1. Unit 3: Costs of Production and Perfect Competition
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2. 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
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3. 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
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4. Short-run Supply Curve4
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5. 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 5

6. 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 6
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7. 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

8. 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 8
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9. 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
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10. Per Unit vs. Lump Sum
A PER UNIT tax or subsidy 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 10
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11. 2008 Audit Exam
18.B

12. Perfect Competition
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13. 2006 FRQ 13
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14. 2006 FRQ 14
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15. #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
Profit=$40
$16 15 10 9 5
Price MC
MR=D=AR= P 14
ATC
Quantity

16. #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 16

17. #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

18. #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
TR=$100 10
TC=$60
Profit=$40
$12 11 6 5 3
Price MC
MR=D=AR= P 10
ATC
Quantity

19. 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”
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20. 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 20
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21. Which of the following is a correctly labeled graph for firm making economic profit?21
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22. #1 #3 #2 #4 ATC MC MC ATC PF MR=D MR=D Q Q QF QF MC ATC ATC MC MR=D

23. #1 #3 #2 #4 ATC MC MC ATC PF MR=D MR=D Q Q QF QF MC ATC ATC MC MR=D
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24. #1 #3 #2 #4 ATC MC MC ATC PF MR=D MR=D Q Q QF QF MC ATC ATC MC MR=D
Economic Loss
Profit too big Q Q QF QF #2 #4 P MC P
ATC
ATC MC
MR=D
MR=D
MC&ATC
Wrong
MR > MC Q Q QF QF

25. 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

26. Perfect Competition in the Long-Run
You are a wheat farmer. You learn that there is more profit in making corn. What do you do in the long run?
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27. (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.
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28. 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 28
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29. 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 29
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30. Going from Short-Run to Long-Run30
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31. 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

32. 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 32
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33. 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 33
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34. 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 34

35. 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

36. 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 36
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37. 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 37
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38. 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 38
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39. 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. 39
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40. 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

41. 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 41
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42. 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 42
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43. 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 43
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44. 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

45. 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 45
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46. 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 46
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47. 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 47
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48. Practice 48

49. 2012 Multiple Choice #23
Answer: D 49

50. 2008 Audit Exam
26. C

51. 2012 Multiple Choice #38
Answer: C 51

52. C

53. 2010 FRQ #1 53

54. 54

55. 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) 55
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56. 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 56
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57. 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 57
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58. 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 58
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59. 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 59
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