Download Average variable cost

Limits, Alternatives, and Choices
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 Adam Smith -- Each person motivated by self-interest will produce what is
best for the economy. The economy will run smoothly as if guided by an
invisible hand = laissez faire – father of capitalism.
 Economics – How we use our limited resources to satisfy our unlimited
wants.
Land (fators
of
production)
Captial
Labor
entrepreneur
Household
(wages, rent,
interest,
profit)
Business
Return to
factors
$
Business
Household
goods
&services
 Limited Resources: Labor, Land, Capital, Entrepreneurial Ability.
 Labor—16 or over working or actively seeking work
 Unemployed -- % of labor force not working.
 Underemployed – working at less than full capacity
 Discouraged worker – not working , not looking no longer counted in labor
force
 Land – all natural resources
 Capital – a produced means of further production
 Entrepreneur – innovator, risk taker
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 Production possibilities curve assumes full employment of resources and
fixed technology.
 Point X= unemployment / underemployment
 Malthus – dismal science population expands geometrically food supply
expands arithmetically – unless checked by war famine or disease.
 We all starve to death.
 Law of increasing opportunity cost have to give up greater amounts of
one good to get more of other goods, because resources are not perfectly
transferrable.
 What—money votes demand.
 How -- More efficient that is how we want to produce it.
 For Whom -- We produce for people whom with money.
 Demand Quantity of a good or service consumers are willing and able to
buy at alternative prices in a giving period of time ceteris paribus (all else
had constant.)
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 Δin demand caused by the non-price determinants of D caused
movement to a new curve.
(less is left) (more is right)
 “Tastes & preferences”= need, related goods ,complements,
substitutions, expectations, income (inferior goods& normal goods)
 Inferior goods as income increase, demand decrease, as income
decrease, demand decrease.
 Normal goods as income increase, demand increase, as income
decrease, demand decrease.
 Δin Qd(Quantity Demanded) caused by a Δin price causes movements
along the same curve
 3 reasons why demand curve is downward sloping
 income effect
 substitution effect
 Take the product to substitute other goods
 diminishing marginal utility (less) (additional) (satisfaction)
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
Supply – quantity of a good or service sellers are willing and able to
supply at given period of time ceteris paribus.
Δin Qs=Δin P
Δin S=Δ in non price determinants of supply.
1.
2.
3.
4.
5.
6.
Weather cost of inputs resource prices.
Technology
Productivity of resource (quality)
Expectations
Numbers of sellers
Taxes and subsidies
 Equilibrium price
Pe Qs=Qd
Elasticity
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 Elasticity – responsiveness of quantity demanded to changes in price.
 The formula for the coefficient of the price elasticity of
demand:
 Calculating the Percentage Change in Quantity Demanded
 The formula used to calculate the percentage change in
quantity demanded is:
[QDemand(NEW) - QDemand(OLD)] / QDemand(OLD)
 Calculating the Percentage Change in Price
 The formula used to calculate the percentage change in
price is:
[Price(NEW) - Price(OLD)] / Price(OLD)
 Final Step of Calculating the Price Elasticity of Demand
PEoD = (% Change in Quantity Demanded)/(% Change in
Price)
 Inelastic Demand: The percentage change in quantity demanded is less
than the percentage change in price. Quantity demanded change
proportionately less than price changes. ( Price goes up, total revenue
goes up/ price goes down, total revenue goes down)
 Elastic Demand: The percentage change in quantity demanded is
greater than the percentage change in price. Quantity demanded change
proportionately greater than price changes. ( Price goes up, total revenue
goes down/ price goes down, total revenue goes up)
 Unit elastic: price goes down/ up, the total revenue stays the same.
Total Revenue = Time X Quantity
 Consumer Surplus: Consumer got produced less than they were willing
to pay a deal
 Elastic of supply – determinant time.
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 Price Floor – A minimum price for good or services
 Price Ceiling – A maximum price that can be charged for a good or
service.
 Shortage
Chapter 7
Businesses and the Costs of Production
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 Implicit Cost – the opportunity costs of using resources that it already
owns to make firm’s own products rather than selling those resources to
outsiders for cash.
 Explicit Cost – the monetary payments it makes to those from whom it
must purchase resources that it does not own. ( out of pocket)
Economic costs = explicit costs + implicit costs
(Economic cost as the payment that must be made to obtain and retain the
services of a resources)
 Fixed Cost – Those costs that do not vary with changes in output. Fixed
costs are associated with the very existence of a firm’s plant and
therefore must be paid even if its output is zero. (Do not vary with levels
of output)
 Variable costs – Those costs that change with the level of output,
include payments for materials, fuel, power, transportation services, most
labor, and similar variable resources. (Many with levels of output)
 Short Run -- a period too brief for a firm to alter its plant capacity, yet
long enough to permit a change in the degrees to which the plant’s
current capacity is used. (Fixed & Variable Costs)
 Long Run – a period long enough for it to adjust the quantities of all
resources that it employs, including plant capacity. ( all costs are
variable)
 Accounting Profit—the profit number that accountants calculate by
subtracting total explicit cost form total sales revenue.
(Revenue – explicit costs)
 Economic Profit – the result of subtracting all of your economic cost –
both explicit costs and implicit costs form revenue.
(Revenue –explicit costs- implicit costs)
 Normal Profit – Just enough to keep you in business, but not enough to
attract competition
Chapter 7
Businesses and the Costs of Production9/13/2011 9:44:00 PM
 Total Product (TP) – the total quantity, or total output, of a particular
good or service produced.
 Marginal Product (MP) – the extra output or added product associated
with adding a unit of a variable resource.
Marginal Product = Δ in total product / Δ in labor input
 Average product (AP) – labor productivity , is output per unit of labor
input:
Average Product = total product / units of labor
 Law of diminishing returns as a variable product is added to fixed
beyond some point the additional output per unit of input declines.
Chapter 7
Businesses and the Costs of Production9/13/2011 9:44:00 PM
 Marginal Revenue
MR=ΔTR/ΔQ
 Marginal Revenue Product
MRP=MPXR
 Marginal Product
MP=ΔTP/Δinput
 Total Product : – the total quantity, or total output, of a particular good
or service produced. (What you produce)
 Average Product
AP=TP/ input
 Average Cost
AC=TC/Q
*whenever you see marginal, always Δ in the top & Δ in the button
* whenever you see product, always divide by input
 Total Cost : the sum of fixed cost and variable cost at each level of
output
TC= TFC+TVC
 Average Fixed Cost (AFC) for any output level is found by dividing total
fixed cost (TFC) by that amount of output (Q)
AFC= TFC/Q
 Average Variable Cost (AVC) for any output level is calculated by
dividing total variable cost (TVC) by that amount of output (Q)
AVC= TVC/Q
 Average Total Cost (ATC) for any output level is found by dividing total
cost (TC) by that output (Q) or by adding AFC and AVC at that output
ATC=TC/Q=(TFC/Q)+(TVC/Q)=AFC+AVC
 Marginal Cost (MC) : the extra, or additional, cost of producing one
more unit of output.
MC=ΔTC/ΔQ

Law of diminishing returns : as you add variable input to fixed input
eventually the output per unit of input will decline.
~~$10 per worker, $1 per box~~
workers
Total output
Marginal
product
Variable cost
Average
variable cost
1
1
1
$11
$11
2
5
4
$25
$5
3
11
6
$41
$3.72
4
20
9
$60
$3
5
30
10
$80
$2.67
6
35
5
$95
$2.71
*marginal product increase, average variable cost decrease.
###Graph Page 174,176,177, 180
 COLA = Cost of Living Adjustment
 Total Cost goes up, fixed cost stays the same
 Large fixed cost, need large output
 Economies of Scales : as output increases, cost per unit decrease
 Diseconomies of Scales : as output increase, cost per unit increase
 Constant Returns to Scales : as output increase, cost per unit stays
the same
The long run average cost curve is made up of a series of short
run average costs curve.
Cost curves are mirror image of productivity curves—when MRP is
rising MC is falling and when MP is falling MC is rising. The MC
curve DRIVES the AVERAGE COST CURVE – MP DRIVES the
average product.
Chapter 8
Pure Competition in the Short Run9/13/2011 9:44:00 PM
 Characteristics of Pure Competition
 Large number of sellers, but no enough to influence the market
 Easy entry
 Easy exit
 Perfect information
 Demand curve for firm perfectly elastic (P=MR=AR=D)
 Industry curve downward sloping
 Productive and allocative efficiency (producing @ lowest point @
ATC)
 Price taker ( in cannot change market price; it can only adjust to it)




Normal profit only, no pure profit
Max profits where MR=MC
Advertise as an industry
Homogeneous products
 Normal profit : just enough to keep you in business, not enough to
attract competition
 Pure profit : above normal profits, attracts competition unless blocked
entry.
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 Minimizing Losses : stay open as long as you can cover all of your
variable costs and any part of your fixed costs.
 Maximize profit or minimize losses by producing where MR=MC
 Shut down if you can not cover variable cost.
Gas Station
Attendant
$2.5
FC=Rent(always the
same)
Gas (cost per gallon)
$0.5
VC= Cost of Gas +
Attendant
Rent
$60
TC = FC + VC
Price (per gallon)
$1
Profit = TR – TC
Gas Station 1
50 gallon
TR
VC
TC
Profit
$50
$25
$60
$50
$25
$25
-$100
4
$25
OPEN
$50
$110
-$60
TR
VC
TC
Profit
$100
$25
$60
$100
$50
$25
-$135
Gas Station 2
100 gallon
2
$50
OPEN/
CLOSE
$75
$135
-$35
*Dependents on expectation of profit
Gas Station 3
40 gallon
TR
VC
TC
Profit
$40
$25
$60
$40
$20
$25
-$105
3
$20
CLOSE
$45
$105
-$65
TR
VC
TC
Profit
$170
$25
$60
$170
$85
$25
-$170
Gas Station 4
170 gallon
$85
BREAK
EVEN
$110
$170
$0
4
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Monopolistic Competition
1. Product differentiation
2. Easy entry
3. Price and product competition
4. Some firms can make a pure profit in the short run
5. Normal profits in long run
6. Underutilized plants – wastes societies scare resources
7. Does NOT have productive or allocative efficiency
8. If each firm produced at optimal there would be fewer firms
9. Advertise heavily
10.
11.
Produce where MR=MC
Large number of varying size firms
Oligopoly
1. Largest 4 firms have a high concentration ratio
2. 4 largest firms control 85% of the market
3. restrict output in order to charge higher prices
4. mutual independence (I have your back)
5. play dirty – collusion , price fixing, cartels
6. prices wars
7. homogenous (steel) or heterogeneous product (computers, cars)
8. follow the leaders (airlines)
9. often occur through merges (banks)
10. large firms
11. advertise heavily
12. pure profits because of huge barriers to entry
13. kinked demand curve competition ignores price increase but
matches prices decrease
14. play follow the leader
15.
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Characteristic of monopoly
1. Single seller
2. No close substitutes
3. Price market (control the price)
4. Block entry
5. MR curve below demand curve (because you can have different price for
products)
6. Pure profit
7. Restricts output to change higher prices
8. Firm is industry
9. Advertise
10. Other firm exists
11. Max profit where MR=MC
12. Non price competition
13. Possible losses
3 types monopoly
 Privately owned, privately regulated


Privately owned, government regulated
Government regulated, government regulated
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