1. Unit 3: Perfect Competition

2. Production is Converting inputs into output
Lets look at an example to show the relationship between inputs and outputs
Production is Converting inputs into output
Analyzing Production

3. Production Simulation
1 stapler, 1 scissors, 1 table, and plenty of paper
Fold into ½  Cut  Fold into ¼  Cut  Wrap  Staple  Add more links

4. Production Simulation
Rules
There will be several rounds and each round last 2 min.
One additional worker will be hired at each round.
Workers have to fold & cut ONE paper at a time.
Workers can only fold the new paper AFTER the pervious one is cut.
Workers can only add links to one side of the chain.
Responsibilities
The manager will hire the workers.
Each worker has to be assigned to do some job.
The inspector will make sure each worker is following the rules and product is made to specifications.

5. Production Simulation
Complete the chart for your firm:
# of Workers (inputs)
Total Product (output)
Marginal Product 1 2 3 4 5 6

6. Production Simulation
Products
# of Workers (inputs)
Total Product (output)
Marginal Product 1 2 3 4 5 6
Workers

7. Too many cooks in the kitchen!
Production Analysis
What happens to the Total Product as you hire more workers?
What happens to marginal product as you hire more workers?
What would happen to total output if every student in the room tried to make links given only one stapler (limited resource)?
The Law of Diminishing Marginal Returns
As variable resources (workers) are added to fixed resources (machinery, tool, etc.), the additional output produced from each new worker will eventually fall.
Too many cooks in the kitchen!

8. Graphing Production
“I always gives 110% to my job. 40% on Monday, 30% on Tuesday, 20% on Wednesday, 15% on Thursday, and 5% on Friday.”
The Law of Diminishing Marginal Returns is NOT the results of laziness, it is the result of limited fixed resources.

9. Three Stages of Returns
Stage I: Increasing Marginal Returns
MP rising. TP increasing at an increasing rate.
Specialization.
Total Product
Total Product
Stage I
Marginal and Average Product
Average Product
Marginal Product

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

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

12. Stage I: Increasing Marginal Returns
Calculate MP and AP
Identify the three stages of returns
Stage I: Increasing Marginal Returns
# 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

13. Identify the three stages of returns
Stage I: Increasing Marginal Returns
Stage II: Decreasing Marginal Returns
# 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

14. Identify the three stages of returns
Stage I: Increasing Marginal Returns
Stage II: Decreasing Marginal Returns
Stage III: Negative Marginal Returns
# 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

15. Identify the three stages of returns
Stage I: Increasing Marginal Returns
Stage II: Decreasing Marginal Returns
Stage III: Negative Marginal Returns
# 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

16. Costs of Production

17. From now on, all COSTS are automatically ECONOMIC COSTS
Accountants
Economists
Only look at EXPLICIT COSTS
Look at the EXPLICIT COSTS and the IMPLICIT COSTS
Implicit costs are the opportunity costs such as forgone time and forgone income.
Explicit costs are the traditional “out-of pocket costs” of decision making.
Rent, Wages, Materials, Electricity Bills
Forgone Wage, Forgone Rent, Time
Accounting
Profit
Total
Revenue
Accounting Costs
(Explicit Only)
Economic
Economic Costs
(Explicit + Implicit)

18. What do you need to open a pet store?
Production Costs
What do you need to open a pet store? 18

19. Definitions Fixed 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

20. Different Economic Costs
Total Costs
TP = Total Product
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

21. Total Product (TP)- total output or quantity produced
Marginal Product (MP)- the additional output generated by additional inputs (workers).
Average Product (AP)- the output per unit of input
Marginal Product =
Δ Total Product
Δ Inputs
Average Product =
Total Product
Units of Labor

22. “Short-Run” Production Cost
Short-Run is NOT a set specific amount of time.
The short-run is a period in which at least one resource is fixed.
Ex. Plant capacity/size is NOT changeable
In the long-run ALL resources are variable
NO fixed resources
Plant capacity/size is changeable 22

23. Calculating TC, VC, FC, ATC, AFC, & MCTP VC FC TC MC
AVC
AFC
ATC 10 1 2 16 3 21 4 24 5 35 6 54 7 77

24. Total Costs TP VC FC TC MC AVC AFC ATC 10 1 2 16 3 21 4 24 5 35 6 54 710 1 2 16 3 21 4 24 5 35 6 54 7 77

25. Total Costs TP VC FC TC MC AVC AFC ATC 10 1 20 2 16 26 3 21 31 4 24 3410 1 20 2 16 26 3 21 31 4 24 34 5 35 45 6 54 64 7 77 87

26. What is the TC, FC, & VC for producing 4 units?
TOTAL COSTS GRAPH TC
VC + FC = TC VC
150
140
130
120
110 50 40 30 20 10
Cost dollars FC
What is the TC, FC, & VC for producing 4 units?
100 FC

27. Per Unit Costs TP VC FC TC MC AVC AFC ATC 10 - 1 20 2 16 26 6 3 21 3110 - 1 20 2 16 26 6 3 21 31 5 4 24 34 35 45 11 54 64 19 7 77 87 23

28. Per Unit Costs TP VC FC TC MC AVC AFC ATC 10 - 1 20 2 16 26 6 8 3 2110 - 1 20 2 16 26 6 8 3 21 31 5 7 4 24 34 35 45 11 54 64 19 9 77 87 23

29. Per Unit Costs TP VC FC TC MC AVC AFC ATC 10 - 1 20 2 16 26 6 8 5 3 2110 - 1 20 2 16 26 6 8 5 3 21 31 7
3.3 4 24 34
2.5 35 45 11 54 64 19 9
1.6 77 87 23
1.4

30. Per Unit Costs TP VC FC TC MC AVC AFC ATC 10 - 1 20 2 16 26 6 8 5 13 310 - 1 20 2 16 26 6 8 5 13 3 21 31 7
3.3
10.3 4 24 34
2.5
8.5 35 45 11 9 54 64 19
1.6
10.6 77 87 23
1.4
12.4

31. How much does the 9th unit costs?
Per-Unit COSTS (Average & Marginal)
How much does the 9th unit costs? 12 11 10 9 8 7 6 5 4 3 2 1 MC
ATC and AVC get closer and closer but NEVER touch
ATC
AVC
Costs (dollars)
Average Fixed Cost
AFC
Quantity

32. Per-Unit COSTS (Average & Marginal)
At output Q, what area represents:
TC ( )   
VC ( )   
FC ( )   
ADQ0
BEQ0
ADEB or CFQ0 D A
Fixed Cost
Total Cost
Costs (dollars) B E
Variable Cost C F
Fixed Cost Q
Quantity

33. Why is the MC curve U-shaped?12 11 10 9 8 7 6 5 4 3 2 1 MC
Costs (dollars)
Quantity

34. Relationship between Production & Cost
Why is the MC curve U-shaped?
When MP is increasing, MC falls.
When MP falls, MC increase.
MP & MC are mirror images of each other.
Marginal Product
Marginal Cost
Marginal Product
Marginal Cost
Quantity of labor
Quantity of output

35. 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 ($10)
Workers
Total Product
Marginal Product
Total Cost
Marginal Cost -
$20 1 5
$30 2 13 8
$40 3 19 6
$50 4 23
$60 25
$70 26
$80

36. Why is the MC curve U-shaped?
The MC curve falls and then rises because of Diminishing Marginal Returns.
Marginal Cost =
Δ Total Cost
Δ Total Product
Workers
Total Product
Marginal Product
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

37. 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 Product
Marginal Product
Total Cost
Marginal Cost -
$20 1 5
$30 $2 2 13 8
$40
$1.25 3 19 6
$50
$1.6 4 23
$60
$2.5 25
$70 $5 26
$80
$10

38. Relationship between Production & Cost
The MC curve intersects the ATC curve at its lowest point.
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.
Why is the ATC curve U-shaped?
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. MC
ATC
Cost (dollars)
Quantity of output

39. Analyzing Production
Lets look at an example to show the relationship between inputs and outputs

40. 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

41. 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

42. 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

43. 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?

44. 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!

45. 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!

46. 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!

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

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

49. 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

50. 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

51. 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

52. 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?

53. 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!

54. 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!

55. 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

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

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