microeconomic principles
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Microeconomic Principles
MICROECONOMIC PRINCIPLES WEEK 1
Introduction to Economics & The Production Possibilities Frontier Threshold Concepts of Economics engaged in this Topic Economic Models * Opportunity Cost Marginal Analysis *the main threshold concept engaged in this topic The Economic Problem Wants, desires: unlimited Resources: scarce –Not freely available Economic choice Economics –How people use scarce resources to satisfy unlimited wants Wants: unlimited Resources: scarce; not freely available Therefore we need to make choices Economics –How people use scarce resources to satisfy unlimited wants Microeconomics vs Macroeconomics Microeconomics –Study of the economic behaviour in particular markets Individual agents’ economic choices Markets coordinate the choices of economic decision makers Macroeconomics –Study of the economic behaviour of entire economies Resources Inputs / Factors of Production ◦Used to produce goods and services Goods and services are scarce because resources are scarce 1.Labour 2.Capital (not financial) 3.Natural resources 4.Entrepreneurial ability Labour –Physical and mental effort used to produce goods and services –We allocate our time to different uses –Payment: Wage
Microeconomic Principles
Capital –Buildings, equipment, and human skills used to produce goods and services –Physical capital Human creations used to produce goods and services –Human capital Knowledge and skill people acquire to increase their productivity –Payment for physical capital: Interest Natural resources –All gifts of nature –Renewable resource Can be drawn on indefinitely if used conservatively –Exhaustible resource Does not renew itself Available in a limited amount –Payment: Rent Entrepreneurial ability –Imagination required to develop a new product or process –Skill needed to organize production –Willingness to take the risk of profit or loss –Payment: Profit - market driven: Market determined ‘wage’ for level of entrepreneurial ability Entrepreneur –Profit-seeking decision maker who starts with an idea –Organizes an enterprise to bring that idea to life –Assumes the risk of the operation Goods and Services Good –Tangible product used to satisfy human wants Service –Activity, or intangible product, used to satisfy human wants
Economic Decision Makers -Households ◦Consumers -Demand goods and services ◦Resource owners -Supply resources -Firms, Governments, Rest of the World -Demand resources ◦Produce goods and services Markets Market –Set of arrangements by which buyers and sellers carry out exchange at mutually agreeable terms Product markets –Goods and services are bought and sold Resource markets –Resources are bought and sold
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Microeconomic Principles
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The simple circular-flow model for households and firms Most basic macroeconomic model Households earn income by supplying resources (e.g. labor) to the resource market, as shown in the lower portion of the model. Firms demand these resources to produce goods and services, which they supply to the product market, as shown in the upper portion of the model. Households spend their income to demand these goods and services. This spending flows through the product market as revenue to firms.
Rational Self-Interest Individuals are assumed to be rational ◦Make the best choice, Given the available information ◦Maximise expected benefit Assumed to be independent of framing (framing is how a choice is presented) - marketing. With a given cost ◦Minimise expected cost For a given benefit Marginal Analysis Comparison ◦Expected marginal benefit (what I will gain) ◦Expected marginal cost (what I have to give up) Marginal ◦Incremental, additional, extra The Scientific Method Variable (say price of petrol) –A measure that can take on different values at different times Other-things-constant assumption –Other variables remain unchanged –Ceteris paribus
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Microeconomic Principles Choice and Opportunity Cost Make a choice ◦Pass up another opportunity Opportunity cost ◦The value of the best alternative forgone when an item or activity is chosen ◦Opportunity lost THRESHOLD CONCEPT Economic Models Economic Model ◦Simplification of economic reality ◦Assumptions are made to build the model ◦The model is used to make predictions A model is a tool for economic agents and if it is a good model will help make good decisions. First Model –The PPF Production Possibilities Frontier (PPF)
- frontier (when you can’t produce more of one good without giving up some of the other.)
Assumptions ◦Two products ◦Given time frame, e.g. 1 year ◦Fixed resources (quantity, quality) ◦Fixed technology (quantity, quality) ◦Fixed ‘rules of the game’ (no changes) Efficiency and the PPF Efficiency –When there is no way resources can be reallocated to increase the production of one good without decreasing the production of another –Getting the most from available resources Inefficient combinations –inside the PPF Unattainable combinations -outside The Economy’s Production Possibilities Frontier If the economy uses its available resources and technology efficiently to produce consumer goods and capital goods, that economy is on the production possibilities frontier, AF. The PPF is bowed out to reflect the law of increasing opportunity cost; the economy must sacrifice more and more units of consumer goods to produce an additional increment of capital goods. Note that more consumer goods must be given up in moving from E to F than in moving from A to B, although in each case the gain in capital goods is 10 million units. Points inside the PPF, such as I, represent inefficient use of resources. Points outside the PPF, such as U, represent unattainable combinations.
Microeconomic Principles
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The Shape of the PPF Movement down along PPF –Give up some of the good on the y-axis to get more of the good on the x-axis. Slope of PPF ◦Opportunity cost of 1 unit of the good on the x-axis Law of increasing opportunity costs –To produce more of one good, a successively larger amount of the other good must be sacrificed Resources are different, not equally adaptable to all goods.
Therefore, the PPF is concave. What Can Shift the PPF? Economic growth –An increase in the economy’s ability to produce goods and services –Outward shift of the economy’s PPF Due to: 1.Changes in resource availability 2.Increases in capital stock 3.Technological change 4.Improvements in the rules of the game Shifts of the Economy’s PPF (a) Increase in available resources, technology breakthrough, or improvement in the rules of the game
(b) Decrease in available resources or greater uncertainty in the rules of the game
When the resources available to an economy change, the PPF shifts. If more resources become available, if technology improves, or if the rules of the game improve, the PPF shifts outward, as in panel (a), indicating that more output can be produced. A decrease in available resources causes the PPF to shift inward, as in panel (b)
(c) Change in resources, technology, or rules that benefits consumer goods
Microeconomic Principles
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(d) Change in resources, technology, or rules that benefits capital goods
Panel (c) shows a change affecting consumer goods production. More consumer goods can now be produced at any given level of capital goods. Panel (d) shows a change affecting capital goods production.
Week 2
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Microeconomic Principles
Producer (firm) Theory –Producer Choices & Constraints –Chapter 13 Please note: the numerical examples in these slides are taken from the “Producer Theory Reading” in the ‘Readings’ folder on iLearn. This is to give you an additional set of examples, other than the one covered in your textbook. Threshold Concepts of Economics engaged in this Topic Economic Models Opportunity Cost Marginal Analysis * * the main threshold concept engaged in this topic Cost and Profit Producers Aim Maximise Profit Calculate profit = Total revenue – total costs Opportunity cost ◦All resources have an opportunity cost Explicit Costs - land(rent), labour(wages), capital(interest). ◦Opportunity cost of resources employed by a firm ◦Actual payments ◦On the accounting statement Implicit Costs enterprise (normal profit). owners would want compensation for being part of the firm minimum profit liked to make. ANY profit above normal profit is called “Supernormal profit” or economic profit. ◦A firm’s opportunity cost of using its own resources or those provided by its owners ◦Without a corresponding actual payment ◦Not on the accounting statement Models have two dimensions. Assume two resources. 1. Labour
2. Capital
Alternative Measures of Profit Accounting Profit ◦Total revenue minus explicit costs Economic Profit (a.k.a. Supernormal Profit) ◦Total revenue minus all costs(implicit and explicit) Opportunity cost of all resources Opportunity costs include the profit that an entreprenure would make running another business. Normal Profit ◦The minimum profit required by the entrepreneur/s. ◦This is therefore equal to the opportunity cost of entrepreneurship. E.g.: Wheeler Dealer Accounts, 2015 Production in the Short Run Variable Resources ◦Can be varied in the short run to an increase or decrease in production – does change with level of output. – labour is a variable resource Fixed Resources ◦Cannot be varied in the short run – does not change with level of output. – capital remains fixed until it reaches threshold. E.g building can hold 1000 people. (Already paid for). Short Run ◦At least one resource is fixed – not long enough to vary every single resource. Long Run ◦No resource is fixed – do have enough time to vary all resources.
Production Terminology
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Microeconomic Principles >Total Product (TP) ◦A firm’s total output >Production function ◦Relationship between amount of resources employed and total product -----3 stages of the production process -Total product curve. -----1st stage increasing at an increasing rate. – workers are specialising 2nd stage increasing at a decreasing rate. – crowding around same fixed capital 3rd stage decreasing. – so many variable resources on the fixed resource that the output goes backwards altogether.
Generic version of Total Product Curve - No business wants to go to stage three.
----->Marginal (extra) Product (MP)
- extra product produced by the extra worker (size of each jump).
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Microeconomic Principles ◦Change in total product from an additional unit of resource ◦Other things constant e.g. 1 worker makes 4, 2 workers make 8
therefore the jump is 4.
If it goes negative thus the TP (total product) is decreasing. Generic version of MP.
“The law of Diminishing marginal returns” Marginal Returns Increasing marginal returns ◦Marginal product increases Diminishing marginal returns ◦Marginal product decreases Law of diminishing marginal returns ◦As more of a variable resource is added to a given amount of another resource ◦Marginal product eventually declines Could become negative E.g.: The Short-Run Relationship Between Units of Labour and Tons of Furniture Moved
Marginal product increases as the firm hires each of the first three workers, reflecting increasing marginal returns. Then marginal product declines, reflecting diminishing marginal returns. Adding more workers may, at some point, actually reduce total product (as occurs here with an eighth worker) because workers start getting in each other’s way.
Microeconomic Principles
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The Total and Marginal Product of Labour
Labour Costs in the Short Run Fixed Cost, FC ◦Any production cost that is independent of the firm’s rate of output Variable Cost, VC ◦Any production cost that changes as the rate of output changes Total cost, TC = TFC + TVC Total cost of a firm = Total of fixed (e.g. capital) cost + Total of variable (e.g labour) costs
TC and TVC are the opposite of TP
Increase at a decreasing rate than increase at an increasing rate. THUS, THIS IS THE OPPOSITE OF TP as TP goes up at an increasing rate then increases at a decreasing rate. (From before)
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Microeconomic Principles
TP (Total product) is simply the inverse (opposite) of TVC(total variable cost)
Marginal Cost, MC = ΔTC/ΔQ (Q= Quantity) (the triangle means ‘1 extra’) - Marginal cost is the extra cost of producing an extra unit of output. Marginal cost is essentially the slope. The rise/run.
Because the slop first goes down then up. Increases at a decreasing rate then increases at a increasing rate.
The law of diminishing marginal returns.
THIS IS THE OPPOSITE OF MARGINAL PRODUCT. ◦Change in total cost resulting from a one-unit change in output Changes in MC ◦Reflect changes in marginal productivity Increasing marginal returns ◦MC falls Diminishing marginal returns ◦MC increases e.g Boost on campus. Lease is a fixed cost. Staff – sell more boost juice higher amount of employess less… less employes thus, variable cost. E.g.: Short Run Total and Marginal Cost Data for Smoother Mover
Because of increasing marginal returns from the first three workers, marginal cost declines at first, as shown in column (6). Because of diminishing marginal returns beginning with the fourth worker, marginal cost starts increasing.
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Microeconomic Principles Costs in the Short Run Ct’d Total Fixed Cost curve ◦Straight horizontal line Total Variable Cost curve ◦Starts at the origin Total Cost curve ◦Total Fixed Cost curve + Total Variable Cost curve Slope of Total Cost curve ◦Marginal Cost E.g.: Total and Marginal Cost Curves for Smoother Mover
Average Cost in the Short Run Average Variable Cost, AVC = TVC/Q Average Fixed Cost, AFC = TFC/Q Average Total Cost, ATC = TC/Q ◦ATC = AFC + AVC
◦Variable cost divided by output(QUANTITY) ◦Fixed cost divided by quantity ◦Total cost divided by output
AFC – Decreases but does not ever reach 0.
Marginal cost (from before) (Average Total cost) (Average Variable Cost) An important relationship… When MC < average cost ◦The marginal pulls down the average When MC > average cost ◦The marginal pulls up the average U-shape of average cost curves ◦Law of diminishing marginal returns Therefore MC intersects AVC and ATC at their minimum points (min – the average cannot keep going down).
Microeconomic Principles
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E.g.: Short Run Total, Marginal, and Average Cost Data for Smoother Mover
Marginal cost first falls then increases because of increasing then diminishing marginal returns from labour. As long as marginal cost is below average cost, average cost declines. Once marginal cost exceeds average cost, average cost increases. Columns (4), (5), and (6) show the relation between marginal and average costs. E.g.: Average and Marginal Cost Curves for Smoother Mover
Costs in the Long Run - we have time to change all of our resources including our capital. Long Run ◦Planning horizon ◦All resources can be varied Firms plan for the long run Firms produce in the short run Economies of scale If the LRATC is going down it is called Economies of Scale ◦Forces that reduce a firm’s average cost ◦As the scale of operation increases in the long run
In the long run above there is not only one ATC (Average total cost) but there is two with TWO Capital resources which the cost is dropped from $12 to $9 with two resources instead of one. (SRun = $12 LRun = $9)
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Microeconomic Principles
The lowest point is called “Minimum efficient scale”
If we look at the lowest pointsof all the average cost curves. ITS CALLED The ‘long run average total cost curves’ (The lowest possible AC at each level of output when K(capital) is allowed to vary). Diseconomies of scale If the LRATC is going up it is called Economies of Scale ◦Forces that may eventually increase a firm’s average cost ◦As the scale of operation increases in the long run The idea is as the firm gets larger it reaches economies of scale however, as it gets too large the logistics of managing the huge firm causes the LRATC to go up. Costs in the Long Run Long run average cost curve ◦Indicates the lowest average cost of production At each rate of output when the scale of the firm varies ◦Planning curve ◦U-shaped Economies of scale Diseconomies of scale Short Run Average Total Cost Curves Form the Long Run Average Cost Curve, or Planning Curve
Curves SS’, MM’, and LL’ show short-run average total costs for small, medium, and large plants, respectively. For output less than qa, average cost is lowest when the plant is small. Between qaand qb, average cost is lowest with a medium-size plant. If output exceeds qb, the large plant offers the lowest average cost. The long-run average-cost curve connects these low cost segments of each curve and is identified as SabL’. Many Short Run ATC Curves Form a Firm’s Long Run Average Cost Curve, or Planning Curve
Microeconomic Principles
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With many possible plant sizes, the long-run average cost curve is the envelope of portions of the short-run average cost curves. Each short-run curve is tangent to the long-run average cost curve. Each point of tangency represents the least-cost way of producing that rate of output.
Constant long run average cost (IF) Constant long run average cost ◦Over some range of output ◦Long-run average cost neither increases nor decreases with changes in firm size ◦No economies of scale ◦No diseconomies of scale A Firm’s Long Run Average Cost Curve
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Microeconomic Principles Week 3
Perfect Competition Threshold Concepts of Economics engaged in this Topic Economic Models Opportunity Cost * Marginal Analysis * the main threshold concept engaged in this topic Market Structures Market structure – a catergory that we slot real industries into based on certain features – 4 categories: 1. Perfect competition – very many firms, no barriers to entry e.g foreign exchange market. 2. Monopoly – one firm in industry e.g the star casino 3. Monopolistic competition – Many firms 4. Oligopoly – ◦Number of suppliers ◦Product’s degree of uniformity ◦Ease of entry into the market ◦Forms of competition among forms A firm’s decisions ◦How much to produce; what price to charge ◦Depend on the structure of the market Perfectly Competitive Market Perfect competition ◦Many buyers and sellers ◦Commodity; standardized product ◦Fully informed buyers and sellers ◦No barriers to entry Identical products, and standardised Perfect information – correct and easy to find out about the product. E.g very easy to find price of aus dollar. Individual buyer or seller ◦No control over price ◦Price takers Demand under Perfect Competition Market price ◦Determined by supply and demand ◦(more on this in the NEXT topic) Market decides price not the firm. Can’t decide price but can decide the quantity. This is decided through marginal analysis (marginal revenue VS marginal cost) Marginal revenue: The extra revenue from one extra unit calculated as change in total revenue divided by change in total quantity.
Microeconomic Principles
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Thus in perfect competition the MR = P (marginal revenue = price). Now let’s look at marginal cost.
Should stop producing when MC is higher than MR which could lead to a loss. The point where they both meet is known as MR = MC which is called the “Profit maximising rule”. In the situation of a loss the profit maxismising rule becomes the “loss minimising rule”. Demand curve facing one supplier ◦Horizontal line at the market price ◦Perfectly sensitive to the price. Price taker ◦Firm that faces a given market price ◦Its quantity supplied has no effect on that price ◦Perfectly competitive firm that decides to produce must accept, or “take,” the market price
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Microeconomic Principles Market equilibrium & firm’s demand curve in perfect competition
In panel (a), the market price of $5 is determined by the intersection of the market demand and market supply curves. A perfectly competitive firm can sell any amount at that price. The demand curve facing the perfectly competitive firm is horizontal at the market price, as shown by demand curve d in panel (b). Market equilibrium & firm’s demand curve in perfect competition
The market price of $5 is determined by the market. A perfectly competitive firm can sell any amount at that price. The demand curve facing the perfectly competitive firm is horizontal at the market price, as shown by the demand curve in panel (b). Short Run Profit Maximization Maximize economic profit ◦Quantity at which total revenue exceeds total cost by the greatest amount Total revenue, TR Total cost, TC Profit = TR –TC If TR > TC: economic profit If TC > TR: economic loss TOTAL PROFIT = TOTAL REVENUE – TOTAL COST HOW DO WE CALCULATE TR AND TC? PRICE X Q = TR
AVERAGE TOTAL COST X Q = TC
THE Q IS COMMON THUS, THE EQUATION (P-ATC)Q = TOTAL PROFIT
Microeconomic Principles
MICROECONOMIC PRINCIPLES WEEK 1
Introduction to Economics & The Production Possibilities Frontier Threshold Concepts of Economics engaged in this Topic Economic Models * Opportunity Cost Marginal Analysis *the main threshold concept engaged in this topic The Economic Problem Wants, desires: unlimited Resources: scarce –Not freely available Economic choice Economics –How people use scarce resources to satisfy unlimited wants Wants: unlimited Resources: scarce; not freely available Therefore we need to make choices Economics –How people use scarce resources to satisfy unlimited wants Microeconomics vs Macroeconomics Microeconomics –Study of the economic behaviour in particular markets Individual agents’ economic choices Markets coordinate the choices of economic decision makers Macroeconomics –Study of the economic behaviour of entire economies Resources Inputs / Factors of Production ◦Used to produce goods and services Goods and services are scarce because resources are scarce 1.Labour 2.Capital (not financial) 3.Natural resources 4.Entrepreneurial ability Labour –Physical and mental effort used to produce goods and services –We allocate our time to different uses –Payment: Wage
Microeconomic Principles
Capital –Buildings, equipment, and human skills used to produce goods and services –Physical capital Human creations used to produce goods and services –Human capital Knowledge and skill people acquire to increase their productivity –Payment for physical capital: Interest Natural resources –All gifts of nature –Renewable resource Can be drawn on indefinitely if used conservatively –Exhaustible resource Does not renew itself Available in a limited amount –Payment: Rent Entrepreneurial ability –Imagination required to develop a new product or process –Skill needed to organize production –Willingness to take the risk of profit or loss –Payment: Profit - market driven: Market determined ‘wage’ for level of entrepreneurial ability Entrepreneur –Profit-seeking decision maker who starts with an idea –Organizes an enterprise to bring that idea to life –Assumes the risk of the operation Goods and Services Good –Tangible product used to satisfy human wants Service –Activity, or intangible product, used to satisfy human wants
Economic Decision Makers -Households ◦Consumers -Demand goods and services ◦Resource owners -Supply resources -Firms, Governments, Rest of the World -Demand resources ◦Produce goods and services Markets Market –Set of arrangements by which buyers and sellers carry out exchange at mutually agreeable terms Product markets –Goods and services are bought and sold Resource markets –Resources are bought and sold
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Microeconomic Principles
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The simple circular-flow model for households and firms Most basic macroeconomic model Households earn income by supplying resources (e.g. labor) to the resource market, as shown in the lower portion of the model. Firms demand these resources to produce goods and services, which they supply to the product market, as shown in the upper portion of the model. Households spend their income to demand these goods and services. This spending flows through the product market as revenue to firms.
Rational Self-Interest Individuals are assumed to be rational ◦Make the best choice, Given the available information ◦Maximise expected benefit Assumed to be independent of framing (framing is how a choice is presented) - marketing. With a given cost ◦Minimise expected cost For a given benefit Marginal Analysis Comparison ◦Expected marginal benefit (what I will gain) ◦Expected marginal cost (what I have to give up) Marginal ◦Incremental, additional, extra The Scientific Method Variable (say price of petrol) –A measure that can take on different values at different times Other-things-constant assumption –Other variables remain unchanged –Ceteris paribus
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Microeconomic Principles Choice and Opportunity Cost Make a choice ◦Pass up another opportunity Opportunity cost ◦The value of the best alternative forgone when an item or activity is chosen ◦Opportunity lost THRESHOLD CONCEPT Economic Models Economic Model ◦Simplification of economic reality ◦Assumptions are made to build the model ◦The model is used to make predictions A model is a tool for economic agents and if it is a good model will help make good decisions. First Model –The PPF Production Possibilities Frontier (PPF)
- frontier (when you can’t produce more of one good without giving up some of the other.)
Assumptions ◦Two products ◦Given time frame, e.g. 1 year ◦Fixed resources (quantity, quality) ◦Fixed technology (quantity, quality) ◦Fixed ‘rules of the game’ (no changes) Efficiency and the PPF Efficiency –When there is no way resources can be reallocated to increase the production of one good without decreasing the production of another –Getting the most from available resources Inefficient combinations –inside the PPF Unattainable combinations -outside The Economy’s Production Possibilities Frontier If the economy uses its available resources and technology efficiently to produce consumer goods and capital goods, that economy is on the production possibilities frontier, AF. The PPF is bowed out to reflect the law of increasing opportunity cost; the economy must sacrifice more and more units of consumer goods to produce an additional increment of capital goods. Note that more consumer goods must be given up in moving from E to F than in moving from A to B, although in each case the gain in capital goods is 10 million units. Points inside the PPF, such as I, represent inefficient use of resources. Points outside the PPF, such as U, represent unattainable combinations.
Microeconomic Principles
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The Shape of the PPF Movement down along PPF –Give up some of the good on the y-axis to get more of the good on the x-axis. Slope of PPF ◦Opportunity cost of 1 unit of the good on the x-axis Law of increasing opportunity costs –To produce more of one good, a successively larger amount of the other good must be sacrificed Resources are different, not equally adaptable to all goods.
Therefore, the PPF is concave. What Can Shift the PPF? Economic growth –An increase in the economy’s ability to produce goods and services –Outward shift of the economy’s PPF Due to: 1.Changes in resource availability 2.Increases in capital stock 3.Technological change 4.Improvements in the rules of the game Shifts of the Economy’s PPF (a) Increase in available resources, technology breakthrough, or improvement in the rules of the game
(b) Decrease in available resources or greater uncertainty in the rules of the game
When the resources available to an economy change, the PPF shifts. If more resources become available, if technology improves, or if the rules of the game improve, the PPF shifts outward, as in panel (a), indicating that more output can be produced. A decrease in available resources causes the PPF to shift inward, as in panel (b)
(c) Change in resources, technology, or rules that benefits consumer goods
Microeconomic Principles
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(d) Change in resources, technology, or rules that benefits capital goods
Panel (c) shows a change affecting consumer goods production. More consumer goods can now be produced at any given level of capital goods. Panel (d) shows a change affecting capital goods production.
Week 2
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Microeconomic Principles
Producer (firm) Theory –Producer Choices & Constraints –Chapter 13 Please note: the numerical examples in these slides are taken from the “Producer Theory Reading” in the ‘Readings’ folder on iLearn. This is to give you an additional set of examples, other than the one covered in your textbook. Threshold Concepts of Economics engaged in this Topic Economic Models Opportunity Cost Marginal Analysis * * the main threshold concept engaged in this topic Cost and Profit Producers Aim Maximise Profit Calculate profit = Total revenue – total costs Opportunity cost ◦All resources have an opportunity cost Explicit Costs - land(rent), labour(wages), capital(interest). ◦Opportunity cost of resources employed by a firm ◦Actual payments ◦On the accounting statement Implicit Costs enterprise (normal profit). owners would want compensation for being part of the firm minimum profit liked to make. ANY profit above normal profit is called “Supernormal profit” or economic profit. ◦A firm’s opportunity cost of using its own resources or those provided by its owners ◦Without a corresponding actual payment ◦Not on the accounting statement Models have two dimensions. Assume two resources. 1. Labour
2. Capital
Alternative Measures of Profit Accounting Profit ◦Total revenue minus explicit costs Economic Profit (a.k.a. Supernormal Profit) ◦Total revenue minus all costs(implicit and explicit) Opportunity cost of all resources Opportunity costs include the profit that an entreprenure would make running another business. Normal Profit ◦The minimum profit required by the entrepreneur/s. ◦This is therefore equal to the opportunity cost of entrepreneurship. E.g.: Wheeler Dealer Accounts, 2015 Production in the Short Run Variable Resources ◦Can be varied in the short run to an increase or decrease in production – does change with level of output. – labour is a variable resource Fixed Resources ◦Cannot be varied in the short run – does not change with level of output. – capital remains fixed until it reaches threshold. E.g building can hold 1000 people. (Already paid for). Short Run ◦At least one resource is fixed – not long enough to vary every single resource. Long Run ◦No resource is fixed – do have enough time to vary all resources.
Production Terminology
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Microeconomic Principles >Total Product (TP) ◦A firm’s total output >Production function ◦Relationship between amount of resources employed and total product -----3 stages of the production process -Total product curve. -----1st stage increasing at an increasing rate. – workers are specialising 2nd stage increasing at a decreasing rate. – crowding around same fixed capital 3rd stage decreasing. – so many variable resources on the fixed resource that the output goes backwards altogether.
Generic version of Total Product Curve - No business wants to go to stage three.
----->Marginal (extra) Product (MP)
- extra product produced by the extra worker (size of each jump).
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Microeconomic Principles ◦Change in total product from an additional unit of resource ◦Other things constant e.g. 1 worker makes 4, 2 workers make 8
therefore the jump is 4.
If it goes negative thus the TP (total product) is decreasing. Generic version of MP.
“The law of Diminishing marginal returns” Marginal Returns Increasing marginal returns ◦Marginal product increases Diminishing marginal returns ◦Marginal product decreases Law of diminishing marginal returns ◦As more of a variable resource is added to a given amount of another resource ◦Marginal product eventually declines Could become negative E.g.: The Short-Run Relationship Between Units of Labour and Tons of Furniture Moved
Marginal product increases as the firm hires each of the first three workers, reflecting increasing marginal returns. Then marginal product declines, reflecting diminishing marginal returns. Adding more workers may, at some point, actually reduce total product (as occurs here with an eighth worker) because workers start getting in each other’s way.
Microeconomic Principles
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The Total and Marginal Product of Labour
Labour Costs in the Short Run Fixed Cost, FC ◦Any production cost that is independent of the firm’s rate of output Variable Cost, VC ◦Any production cost that changes as the rate of output changes Total cost, TC = TFC + TVC Total cost of a firm = Total of fixed (e.g. capital) cost + Total of variable (e.g labour) costs
TC and TVC are the opposite of TP
Increase at a decreasing rate than increase at an increasing rate. THUS, THIS IS THE OPPOSITE OF TP as TP goes up at an increasing rate then increases at a decreasing rate. (From before)
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Microeconomic Principles
TP (Total product) is simply the inverse (opposite) of TVC(total variable cost)
Marginal Cost, MC = ΔTC/ΔQ (Q= Quantity) (the triangle means ‘1 extra’) - Marginal cost is the extra cost of producing an extra unit of output. Marginal cost is essentially the slope. The rise/run.
Because the slop first goes down then up. Increases at a decreasing rate then increases at a increasing rate.
The law of diminishing marginal returns.
THIS IS THE OPPOSITE OF MARGINAL PRODUCT. ◦Change in total cost resulting from a one-unit change in output Changes in MC ◦Reflect changes in marginal productivity Increasing marginal returns ◦MC falls Diminishing marginal returns ◦MC increases e.g Boost on campus. Lease is a fixed cost. Staff – sell more boost juice higher amount of employess less… less employes thus, variable cost. E.g.: Short Run Total and Marginal Cost Data for Smoother Mover
Because of increasing marginal returns from the first three workers, marginal cost declines at first, as shown in column (6). Because of diminishing marginal returns beginning with the fourth worker, marginal cost starts increasing.
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Microeconomic Principles Costs in the Short Run Ct’d Total Fixed Cost curve ◦Straight horizontal line Total Variable Cost curve ◦Starts at the origin Total Cost curve ◦Total Fixed Cost curve + Total Variable Cost curve Slope of Total Cost curve ◦Marginal Cost E.g.: Total and Marginal Cost Curves for Smoother Mover
Average Cost in the Short Run Average Variable Cost, AVC = TVC/Q Average Fixed Cost, AFC = TFC/Q Average Total Cost, ATC = TC/Q ◦ATC = AFC + AVC
◦Variable cost divided by output(QUANTITY) ◦Fixed cost divided by quantity ◦Total cost divided by output
AFC – Decreases but does not ever reach 0.
Marginal cost (from before) (Average Total cost) (Average Variable Cost) An important relationship… When MC < average cost ◦The marginal pulls down the average When MC > average cost ◦The marginal pulls up the average U-shape of average cost curves ◦Law of diminishing marginal returns Therefore MC intersects AVC and ATC at their minimum points (min – the average cannot keep going down).
Microeconomic Principles
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E.g.: Short Run Total, Marginal, and Average Cost Data for Smoother Mover
Marginal cost first falls then increases because of increasing then diminishing marginal returns from labour. As long as marginal cost is below average cost, average cost declines. Once marginal cost exceeds average cost, average cost increases. Columns (4), (5), and (6) show the relation between marginal and average costs. E.g.: Average and Marginal Cost Curves for Smoother Mover
Costs in the Long Run - we have time to change all of our resources including our capital. Long Run ◦Planning horizon ◦All resources can be varied Firms plan for the long run Firms produce in the short run Economies of scale If the LRATC is going down it is called Economies of Scale ◦Forces that reduce a firm’s average cost ◦As the scale of operation increases in the long run
In the long run above there is not only one ATC (Average total cost) but there is two with TWO Capital resources which the cost is dropped from $12 to $9 with two resources instead of one. (SRun = $12 LRun = $9)
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Microeconomic Principles
The lowest point is called “Minimum efficient scale”
If we look at the lowest pointsof all the average cost curves. ITS CALLED The ‘long run average total cost curves’ (The lowest possible AC at each level of output when K(capital) is allowed to vary). Diseconomies of scale If the LRATC is going up it is called Economies of Scale ◦Forces that may eventually increase a firm’s average cost ◦As the scale of operation increases in the long run The idea is as the firm gets larger it reaches economies of scale however, as it gets too large the logistics of managing the huge firm causes the LRATC to go up. Costs in the Long Run Long run average cost curve ◦Indicates the lowest average cost of production At each rate of output when the scale of the firm varies ◦Planning curve ◦U-shaped Economies of scale Diseconomies of scale Short Run Average Total Cost Curves Form the Long Run Average Cost Curve, or Planning Curve
Curves SS’, MM’, and LL’ show short-run average total costs for small, medium, and large plants, respectively. For output less than qa, average cost is lowest when the plant is small. Between qaand qb, average cost is lowest with a medium-size plant. If output exceeds qb, the large plant offers the lowest average cost. The long-run average-cost curve connects these low cost segments of each curve and is identified as SabL’. Many Short Run ATC Curves Form a Firm’s Long Run Average Cost Curve, or Planning Curve
Microeconomic Principles
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With many possible plant sizes, the long-run average cost curve is the envelope of portions of the short-run average cost curves. Each short-run curve is tangent to the long-run average cost curve. Each point of tangency represents the least-cost way of producing that rate of output.
Constant long run average cost (IF) Constant long run average cost ◦Over some range of output ◦Long-run average cost neither increases nor decreases with changes in firm size ◦No economies of scale ◦No diseconomies of scale A Firm’s Long Run Average Cost Curve
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Microeconomic Principles Week 3
Perfect Competition Threshold Concepts of Economics engaged in this Topic Economic Models Opportunity Cost * Marginal Analysis * the main threshold concept engaged in this topic Market Structures Market structure – a catergory that we slot real industries into based on certain features – 4 categories: 1. Perfect competition – very many firms, no barriers to entry e.g foreign exchange market. 2. Monopoly – one firm in industry e.g the star casino 3. Monopolistic competition – Many firms 4. Oligopoly – ◦Number of suppliers ◦Product’s degree of uniformity ◦Ease of entry into the market ◦Forms of competition among forms A firm’s decisions ◦How much to produce; what price to charge ◦Depend on the structure of the market Perfectly Competitive Market Perfect competition ◦Many buyers and sellers ◦Commodity; standardized product ◦Fully informed buyers and sellers ◦No barriers to entry Identical products, and standardised Perfect information – correct and easy to find out about the product. E.g very easy to find price of aus dollar. Individual buyer or seller ◦No control over price ◦Price takers Demand under Perfect Competition Market price ◦Determined by supply and demand ◦(more on this in the NEXT topic) Market decides price not the firm. Can’t decide price but can decide the quantity. This is decided through marginal analysis (marginal revenue VS marginal cost) Marginal revenue: The extra revenue from one extra unit calculated as change in total revenue divided by change in total quantity.
Microeconomic Principles
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Thus in perfect competition the MR = P (marginal revenue = price). Now let’s look at marginal cost.
Should stop producing when MC is higher than MR which could lead to a loss. The point where they both meet is known as MR = MC which is called the “Profit maximising rule”. In the situation of a loss the profit maxismising rule becomes the “loss minimising rule”. Demand curve facing one supplier ◦Horizontal line at the market price ◦Perfectly sensitive to the price. Price taker ◦Firm that faces a given market price ◦Its quantity supplied has no effect on that price ◦Perfectly competitive firm that decides to produce must accept, or “take,” the market price
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Microeconomic Principles Market equilibrium & firm’s demand curve in perfect competition
In panel (a), the market price of $5 is determined by the intersection of the market demand and market supply curves. A perfectly competitive firm can sell any amount at that price. The demand curve facing the perfectly competitive firm is horizontal at the market price, as shown by demand curve d in panel (b). Market equilibrium & firm’s demand curve in perfect competition
The market price of $5 is determined by the market. A perfectly competitive firm can sell any amount at that price. The demand curve facing the perfectly competitive firm is horizontal at the market price, as shown by the demand curve in panel (b). Short Run Profit Maximization Maximize economic profit ◦Quantity at which total revenue exceeds total cost by the greatest amount Total revenue, TR Total cost, TC Profit = TR –TC If TR > TC: economic profit If TC > TR: economic loss TOTAL PROFIT = TOTAL REVENUE – TOTAL COST HOW DO WE CALCULATE TR AND TC? PRICE X Q = TR
AVERAGE TOTAL COST X Q = TC
THE Q IS COMMON THUS, THE EQUATION (P-ATC)Q = TOTAL PROFIT
