110,00090,000 LONG-RUN SUPPLY IN A CONSTANT COST INDUSTRY P1P2P3P1P2P3

34 P Q =$50 S D1D1 Z1Z1 Q1Q1 D2D2 Z2Z2 Q2Q2 Q3Q3 D3D3 Z3Z3 100,000110,00090,000 LONG-RUN SUPPLY IN A CONSTANT COST INDUSTRY P1P2P3P1P2P3

35 P Q $ S D1D1 Y1Y1 Q1Q1 D2D2 Y2Y2 Q2Q2 Q3Q3 D3D3 Y3Y3 100,000110,00090,000 LONG-RUN SUPPLY IN AN INCREASING COST INDUSTRY P1P2P3P1P2P3

36 P MR Q MC ATC Quantity Price Price = MC = Minimum ATC (normal profit) LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRM

37 PURE COMPETITION AND EFFICIENCY Productive Efficiency Price = Minimum ATC Allocative Efficiency Price = MC Underallocation Price > MC Overallocation Price < MC

38 PURE COMPETITION AND EFFICIENCY Productive Efficiency Price = Minimum ATC Allocative Efficiency Price = MC Underallocation Price > MC Overallocation Price < MC Resources are efficiently allocated under competition.


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