1. AP Microeconomics
In Class Review #3

2. A Producer’s price is derived from 3 things:
Cost of Production
Competition between firms
Demand for product

3. Total Costs TC = TFC + TVC TFC = Fixed Costs TVC = Variable Costs
Constant costs paid regardless of production
TVC = Variable Costs
Costs that vary as production is changed TC
TVC
Cost
TFC
Output

4. Total Revenue TR = p × q The money received from sale of product TC TR
Cost & Revenue
TR = p × q
The money received from sale of product TC TR
Break Even
Profit
Loss
Output

5. Profit = TR - TC Accounting: Calculates actual costs a business incurs
Explicit!!
Ex) inputs, salaries, rent, both fixed and variable
Economic:
Calculates all accounting costs plus the what if, or opportunity, costs
Implicit!!!!
Ex) what was given up, lost interest, “freebie” costs

6. Short Run vs. Long Run Short Run Long Run
At least one fixed factor of production, usually capital
No Expansion
No entry/exit industry
Long Run
All factors are variable
Expansion possible
Yes can enter or leave industry

7. 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

8. The Production Function
Input
Total Product
Marginal Product
Average Product
Stages of Production 1 10 2 24 3 39 4 52 5 60 6 66 7 63 8 56
+10 10 I 12
+14 I
+15 13 I
+13 13 II +8 12 II +6 11 II -3 9
III -7 7
III

9. Key Graph Parts to Remember:
Stages follow MP
AP intersects MP at its high point
MP increases, decrease & then goes negative
Output TP AP MP

10. Production Function Law of Diminishing Returns
Due to limited capacity, output will slow down and then decrease beyond a certain point
Choice of Technology
Capital (K) and Labor (L) are both complements and substitutes, firms will find the combination that is the most efficient (cheapest)

11. Producer’s Costs TFC: Total Fixed Costs
AFC: Average Fixed Costs; TFC/q
AVC: Average Variable Costs; TVC/q
Marginal Costs ΔTC

12. 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)

13. Putting it all together
Market (Industry)
Firm MC
Price
Cost S
ATC MR PX
AVC D QX
Quantity
Output

14. 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)

15. GRAPH: LRAC Market Firm S0 S1 P0 P1 D Quantity Cost Price LRAC
SRMC P0
SRMC
SRAC
SRAC P1
LRAC D
Level #2
Level #1
Quantity
Outputs

16. Operating Profit:
Minimizing losses, it is better to produce and lose a little than it is to produce nothing and lose total fixed costs
TR - TVC
Choices: produce with loss
Cost MC
ATC
Losses PX MR
Op. Profit
AVC QX
Output

17. Shutting Down vs. Exiting the Industry
Short Run option
Still paying out Total Fixed Costs but not producing
Exiting:
Long Run option
No costs, no production, business no longer exists

18. Expanding Production Economies of Scale Diseconomies 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

19. Expanding Production Increasing Returns Diminishing Returns
LR, expand and increase production
Diminishing Returns
LR, expand and decrease production

20. Graphing Expansion Long-run ATC Unit Costs Output Firm Economies
of scale
Constant returns
to scale
Diseconomies
of scale
Unit Costs
Long-run ATC
Output

21. Perfectly Competitive Making ProfitMC MR
PROFIT
ATC
AVC

22. Perfectly Competitive Minimizing Losses
Any Price btwn the average cost curves represents an economic loss but an operating profit

23. Perfectly Competitive Breaking Even

24. Perfectly Competitive Shut Down
Any Price below AVC’s min point represent total loss

25. 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

26. Income vs. Substitution
Substitution Effect
Choose to subs work for leisure to get more money
Normal Supply Curve
Income Effect
Choose current income with less work, want more leisure time
Backward Bending SL PL PL SL QL QL

27. 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

28. 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

29. Marginal Revenue Product
Example: PL = $60 and PX = $10
Labor
(L)
Total Output
(Q)
Marginal Product
(MPL)
Marginal Revenue Product
(MRPL) 1 5 2 20 3 30 4 35 +5
$50
+15
$150
$100
+10
$50 +5 +0 $0
MRPL = MPL × PX
MPL = ΔOutput

30. 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.

31. Graph: Labor Market Firm Cost & Rev Price SL MRCL PL WL DL MRPL QL
Quantity
Quantity

32. 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)