1. Unit 3: Costs of Production and Perfect Competition

2. Revenue = Price x Quantity
Revenue and Profit 3.1
Revenue = Price x Quantity

3. Accountants vs. Economists
Accountants look at only EXPLICIT COSTS
Explicit costs (out of pocket costs) are payments paid by firms for using the resources of others.
Example: Rent, Wages, Materials, Electricity Bills
Accounting
Profit
Total
Revenue
Accounting Costs
(Explicit Only)
Economists examine both the EXPLICIT COSTS and the IMPLICIT COSTS
Implicit costs are the opportunity costs that firms “pay” for using their own resources
Example: Forgone Wage, Forgone Rent, Time
Economic
Profit
Total
Revenue
Economic Costs
(Explicit + Implicit)

4. From now on, all costs we discuss will be ECONOMIC COSTS
Accountants vs. Economists
Accountants look at only EXPLICIT COSTS
Explicit costs (out of pocket costs) are payments paid by firms for using the resources of others.
Example: Rent, Wages, Materials, Electricity Bills
From now on, all costs we discuss will be ECONOMIC COSTS
Accounting
Profit
Total
Revenue
Accounting Costs
(Explicit Only)
Economists examine both the EXPLICIT COSTS and the IMPLICIT COSTS
Implicit costs are the opportunity costs that firms “pay” for using their own resources
Example: Forgone Wage, Forgone Rent, Time
Economic
Profit
Total
Revenue
Economic Costs
(Explicit + Implicit)

5. No Economic Profit = Normal Profit
Practice
Assume the following:
David left his job as a lawyer earning $8,000 a month to open up an ice cream shop
Last month he sold 5,000 sundaes for $2 each and 8,000 cones for $1 each
His rent is $1000 per month
His other expenses like labor, ice cream, cones, etc. add up to $9,000 per month
Last month he took a family vacation that cost $5000
Calculate David’s accounting profit
Calculate David’s economic profit
Should David go back to being a lawyer?
What must be true for accounting profit if economic profit is zero?
No Economic Profit = Normal Profit
$8,000= Revenue ($18,000) minus explicit costs ($10,000). Don’t include the family vacation since it is not a business expense.
$0= Revenue minus explicit costs and implicit costs ($8,000 forgone wage)
Not necessarily, he makes just as much money per month with his shop as he did being a lawyer.
Accounting profit must be positive when economic profit is zero

6. Normal Profit
In an efficient competitive market, firms that have identical products will make a normal profit.
They will break even and make no economic profit
Traffic Analogy
When there is heavy traffic, why do all lanes go the same slow speed?
Cars leave slower lanes and enter faster lanes.
Similarly, what happens in perfectly competitive markets if firms earn excessive profit?

7. Maximizing PROFIT!

8. Assume every unit can be sold for $10. Which unit maximizes profit?
Use marginal analysis to explain why you should never produce 5 units
Marginal Cost
Price
$12
$10 $8 $6
Marginal
Revenue
Quantity

9. Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
To maximum profit firms must make the right output
Firms should continue to produce until the additional revenue from each new output equals the additional cost.
Example (Assume the price is $10)
Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11

10. Profit Maximizing Rule Short-Run Profit Maximization
MR=MC
Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
To maximum profit firms must make the right output
Firms should continue to produce until the additional revenue from each new output equals the additional cost.
Example (Assume the price is $10)
Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11

11. Production = Converting inputs into output

12. Widget Production Simulation

13. Production Simulation
Overview
The class will be divided into two firms.
There will be several rounds in which each firm will produce chains out of paper.
Each round last exactly 1 minute
Each firm is going to hire one more worker at the start of each round.
Resources
1 stapler, 1 scissors, 1 table, and plenty of staples and paper
Rules
Workers cannot stockpile slips of paper. No extras
Workers cannot cut more than one paper at a time
Workers can only add links to one side of the chain
Each link must pass inspection
If links don’t meet specifications they won’t count
Responsibilities
The manager will hire the workers.
The inspector will check to make sure each product is made to specifications

14. Production Simulation
Step 1: Cut paper down the middle into two piece
Step 2: Fold piece down the middle
Step 3: Wrap ends around and staple
Step 4: Add more links to one end

15. Fill out this chart based on your firm’s production
# of Workers
(Input)
# of Links
(Output)
Marginal
Product 1 2 3 4 5 6

16. Inputs and Outputs Average Product =
To earn profit, firms must make products (output)
Inputs are the resources used to make outputs.
Input resources are also called FACTORS.
Total Physical Product (TP)- total output or quantity produced
Marginal Product (MP)- the additional output generated by additional inputs (workers).
Marginal Product =
Change in Total Product
Change in Inputs
Average Product (AP)- the output per unit of input
Average Product =
Total Product
Units of Labor

17. Fixed vs. Variable
Fixed Resources- Resources that don’t change with the quantity produced
Ex: Table, scissors, and stapler
Variable Resources- Resources that do change with the quantity produced
Ex: Workers, paper, and staples
Identify three fixed resources and three variable resources for a pizza restaurant

18. The Law of Diminishing Marginal Returns Too many cooks in the kitchen!
Production Analysis
What happens to marginal product as you hire more workers?
Why does this happens?
The Law of Diminishing Marginal Returns
As variable resources (workers) are added to fixed resources (ovens, machinery, tool, etc.), the additional output produced from each additional worker will eventually fall.
Too many cooks in the kitchen!

19. Notice that as you hire more workers the additional links each additional worker creates begins to decrease
This is because of the fixed resources and the Law of Diminishing Marginal Returns

20. Graphing Production

21. Unit 3: Costs of Production and Perfect Competition 3.2

23. Three Stages of Returns
Stage I: Increasing Marginal Returns
MP rising. TP increasing at an increasing rate.
Why? Specialization.
Total
Product
Total Product
Quantity of Labor
Marginal and Average Product
Average Product
Quantity of Labor
Marginal Product

24. Three Stages of Returns
Stage II: Decreasing Marginal Returns
MP Falling. TP increasing at a decreasing rate.
Why? Fixed Resources. Each worker adds less and less.
Total
Product
Total Product
Quantity of Labor
Marginal and Average Product
Average Product
Quantity of Labor
Marginal Product

25. Three Stages of Returns
Stage III: Negative Marginal Returns
MP is negative. TP decreasing.
Workers get in each others way
Total
Product
Total Product
Quantity of Labor
Marginal and Average Product
Average Product
Quantity of Labor
Marginal Product

26. Remember quantity of workers goes on the x-axis.
With your partner calculate MP and AP then discuss what the graphs for TP, MP, and AP look like.
Remember quantity of workers goes on the x-axis.
# of Workers
(Input)
Total Product(TP) PIZZAS
Marginal Product(MP)
Average Product(AP) 1 10 2 25 3 45 4 60 5 70 6 75 7 8

27. Remember quantity of workers goes on the x-axis.
With your partner calculate MP and AP then discuss what the graphs for TP, MP, and AP look like.
Remember quantity of workers goes on the x-axis.
# of Workers
(Input)
Total Product(TP) PIZZAS
Marginal Product(MP)
Average Product(AP) - 1 10 2 25 15 3 45 20 4 60 5 70 6 75 7 8 -5

28. Remember quantity of workers goes on the x-axis.
With your partner calculate MP and AP then discuss what the graphs for TP, MP, and AP look like.
Remember quantity of workers goes on the x-axis.
# of Workers
(Input)
Total Product(TP) PIZZAS
Marginal Product(MP)
Average Product(AP) - 1 10 2 25 15
12.5 3 45 20 4 60 5 70 14 6 75 7
10.71 8 -5
8.75

29. Identify the three stages of returns Total Product(TP) PIZZAS
# of Workers
(Input)
Total Product(TP) PIZZAS
Marginal Product(MP)
Average Product(AP) - 1 10 2 25 15
12.5 3 45 20 4 60 5 70 14 6 75 7
10.71 8 -5
8.75

30. Identify the three stages of returns Total Product(TP) PIZZAS
# of Workers
(Input)
Total Product(TP) PIZZAS
Marginal Product(MP)
Average Product(AP) - 1 10 2 25 15
12.5 3 45 20 4 60 5 70 14 6 75 7
10.71 8 -5
8.75

31. More Examples of the Law of Diminishing Marginal Returns
Example #1: Learning curve when studying for an exam
Fixed Resources-Amount of class time, textbook, etc.
Variable Resources-Study time at home
Marginal return-
1st hour-large returns
2nd hour-less returns
3rd hour-small returns
4th hour- negative returns (tired and confused)
Example #2: A Farmer has fixed resource of 8 acres planted of corn. If he doesn’t clear weeds he will get 30 bushels. If he clears weeds once he will get 50 bushels. Twice -57, Thrice-60. Additional returns diminishes each time.

32. Tony’s Hat Store Worksheet

33. Unit 3: Costs of Production and Perfect Competition 3.3

34. Short-Run Production Costs

35. Definition of the “Short-Run”
We will look at both short-run and long-run production costs.
Short-run is NOT a set specific amount of time.
The short-run is a period in which at least one resource is fixed.
Plant capacity/size is NOT changeable
In the long-run ALL resources are variable
NO fixed resources
Plant capacity/size is changeable
Today we will examine short-run costs

36. Different Economic Costs
Total Costs
FC = Total Fixed Costs
VC = Total Variable Costs
TC = Total Costs
Per Unit Costs
AFC = Average Fixed Costs
AVC = Average Variable Costs
ATC = Average Total Costs
MC = Marginal Cost

37. Definitions Fixed Costs: Variable Costs:
Costs for fixed resources that DON’T change with the amount produced
Ex: Rent, Insurance, Managers Salaries, etc.
Average Fixed Costs =
Fixed Costs
Quantity
Variable Costs:
Costs for variable resources that DO change as more or less is produced
Ex: Raw Materials, Labor, Electricity, etc.
Average Variable Costs =
Variable Costs
Quantity

38. Definitions Total Cost: Marginal Cost: Sum of Fixed and Variable Costs
Average Total Cost =
Total Costs
Quantity
Marginal Cost:
Additional costs of an additional output.
Ex: If the production of two more output increases total cost from $100 to $120, the MC is _____.
$10
Marginal Cost =
Change in Total Costs
Change in Quantity

39. Notice that the AVC + AFC = ATC
Calculating Costs
Fill out the chart then
calculate:
ATC of 6 Units
AFC of 2 Units
AVC of 4 Units
ATC of 1 Unit
AVC of 5 Units
AFC of 5 Units
ATC of 5 Units
Output
Variable
Cost
Fixed
Total
Marginal $0
$10 - 1 2
$17 3
$25 4
$40 5
$60 6
$110
$10
$10
$20
$27
$35
$50
$70
$120 -
$10 $7 $8
$15
$20
$50
$20 $5
$10
$12 $2
$14
Notice that the AVC + AFC = ATC
For 5 Units: AVC ($12) + AFC ($2) = ATC ($14)
Is this is true for 4 Units?

40. Notice that the AVC + AFC = ATC
Calculating Costs
Output
Variable
Cost
Fixed
Total
Marginal $0
$10 - 1
$20 2
$17
$27 $7 3
$25
$35 $8 4
$40
$50
$15 5
$60
$70 6
$110
$120
AVC
AFC
ATC -
$10
$20
$8.50 $5
$13.50
$8.33
$3.33
$11.66
$2.50
$12.50
$12 $2
$14
$18.33
$1.67
$20 $5
$10
$12 $2
$14
Notice that the AVC + AFC = ATC

41. Calculating Costs AVC AFC ATC - $10 $20 $8.50 $5 $13.50 $8.33 $3.33
$11.66
$2.50
$12.50
$12 $2
$14
$18.33
$1.67
$20 $5
$10
$12 $2
$14

42. ATC and AVC get closer and closer but NEVER touchMC
Costs
ATC
$20
$18
$16
$14
$12
$10 $8 $6 $4 $2
AVC
ATC and AVC get closer and closer but NEVER touch
Average Fixed Cost
AFC
Quantity
Copyright
ACDC Leadership 2015

43. Calculate TC, VC, and FC of the 5th UnitMC
Costs
ATC
$20
$18
$16
$14
$12
$10 $8 $6 $4 $2
AVC
Calculate TC, VC, and FC of the 5th Unit
TC= $70
VC= $60
TC = $10
AFC
Quantity

44. Total Cost Curves TC
Costs
FC + VC = TC VC
Fixed Cost
$10 FC
Quantity

45. Practice

46. 2008 Audit Exam
50. c

47. 1. A C 2.

48. 7.D

49. Calculating Costs Practice
Fill out the chart then
calculate:
ATC of 6 Units
AFC of 2 Units
AVC of 3 Units
ATC of 5 Units
AVC of 2 Units
AVC of 4 Units
AFC of 4 Units
ATC of 4 Units
Output
Variable
Cost
Fixed
Total
Marginal $0
$20 - 1
$12 2
$22 3
$27 4
$40 5
$60 6
$100
$20
$10 $9
$16
$11 $5

50. How much does the 10th unit costs?MC
$30 25 20 15 10 5
ATC
AVC
Calculate TC, VC, and FC
Total Cost=$200
Variable Cost=$150
Fixed Cost=$50
Notice that VC + FC = TC
AFC
Quantity

51. Per-Unit Costs (Average and Marginal)
At output Q, what area represents: TC VC FC
0CDQ
0BEQ
0AFQ or BCDE

52. More Practice

53. Additional Practice TP VC FC TC MC AVC AFC ATC 100 1 10 2 16 3 21 4 26
100 1 10 2 16 3 21 4 26 5 30 6 36 7 46

54. Calculating TC, VC, FC, ATC, AFC, and MCTP VC FC TC MC
AVC
AFC
ATC
100 1 10 2 16 3 21 4 26 5 30 6 36 7 46

55. Calculating TC, VC, FC, ATC, AFC, and MCTP VC FC TC MC
AVC
AFC
ATC
100 1 10
110 2 16
116 3 21
121 4 26
126 5 30
130 6 36
136 7 46
146

56. Per Unit Costs TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 3 21
100 - 1 10
110 2 16
116 3 21
121 4 26
126 5 30
130 6 36
136 7 46
146

57. Per Unit Costs TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 3
100 - 1 10
110 2 16
116 6 3 21
121 5 4 26
126 30
130 36
136 7 46
146

58. Per Unit Costs TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8
100 - 1 10
110 2 16
116 6 8 3 21
121 5 7 4 26
126
6.5 30
130 36
136 46
146
6.6

59. Per Unit Costs TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8
100 - 1 10
110 2 16
116 6 8 50 3 21
121 5 7
33.3 4 26
126
6.5 25 30
130 20 36
136
16.67 46
146
6.6
14.3
Asymptote

60. Per Unit Costs TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8
100 - 1 10
110 2 16
116 6 8 50 58 3 21
121 5 7
33.3
40.3 4 26
126
6.5 25
31.5 30
130 20 36
136
16.67
22.67 46
146
6.6
14.3
20.9

61. Per Unit Costs TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8
100 - 1 10
110 2 16
116 6 8 50 58 3 21
121 5 7
33.3
40.3 4 26
126
6.5 25
31.5 30
130 20 36
136
16.67
22.67 46
146
6.6
14.3
20.9

62. Calculate A-E TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8 A
100 - 1 10
110 2 16
116 6 8 A 58 3 21
121 5 B
33.3
40.3 4 26
126
6.5 25
31.5 30
130 D E 36
136 C
16.67
22.67 7 46
146
6.6
14.3
20.9

63. Calculating TC, VC, FC, ATC, AFC, and MCTP VC FC TC MC
AVC
AFC
ATC
100 - 1 10
110 2 16
116 6 8 50 58 3 21
121 5 7
33.3
40.3 4 26
126
6.5 25
31.5 30
130 20 36
136
16.67
22.67 46
146
6.6
14.3
20.9

64. Calculating TC, VC, FC, ATC, AFC, and MCTP VC FC TC MC
AVC
AFC
ATC
100 - 1 10
110 2 16
116 6 8 50 58 3 21
121 5 7
33.3
40.3 4 26
126
6.5 25
31.5 30
130 20 36
136
16.67
22.67 46
146
6.6
14.3
20.9

65. Marshmallow Towers Activity https://youtu.be/Ho8lqhsF1B8
*WATCH THIS VIDEO!*

66. Shapes of Cost Curves

67. Why does marginal cost always go down then up?MC
Costs
Quantity

68. MP and MC are mirror images of each other
Relationship between Production and Cost
Output
As more workers are hired, their marginal product increases and then eventually decreases because of the law of diminishing marginal returns MP
The additional costs (MC) of the units they produce fall when MP goes up, but eventually increase as additional workers produce less and less output
MP and MC are mirror images of each other
Quantity of labor
Costs MC
Quantity of output

69. Why is the MC curve U-shaped?
The MC curve falls and then rises because of diminishing marginal returns.
Example:
Assume the fixed cost is $20 and the ONLY variable cost is the cost for each worker (Wage = $10)
Workers
Total Prod
Marg Prod
Total Cost
Marginal Cost 1 5 2 13 3 19 4 23 25 6 26

70. Why is the MC curve U-shaped?
The MC curve falls and then rises because of diminishing marginal returns.
Example:
Assume the fixed cost is $20 and the ONLY variable cost is the cost for each worker (Wage = $10)
Workers
Total Prod
Marg Prod
Total Cost
Marginal Cost - 1 5 2 13 8 3 19 6 4 23 25 26

71. Why is the MC curve U-shaped?
The MC curve falls and then rises because of diminishing marginal returns.
Example:
Assume the fixed cost is $20 and the ONLY variable cost is the cost for each worker (Wage = $10)
Workers
Total Prod
Marg Prod
Total Cost
Marginal Cost -
$20 1 5
$30 2 13 8
$40 3 19 6
$50 4 23
$60 25
$70 26
$80

72. Why is the MC curve U-shaped?
The MC curve falls and then rises because of diminishing marginal returns.
Example:
Assume the fixed cost is $20 and the ONLY variable cost is the cost for each worker (Wage = $10)
Workers
Total Prod
Marg Prod
Total Cost
Marginal Cost -
$20 1 5
$30
10/5 = $2 2 13 8
$40
10/8 = $1.25 3 19 6
$50
10/6 = $1.6 4 23
$60
10/4 = $2.5 25
$70
10/2 = $5 26
$80
10/1 = $10

73. Why is the MC curve U-shaped?
The additional cost of the first 13 units produced falls because workers have increasing marginal returns.
As production continues, each worker adds less and less to production so the marginal cost for each unit increases.
Workers
Total Prod
Marg Prod
Total Cost
Marginal Cost -
$20 1 5
$30
10/5 = $2 2 13 8
$40
10/8 = $1.25 3 19 6
$50
10/6 = $1.6 4 23
$60
10/4 = $2.5 25
$70
10/2 = $5 26
$80
10/1 = $10

74. Relationship between Production and Cost MC
Costs MC
Why does ATC go down then up?
When 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.
ATC
Quantity
MC intersects the ATC curve at ATC’s lowest point
Example:
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.
Notice that MC can increase but still pull down the average.

75. 2008 Audit Question 23
23. C

76. 2010 Question 18 B

77. When in doubt, graph it outMC
Costs
ATC
$12
$10 $8 $2
AVC
AFC
100
Quantity

78. 1. 2. E D

79. Shifting Cost Curves

80. What if Fixed Costs increase to $200
Shifting Costs Curves TP VC FC TC MC
AVC
AFC
ATC
100 - 1 10
110 2 16
116 6 8 50 58 3 21
121 5 7
33.3
30.3 4 26
126
6.5 25
31.5 30
130 20 36
136
16.67
22.67 46
146
6.6
14.3
20.9
What if Fixed Costs increase to $200

81. Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16
100 - 1 10
110 2 16
116 6 8 50 58 3 21
121 5 7
33.3
30.3 4 26
126
6.5 25
31.5 30
130 20 36
136
16.67
22.67 46
146
6.6
14.3
20.9

82. Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 200 100 - 1 10 110 2
200
100 - 1 10
110 2 16
116 6 8 50 58 3 21
121 5 7
33.3
30.3 4 26
126
6.5 25
31.5 30
130 20 36
136
16.67
22.67 46
146
6.6
14.3
20.9

83. Which Per Unit Cost Curves Change?
Shifting Costs Curves TP VC FC TC MC
AVC
AFC
ATC
200 - 1 10
210
100
110 2 16
216 6 8 50 58 3 21
221 5 7
33.3
30.3 4 26
226
6.5 25
31.5 30
230 20 36
236
16.67
22.67 46
246
6.6
14.3
20.9
Which Per Unit Cost Curves Change?

84. ONLY AFC and ATC Increase!
Shifting Costs Curves TP VC FC TC MC
AVC
AFC
ATC
200 - 1 10
210
100
110 2 16
216 6 8 50 58 3 21
221 5 7
33.3
30.3 4 26
226
6.5 25
31.5 30
230 20 36
236
16.67
22.67 46
246
6.6
14.3
20.9
ONLY AFC and ATC Increase!

85. ONLY AFC and ATC Increase!
Shifting Costs Curves TP VC FC TC MC
AVC
AFC
ATC
200 - 1 10
210
110 2 16
216 6 8
100 58 3 21
221 5 7
66.6
30.3 4 26
226
6.5 50
31.5 30
230 40 36
236
33.3
22.67 46
246
6.6
28.6
20.9
ONLY AFC and ATC Increase!

86. If fixed costs change ONLY AFC and ATC Change!
Shifting Costs Curves
If fixed costs change ONLY AFC and ATC Change! TP VC FC TC MC
AVC
AFC
ATC
200 - 1 10
210 2 16
216 6 8
100
108 3 21
221 5 7
66.6
73.6 4 26
226
6.5 50
56.5 30
230 40 46 36
236
33.3
39.3
246
6.6
28.6
35.2
MC and AVC DON’T change!

87. Shift from an increase in a Fixed CostMC
ATC1
ATC
AVC
Costs (dollars)
AFC1
AFC
Quantity

88. Shift from an increase in a Fixed CostMC
ATC1
AVC
Costs (dollars)
AFC1
Quantity

89. What if the cost for variable resources increase
Shifting Costs Curves TP VC FC TC MC
AVC
AFC
ATC
100 - 1 10
110 2 16
116 6 8 50 58 3 21
121 5 7
33.3
30.3 4 26
126
6.5 25
31.5 30
130 20 36
136
16.67
22.67 46
146
6.6
14.3
20.9
What if the cost for variable resources increase

90. Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16
100 - 1 10
110 2 16
116 6 8 50 58 3 21
121 5 7
33.3
30.3 4 26
126
6.5 25
31.5 30
130 20 36
136
16.67
22.67 46
146
6.6
14.3
20.9

91. Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 100 - 1 11 110 10 2
100 - 1 11
110 10 2 18
116 6 8 50 58 3 24
121 5 7
33.3
30.3 4 30
126
6.5 25
31.5 35
130 20 26 43
136
16.67
22.67 55
146
6.6
14.3
20.9

92. Which Per Unit Cost Curves Change?
Shifting Costs Curves TP VC FC TC MC
AVC
AFC
ATC
100 - 1 11
111 10
110 2 18
118 6 8 50 58 3 24
124 5 7
33.3
30.3 4 30
130
6.5 25
31.5 35
135 20 26 43
143
16.67
22.67 55
155
6.6
14.3
20.9
Which Per Unit Cost Curves Change?

93. Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 100 - 1 11 111 10 110
100 - 1 11
111 10
110 2 18
118 7 8 50 58 3 24
124 6
33.3
30.3 4 30
130
6.5 25
31.5 5 35
135 20 26 43
143
16.67
22.67 55
155 12
6.6
14.3
20.9
MC, AVC, and ATC Change!

94. Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 100 - 1 11 111 110 2
100 - 1 11
111
110 2 18
118 7 9 50 58 3 24
124 6 8
33.3
30.3 4 30
130
7.5 25
31.5 5 35
135 20 26 43
143
7.16
16.67
22.67 55
155 12
7.8
14.3
20.9
MC, AVC, and ATC Change!

95. If variable costs change MC, AVC, and ATC Change!
Shifting Costs Curves
If variable costs change MC, AVC, and ATC Change! TP VC FC TC MC
AVC
AFC
ATC
100 - 1 11
111 2 18
118 7 9 50 59 3 24
124 6 8
33.3
41.3 4 30
130
7.5 25
32.5 5 35
135 20 27 43
143
7.16
16.67
23.83 55
155 12
7.8
14.3
22.1

96. Shift from an increase in a Variable Costs
MC1 MC
ATC1
AVC1
ATC
AVC
Costs (dollars)
AFC
Quantity

97. Shift from an increase in a Variable Costs
MC1
ATC1
AVC1
Costs (dollars)
AFC
Quantity

98. Long-Run Costs

99. 2010 Question 19

100. Definition of the “Short-Run”
We will look at both short-run and long-run production costs.
Short-run is NOT a set specific amount of time.
The short-run is a period in which at least one resource is fixed.
Plant capacity/size is NOT changeable
In the long-run ALL resources are variable
NO fixed resources
Plant capacity/size is changeable
Today we will examine LONG-run costs.

101. 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.
Ex: Assume a firm is producing 100 bikes with a fixed number of resources (workers, machines, etc.).
If this firm decides to DOUBLE the number of resources, what will happen to the number of bikes it can produce?
There are only three possible outcomes:
Number of bikes will double (constant returns to scale)
Bikes will more than double (increasing returns to scale)
Bikes will less than double (decreasing returns to scale)

102. Long Run ATC
What happens to the average total costs of a product when a firm increases its plant capacity?
Example of various plant sizes:
I make looms out of my garage with one saw
I rent out building, buy 5 saws, hire 3 workers
I rent a factor, buy 20 saws and hire 40 workers
I build my own plant and use robots to build looms.
I create plants in every major city in the U.S.
Long Run ATC curve is made up of all the different short run ATC curves of various plant sizes.

103. ECONOMIES OF SCALE Why does economies of scale occur?
Firms that produce more can better use Mass Production Techniques and Specialization.
Example:
A car company that makes 50 cars will have a very high average cost per car.
A car company that can produce 100,000 cars will have a low average cost per car.
Using mass production techniques, like robots, will cause total cost to be higher but the average cost for each car would be significantly lower.

104. Long Run AVERAGE Total Cost
Costs
MC1
ATC1
$9,900,000
$50,000
$6,000
$3,000
, , ,000,0000
Quantity Cars

105. Long Run AVERAGE Total Cost
Economies of Scale- Long Run Average Cost falls because mass production techniques are used.
Costs
MC1
ATC1
MC2
$9,900,000
ATC2
$50,000
$6,000
$3,000
, , ,000,0000
Quantity Cars

106. Long Run AVERAGE Total Cost
Economies of Scale- Long Run Average Cost falls because mass production techniques are used.
Costs
MC1
ATC1
MC2
$9,900,000
MC3
ATC2
$50,000
ATC3
$6,000
$3,000
, , ,000,0000
Quantity Cars

107. Long Run AVERAGE Total Cost
Constant Returns to Scale- The long-run average total cost is as low as it can get.
Costs
MC1
ATC1
MC2
$9,900,000
MC3
MC4
ATC2
$50,000
ATC3
ATC4
$6,000
$3,000
, , ,000,0000
Quantity Cars

108. Long Run AVERAGE Total Cost Diseconomies of Scale-
Long run average costs increase as the firm gets too big and difficult to manage.
Costs
MC1
ATC1
MC2
$9,900,000
MC5
MC3
ATC5
MC4
ATC2
$50,000
ATC3
ATC4
$6,000
$3,000
, , ,000,0000
Quantity Cars

109. Long Run AVERAGE Total Cost
These are all short run average costs curves. Where is the Long Run Average Cost Curve?
Costs
MC1
ATC1
MC2
$9,900,000
MC5
MC3
ATC5
MC4
ATC2
$50,000
ATC3
ATC4
$6,000
$3,000
, , ,000,0000
Quantity Cars

110. Long Run AVERAGE Total Cost
Costs
Economies of Scale
Constant Returns to Scale
Diseconomies of Scale
Long Run Average Cost Curve
, , ,000,0000
Quantity Cars

111. Constant Returns to Scale Long Run Average Cost Curve
LRATC Simplified
The law of diminishing marginal returns doesn’t apply in the long run because there are no FIXED RESOURCES.
Costs
Economies of Scale
Constant Returns to Scale
Diseconomies of Scale
Long Run Average Cost Curve
Quantity

112. Unit 3: Costs of Production and Perfect Competition

113. 4 Market Structures Candy Markets Simulation
WATCH THIS VIDEO
*see folder activities and simulation*

114. Four Market Structures
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Every product is sold in a market that can be considered one of the above market structures.
For example:
Fast Food Market
Cars Manufactures
Market for Operating Systems (Microsoft)
Strawberry Market
Cereal Market
Monopolistic Competition (differentiated products)
Oligopoly
Monopoly
Perfect Competition
Oligopoly (3 main producers)

115. Four Market Structures
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Imperfect Competition
Characteristics of Perfect Competition:
Examples: Corn, Strawberries, Milk, etc.
Many small firms
Identical products (perfect substitutes)
Low Barriers- Easy for firms to enter and exit the industry
Seller has no need to advertise
Firms are “Price Takers”
The seller has NO control over price.

116. Four Market Structures
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Characteristics of Monopoly:
Examples: The Electric Company, De Beers,
One large firm (the firm is the market)
Unique product (no close substitutes)
High Barriers- Firms cannot enter the industry
Monopolies are “Price Makers”

117. Barriers to Entry Types of Barriers to Entry 1. Economies of Scale
A monopoly wouldn’t last long if there were not high barriers to keep other firms from entering.
Types of Barriers to Entry
1. Economies of Scale
Ex: There is only one electric company because they are the only ones that can make electricity ay the lowest cost. This is a “natural monopoly”
2. Superior Technology
3. Geography or Ownership of Raw Materials
4. Government Created Barriers
The government issues patents to protect inventors and forbids others from using their invention

118. Four Market Structures Characteristics of Oligopolies:
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Characteristics of Oligopolies:
Examples: Cell Phones, Service Providers, Cars
A Few Large Producers (Less than 10)
Identical or Differentiated Products
High Barriers to Entry
Control Over Price (Price Maker)
Mutual Interdependence
Firms must worry about the decisions of their competitors and use strategy

119. Four Market Structures
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Characteristics of Mono. Comp:
Examples: Fast food, furniture, shoe stores
Relatively Large Number of Sellers
Differentiated Products
Some control over price
Low Barriers- easy for firms to enter
A lot of non-price competition (Advertising)

120. Perfect Competition

121. Imperfect Competition The seller has NO control over price.
FOUR MARKET STRUCTURES
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Imperfect Competition
Characteristics of Perfect Competition:
Examples: Corn, Strawberries, Milk, etc.
Many small firms
Identical products (perfect substitutes)
Low Barriers- Easy for firms to enter and exit the industry
Seller has no need to advertise
Firms are “Price Takers”
The seller has NO control over price.

122. Demand for Perfectly Competitive Firms (A Horizontal straight line)
Why are they Price Takers?
If a firm charges above the market price, NO ONE will buy. They will go to other firms
There is no reason to price low because consumers will buy just as much 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)

123. The Competitive Firm is a Price Taker Price is set by the Industry
(all firms)
Firm P S P
Demand
$10
$10 D Q
5000 Q

124. 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 $10
2nd unit earns $10
Marginal revenue is constant at $10
Notice:
Total revenue increases at a constant rate
MR equal Average Revenue
Firm P
Demand
$10
MR=D=AR=P Q

125. For Perfect Competition: Demand = MR (Marginal Revenue)
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 $10
2nd unit earns $10
Marginal revenue is constant at $10
Notice:
Total revenue increases at a constant rate
MR equal Average Revenue
Firm P
Demand
$10
MR=D=AR=P Q

126. Maximizing PROFIT!

127. Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
To maximum profit firms must make the right output
Firms should continue to produce until the additional revenue from each new output equals the additional cost.
Example (Assume the price is $10)
Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11

128. Profit Maximizing Rule Short-Run Profit Maximization
MR=MC
Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
To maximum profit firms must make the right output
Firms should continue to produce until the additional revenue from each new output equals the additional cost.
Example (Assume the price is $10)
Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11

129. Lets put costs and revenue together to calculate profit.
Industry
Firm
(price taker) P S P MC
Demand $7 $7
ATC D Q
10,000 Q

130. How much output should be produced?
How much is Total Revenue? How much is Total Cost?
Is there profit or loss? How much? P $9 8 7 6 5 4 3 2 1 MC
MR=D=AR=P
Profit = $18
ATC
Total Cost=$45
Total Revenue =$63 Q

131. The profit maximizing rule is also the loss minimizing rule!!!
Suppose the market demand falls. What would happen if the price is lowered from $7 to $5?
The MR=MC rule still applies but now the firm will make an economic loss.
The profit maximizing rule is also the loss minimizing rule!!!

132. How much output should be produced?
How much is Total Revenue? How much is Total Cost?
Is there profit or loss? How much? MC $9 8 7 6 5 4 3 2 1
ATC
Cost and Revenue
Loss =$7
MR=D=AR=P
Total Cost = $42
Total Revenue=$35 Q

133. The Shut Down Rule

134. Assume the market demand falls even more
Assume the market demand falls even more. If the price is lowered from $5 to $4 the firm should stop producing.
Shut Down Rule:
A firm should continue to produce as long as the price is above the AVC
When the price falls below AVC then the firm should minimize its losses by shutting down
Why? If the price is below AVC the firm is losing more money by producing than they would have to pay to shut down.

135. Minimum AVC is shut down point
SHUT DOWN! Produce Zero
Price MC $9 8 7 6 5 4 3 2 1
ATC
AVC
Minimum AVC is shut down point Q

136. P<AVC. They should shut down
Producing nothing is cheaper than staying open.
Price MC $9 8 7 6 5 4 3 2 1
ATC
Fixed Costs=$10
AVC
TC=$35
MR=D=AR=P
TR=$20 Q

137. Profit Maximizing Rule
MR = MC
Three Characteristics of MR=MC Rule:
Rule applies to ALL markets structures (PC, Monopolies, etc.)
The rule applies only if price is above AVC
Rule can be restated P = MC for perfectly competitive firms (because MR = P)

138. Practice

139. #1 MC MR=D=AR= P ATC Quantity $16 15 10 9 14 5
1. Should the firm produce?
2. What output should the firm produce?
3. What is the TR and TC at that output?
4. How much profit or loss?
Yes 10
TR=$140
TC=$100
$16 15 10 9 5
Profit=$40
Price MC
MR=D=AR= P 14
ATC
Quantity

140. #2 MC ATC AVC MR=D=AR=P Quantity 24 20 12 18 15
What output should the firm produce?
What is TR at that output?
What is TC?
How much profit or loss? 6
$90
$120
Loss= $30 24 20 12
Price MC
ATC 18
AVC 15
MR=D=AR=P
Quantity

141. #3 MC ATC AVC MR=D=AR=P Quantity $12 10 11 9
1. What output should the firm produce?
2. What is TR at MR=MC point?
3. What is TC at MR=MC point?
4. How much profit or loss?
Zero Shutdown
(Price below AVC)
$45
$55
Loss=Only Fixed Cost $5
$12 10
Price MC
ATC
AVC 11 9
MR=D=AR=P
Quantity

142. #4 MC MR=D=AR= P ATC Quantity $12 11 6 5 10 3
1. Should the firm produce?
2. What output should the firm produce?
3. What is the TR and TC at that output?
4. How much profit or loss?
Yes 10
TR=$100
TC=$60
$12 11 6 5 3
Profit=$40
Price MC
MR=D=AR= P 10
ATC
Quantity

143. B D

144. 2007 Form B FRQ

145. 2007 Form B FRQ

146. Assume the firm can sell each unit at a price of $30
Maximizing Profit
Assume the firm can sell each unit at a price of $30
How many units should the firm produce to maximize profit?
What is the total revenue at that quantity?
How much is the profit?
Output
Variable
Cost
Fixed
Total
Marginal $0
$20 - 1
$12 2
$22 3
$27 4
$40 5
$60 6
$100
5 Units
$150 Total Revenue ($30 x 5)
$70 Profit ($150 - $80)
Notice that at 6 units the firm is still making profit. It’s just not maximizing profit

147. Maximizing Profit
Output
Variable
Cost
Fixed
Total
Marginal $0
$20 - 1
$12 2
$22 3
$27 4
$40 5
$60 6
$100 TR MR
Profit -
$30
-$2
$60
$18
$90
$43
$120
$150
$70
$180
5 Units
$150 Total Revenue ($30 x 5)
$70 Profit ($150 - $80)
Notice that at 6 units the firm is still making profit. It’s just not maximizing profit

148. 2006 FRQ

149. 2006 FRQ
149

150. Short-run Supply Curve

151. Marginal Cost and Supply As price increases, the quantity increases
$50 45 40 35 30 25 20 15 10 5 MC
ATC
MR5
Cost and Revenue
AVC
MR4
MR3
MR2
MR1 Q

152. Short-run Supply Curve: MC above AVC
Marginal Cost and Supply
When price increases, quantity increases
When price decrease, quantity decreases
$50 45 40 35 30 25 20 15 10 5 MC
= Supply
Short-run
Supply Curve:
MC above AVC
ATC
Cost and Revenue
AVC Q

153. Marginal Cost and Supply
If variable costs increase (ex: per unit tax)
MC2=Supply2
$50 45 40 35 30 25 20 15 10 5
MC1=Supply1
AVC
Cost and Revenue
AVC
When MC increases, SUPPLY decrease Q

154. Marginal Cost and Supply
What if variable costs decrease (ex: subsidy)?
MC1=Supply1
$50 45 40 35 30 25 20 15 10 5
MC2=Supply2
AVC
Cost and Revenue
AVC
When MC decreases, SUPPLY increases Q

155. Marginal Cost and Supply
What happens to quantity if fixed costs increase?
Price MC
MR=D=AR= P PF
ATC1
ATC
Quantity stays the same because MC/Supply doesn’t change
Quantity QF

156. Per Unit vs. Lump Sum
A PER UNIT tax or subsidy only effects the VARIABLE COSTS so MC, AVC, and ATC will shift.
This WILL effect the quantity produced
A LUMP SUM tax or subsidy only effects FIXED COSTS so only AFC and ATC will shift. MC stays the same.
This WILL NOT effect the quantity produced

157. 2008 Audit Exam
18.B

158. Unit 3: Costs of Production and Perfect Competition

159. Perfect Competition

160. Review Identify the 4 Market Structures
Identify the characteristics of perfect competition
Why is a perfectly competitive firm a “price taker”?
Explain why perfectly competitive firms make little profit
How do ALL firms determine what output to produce?
Draw a perfectly competitive firm producing 10 units at a price of $10 making a profit of $30
Draw and label a perfectly competitive firm making a loss.
On your graph, identify the shut down point
List 10 words that rhyme with the word “great”

161. Drawing side-by-side graph for perfectly completive industry and firm
Is the firm making a profit or a loss? Why? P S P MC
ATC
MR=D
$15
$15 D Q
5000 8 Q
Firm
(price taker)
Industry

162. Which of the following is a correctly labeled graph for firm making economic profit?
162

163. #1 #3 #2 #4 ATC MC MC ATC PF MR=D MR=D Q Q QF QF MC ATC ATC MC MR=D

164. They are all wrong for different reasons
ATC
They are all wrong
for different reasons P #1 MC P #3 MC
ATC PF
MR=D
MR=D Q Q QF QF #2 #4 P MC P
ATC
ATC MC
MR=D
MR=D Q Q QF QF

165. #1 #3 #2 #4 Profit too big ATC>P MR > MC ATC MC MC ATC PF MR=DQ Q QF QF #2 #4 P MC P
ATC
ATC MC
MR=D
MR=D
MC&ATC
Wrong
MR > MC Q Q QF QF

166. Where is the profit maximization point? How do you know?
What output should be produced?
What is TR?
What is TC?
How much is the profit or loss?
Where is the Shutdown Point?
$25 20 15 10 MC
MR=P
Profit
ATC
Cost and Revenue
AVC
Total Revenue
Total Cost

167. Perfect Competition in the Long-Run
You are a wheat farmer. You learn that there is a more profit in making corn. What do you do in the long run?

168. (No Economic Profit = Normal Profit)
In the Long-run…
Firms will enter if there is profit
Firms will leave if there is loss
So, ALL firms break even, they make NO economic profit
(No Economic Profit = Normal Profit)
In long run equilibrium a perfectly competitive firm is EXTREMELY efficient.

169. Is the firm making a profit or a loss? Why?
Side-by-side graph for perfectly completive industry and firm in the LONG RUN
Is the firm making a profit or a loss? Why? P S P MC
ATC
MR=D
$15
$15 D Q
5000 8 Q
Firm
(price taker)
Industry

170. Firm in Long-Run Equilibrium
Price = MC = Minimum ATC
Firm is making NO economic profit
Firm is making positive accounting profit P MC
ATC
$15
MR=D
There is no incentive to enter or leave the industry
TC = TR 8 Q

171. Going from Short-Run to Long-Run

172. Is this the short or the long run? Why?
What will firms do in the long run?
What happens to P and Q in the industry?
What happens to P and Q in the firm? P S P MC
ATC
$15
$15
MR=D D Q
5000
6000 8 Q
Industry
Firm

173. Firms enter to earn profit so supply increases in the industry
Price decreases and quantity increases P S P MC S1
ATC
$15
$15
MR=D
$10 D Q
5000
6000 8 Q
Industry
Firm

174. Price falls for the firm because they are price takers.
Price decreases and quantity decreases P S P MC S1
ATC
$15
$15
MR=D
$10
$10
MR1=D1 D Q
5000
6000 5 8 Q
Industry
Firm

175. New Long Run Equilibrium at $10 Price
Zero Economic Profit P P MC S1
ATC
$10
$10
MR1=D1 D Q
5000
6000 5 Q
Industry
Firm

176. Is this the short or the long run? Why?
What will firms do in the long run?
What happens to P and Q in the industry?
What happens to P and Q in the firm? P S P MC
ATC
$15
$15
MR=D D Q
4000
5000 8 Q
Industry
Firm

177. Firms leave to avoid losses so supply decreases in the industry
Price increases and quantity decreases S1 P S P MC
ATC
$20
$15
$15
MR=D D Q
4000
5000 8 Q
Industry
Firm

178. Price increase for the firm because they are price takers.
Price increases and quantity increases S1 P S P MC
ATC
$20
$20
MR1=D1
$15
$15
MR=D D Q
4000
5000 8 9 Q
Industry
Firm

179. New Long Run Equilibrium at $20 Price
Zero Economic Profit S1 P P MC
ATC
$20
$20
MR1=D1 D Q 9
4000 Q
Industry
Firm

180. Going from Long-Run to Long-Run Constant Cost Industry- New firms entering the market does not increase the costs for the firms already in the market.

181. Currently in Long-Run Equilibrium
If demand increases, what happens in the short-run and how does it return to the long run? P S P MC
ATC
$15
$15
MR=D D Q
5000 8 Q
Industry
Firm

182. Demand Increases The price increases and quantity increases
Profit is made in the short-run P S P MC
ATC
$20
$20
MR1=D1
$15
$15
MR=D D1 D Q
5000 8 9 Q
Industry
Firm

183. Firms enter to earn profit so supply increases in the industry
Price Returns to $15 P S S1 P MC
ATC
$20
$20
MR1=D1
$15
$15
MR=D D1 D Q
5000 8 9
7000 Q
Industry
Firm

184. Back to Long-Run Equilibrium
The only thing that changed from long-run to long-run is quantity in the industry P S1 P MC
ATC
$15
$15
MR=D D1 D Q
7000 8 Q
Industry
Firm

185. What if demand falls?
If demand decreases, what happens in the short-run and how does it return to the long run? P S P MC
ATC
$15
$15
MR=D D Q
5000 8 Q
Industry
Firm

186. Demand Decreases The price increases and quantity increases
Profit is made in the short-run P S P MC
ATC
$15
$15
MR=D
$10
$10
MR1=D1 D D1 Q
5000 7 8 Q
Industry
Firm

187. Demand Decreases The price increases and quantity increases
Profit is made in the short-run S1 P S P MC
ATC
$15
$15
MR=D
$10
$10
MR1=D1 D D1 Q
3000
5000 7 8 Q
Industry
Firm

188. Demand Decreases The price increases and quantity increases
Profit is made in the short-run S1 P P MC
ATC
$15
$15
MR=D D1 Q
3000 8 Q
Industry
Firm

189. Practice

190. 2012 Multiple Choice #23
Answer: D

191. 2012 Multiple Choice #38
Answer: C

192. C

193. 2010 FRQ #1

195. Going from Long-Run to Long-Run Increasing Cost Industry- New firms entering the market increase the costs for the firms already in the market. (Only asked once on a FRQ Form B)

196. Currently in Long-Run Equilibrium
If demand increases, what happens in the short-run and how does it return to the long run? P S P MC
ATC
$15
$15
MR=D D Q Q
Industry
Firm

197. INCREASING COST Industry
The price increases and quantity increases
Profit is made in the short-run P S P MC
$25
ATC
$25
$15
$15
MR=D D1 D Q Q
Industry
Firm

198. Firms enter to earn profit but fight for resources causing costs to increase
Price Falls to $20 P S P
MC1 S1 MC
ATC1
$25
ATC
$25
$20
$15
$15
MR=D D1 D Q Q
Industry
Firm

199. Firms enter to earn profit but fight for resources causing costs to increase
Price Falls to $20 P P
MC1 S1
ATC1
$20
MR1 D1 Q Q
Industry
Firm

200. 2008 Audit Exam
26. C

201. Unit 3: Costs of Production and Perfect Competition

202. Law of Demin. Marginal Returns Fixed Cost Low Barriers Price Taker
NAME THAT CONCEPT
Law of Demin. Marginal Returns
Fixed Cost
Low Barriers
Price Taker
MR = MC

203. Variable Costs Shut Down Rule MR=D=AR=P (Mr. Darp) Normal Profit
NAME THAT CONCEPT
Variable Costs
Shut Down Rule
MR=D=AR=P (Mr. Darp)
Normal Profit
Economies of Scale

204. Review Draw and label a perfectly competitive firm making a profit
Draw and label a perfectly competitive firm making a loss
Why is that firm considered a “price taker”?
How do firms determine what output to produce?
On your graph, identify the shut down point
On your graph, identify the firms supply curve
What happens in the industry if there is a profit?
What happens in the industry if there is a loss?
List 10 rides at Disneyland

205. Four Market Structures
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Imperfect Competition
Characteristics of Perfect Competition:
Examples: Corn, Strawberries, Milk, etc.
Many small firms
Identical products (perfect substitutes)
Low Barriers- Easy for firms to enter and exit the industry
Seller has no need to advertise
Firms are “Price Takers”
The seller has NO control over price.

206. Shifting Cost Curves
A change in fixed costs change ATC and AFC (but not MC)
A change in variable costs change ATC, AVC, and MC

207. Changes in fixed costs don’t change output

208. Changes in variable costs change output
50. D
Changes in variable costs change output

209. Efficiency

210. 1. Productive Efficiency 2. Allocative Efficiency
In general, efficiency is the optimal use of societies scarce resources
Perfect Competition forces producers to use limited resources to their fullest.
Inefficient firms have higher costs and are the first to leave the industry.
Perfectly competitive industries are extremely efficient
There are two kinds of efficiency:
1. Productive Efficiency
2. Allocative Efficiency

211. Graphically it is where price equals the minimum ATC
Productive Efficiency- Producing at the lowest possible cost (minimum amount of resources are being used)
Graphically it is where price equals the minimum ATC
Allocative Efficiency- Producing at the amount most desired by society (allocating resources towards the products society wants)
Graphically it is where price equals marginal cost

212. Short-Run Profit Not Productively EfficientMC
MR=D=AR=P
$10
ATC
Notice that Q1 is NOT being made at the lowest possible cost
(ATC not at lowest point). Q Q1

213. Short-Run Loss Not Productively EfficientMC
ATC
MR=D=AR=P $5
Notice that Q2 is NOT being made at the lowest possible cost
(ATC not at lowest point). Q2 Q

214. Long-Run Equilibrium Productively Efficient in the Long-RunMC
ATC $8
MR=D=AR=P
In the long-run, Q2 IS being made at the lowest possible cost
(ATC at lowest point) Q3 Q

215. Allocatively Efficient
Short-Run Profit
Allocatively Efficient P MC
MR=D=AR=P
$10
ATC
Notice that the price people are willing to pay equals the additional cost to produce Q1
(Price = MC) Q Q1

216. NOT Allocatively Efficient
Short-Run Profit
NOT Allocatively Efficient P MC
MR=D=AR=P
$10 $5
ATC
At Q2, the price is greater than the MC so society wants more output produced Q Q2

217. competitive profit maximizing firm is always allocatively efficient
Long-Run Equilibrium P MC
ATC $8
MR=D=AR=P
A perfectly
competitive profit maximizing firm is always allocatively efficient Q3 Q

218. Summary
Perfectly competitive firms are allocatively and productively efficient in the long-run
In the short-run, they are always allocatively efficient, but they are not productively efficient.