Microeconomics Unit 3 COMPLETE Summary - Production & Perfect Competition
Summary
TLDRIn this microeconomics tutorial, Jer Breed explores production functions, marginal products, and costs for firms in perfectly competitive markets. The video covers the law of diminishing marginal returns, fixed and variable costs, and how they influence total costs. It explains the calculation of marginal cost, average costs, and how they intersect with marginal revenue for profit maximization. The tutorial also discusses long-term cost implications, economic vs. accounting profit, and how firms adjust to market changes to reach long-run equilibrium, emphasizing efficiency in perfectly competitive markets.
Takeaways
- ๐ The production function shows the relationship between the quantity of labor hired and the output produced, with diminishing marginal returns setting in as more workers are hired.
- ๐ Marginal product increases initially due to specialization, then decreases, and can eventually become negative as more workers are added.
- ๐ธ Fixed costs remain constant regardless of output, while variable costs increase as production increases; total costs are the sum of fixed and variable costs.
- ๐ Marginal cost is calculated as the change in total cost divided by the change in output and typically forms a U-shape on a graph.
- โ๏ธ Firms aim for profit maximization where marginal revenue equals marginal cost; this is the point at which producing more units is no longer profitable.
- ๐ท๏ธ In a perfectly competitive market, firms are price takers, selling identical products, with zero economic profit in the long run.
- ๐ Long run costs involve all costs being variable, allowing businesses to change their production capacity by expanding factories or hiring more labor.
- ๐ Economies of scale allow firms to reduce average costs as they expand, while diseconomies of scale lead to higher costs as firms grow too large.
- ๐งฎ Economic profit considers both explicit and implicit costs, with zero economic profit known as normal profit.
- โ๏ธ Perfectly competitive firms are both allocatively and productively efficient in the long run, producing at the lowest average total cost.
Q & A
What is the production function in microeconomics?
-A production function shows the relationship between the quantity of labor a firm hires and the quantity of output produced by that labor. It illustrates how changes in labor affect total output.
What are the three phases of the law of diminishing marginal returns?
-The three phases are: 1) Increasing returns: Marginal product rises as specialization occurs. 2) Diminishing returns: Marginal product falls but remains positive. 3) Negative returns: Marginal product becomes negative, decreasing total output.
How is marginal product calculated?
-Marginal product is calculated by taking the change in total product and dividing it by the change in labor quantity. Since the change in labor is usually one worker, it equals the change in total product due to hiring an additional worker.
What is the difference between fixed costs and variable costs?
-Fixed costs do not change with output, such as capital and land. Variable costs, like labor and electricity, change with the quantity of output produced.
What does the marginal cost curve represent, and how is it related to marginal product?
-The marginal cost curve shows the cost of producing one additional unit of output. It is inversely related to marginal product; when marginal product rises, marginal cost falls, and when marginal product falls, marginal cost rises.
What is the relationship between marginal cost and average cost curves?
-The marginal cost curve intersects the average variable cost and average total cost curves at their lowest points. When marginal cost is below the average cost, the average cost is falling. When itโs above, the average cost is rising.
What is the concept of productive efficiency?
-Productive efficiency occurs when a firm produces at the lowest possible average cost. This happens at the minimum point of the average total cost curve, known as the productively efficient quantity.
How are economic profit and accounting profit different?
-Accounting profit is calculated by subtracting explicit costs from total revenue. Economic profit also subtracts implicit costs (opportunity costs) from total revenue, making it a lower figure than accounting profit.
What is the profit-maximizing rule for firms?
-Firms maximize profit by producing at the quantity where marginal revenue equals marginal cost. This ensures that the firm is not producing too much (increasing costs) or too little (missing out on revenue).
What are the characteristics of a perfectly competitive market?
-In a perfectly competitive market, there are many firms selling identical products, with no influence on price (price takers), low barriers to entry, and zero economic profit in the long run due to competition.
Outlines
๐ Introduction to Microeconomics: Production and Competitive Markets
The video introduces the concept of production functions in microeconomics, focusing on the relationship between labor and output in perfectly competitive markets. It explains how a production function charts labor against output and calculates marginal productโthe change in output from hiring additional workers. This section also covers the law of diminishing marginal returns, which states that after a certain point, adding more workers results in less efficient production, even leading to negative returns in some cases. A graph visualizing these concepts is introduced to better understand the dynamics of labor productivity.
๐ก Fixed and Variable Costs Explained
This paragraph dives into the different types of costs in production: fixed costs (which do not change with output levels) and variable costs (which increase with higher output). Total cost is the sum of both fixed and variable costs. A graph is presented to illustrate the relationships between these costs and how they impact total production costs. Additionally, the marginal cost, which represents the cost of producing one more unit, is introduced alongside average variable cost and average total cost, explaining how they interact on a graph, especially at critical points such as when they intersect.
๐ Economies and Diseconomies of Scale
Here, the concept of long-run costs is explored, where all costs become variable as firms can change their capacity by expanding or contracting production. The paragraph introduces economies of scale, where increasing production lowers the average cost, followed by constant returns to scale, where production increases at the same rate as inputs. Finally, diseconomies of scale are discussed, where increasing production leads to inefficiencies, raising the average cost. These changes are explained through a graph that highlights long-run average total costs.
๐ฐ Profit and Maximization in Business
This section focuses on profit maximization, comparing accounting profit (total revenue minus explicit costs) with economic profit (which also subtracts opportunity costs). It explains how firms aim to maximize profit by producing the quantity where marginal revenue equals marginal cost. The paragraph also covers normal profit, where economic profit is zero, and how businesses use marginal analysis to make production decisions. A graph illustrating profit-maximizing behavior in perfectly competitive firms is presented to show the relationship between costs, revenue, and output levels.
๐๏ธ Perfect Competition: Market Equilibrium and Efficiency
The final part explains perfect competition, where many firms sell identical products with no price control, leading to zero economic profit in the long run. It introduces the concepts of allocative and productive efficiency, explaining how in perfect competition, firms produce at both marginal cost and minimum average total cost in the long run. The paragraph also describes how supply and demand shifts bring firms back to long-run equilibrium, ensuring zero economic profit. Lastly, it discusses less common topics like increasing cost industries and the perfectly elastic long-run supply curve.
Mindmap
Keywords
๐กProduction Function
๐กMarginal Product
๐กLaw of Diminishing Marginal Returns
๐กMarginal Cost of Labor
๐กFixed Costs
๐กVariable Costs
๐กTotal Costs
๐กMarginal Cost
๐กAverage Variable Cost
๐กAverage Total Cost
๐กProductive Efficiency
๐กPerfect Competition
Highlights
Introduction to Unit 3 Microeconomics, focusing on production and perfectly competitive markets and firms.
Explanation of the production function: relationship between the quantity of labor hired and the output produced.
Definition and calculation of marginal product: change in total product divided by the change in labor quantity.
Description of the law of diminishing marginal returns, highlighting three phases: increasing returns, diminishing returns, and negative returns.
Marginal product curve explained, showing how it increases, then decreases, and eventually turns negative as more workers are hired.
Introduction to fixed costs (constant regardless of output) and variable costs (change with the quantity of output).
Total cost is the sum of fixed and variable costs; graphs show how fixed costs are horizontal, while variable costs increase with output.
Marginal cost is defined as the change in total cost divided by the change in quantity, showing a 'Nike Swoosh' shape in the graph.
Average variable cost and average total cost intersect marginal cost curves at their minimum points.
Key concept: productive efficiency occurs at the minimum average total cost, where the lowest production cost is achieved.
Discussion of economies of scale: larger businesses see lower average costs as output expands, explained through returns to scale.
Two types of profit: accounting profit (total revenue minus explicit costs) and economic profit (total revenue minus both explicit and implicit costs).
Firms maximize profits where marginal revenue equals marginal cost, a critical point in business decision-making.
Perfect competition described with key characteristics: many firms, identical products, low barriers to entry, and price-taking behavior.
Efficiency of perfectly competitive firms explained, with allocative efficiency and productive efficiency in the long run.
Transcripts
hi everybody Jer breed here from review
eon.com today we're going to be looking
at unit three for microeconomics this is
all about production and perfectly
competitive markets and firms this video
goes along with the total review booklet
from reviewe eon.com if you want to
purchase that head down to the links
below if you want to support this
Channel please like And subscribe as
well let's get into the content
first thing we're going to look at is
the production function a production
function shows the relationship between
the quantity of Labor a firm or business
hires and the quantity of output that
that number of workers produces here is
what it looks like on the chart we have
a table with the quantity of Labor this
is the number of workers hired and the
total product that's the number of units
of output these workers are able to
produce at one unit of Labor we will
have 10 units of output based on this
chart at two units of Labor we have 25
units of output at three units of Labor
we have 36 units of output four units of
Labor we have 46 units of output at five
units of Labor we've got 50 units of
output and at six units of Labor we drop
down to 48 in order to understand the
production function more clearly we need
to calculate the marginal product of
these workers to find the marginal
product you take the change in total
product and divide it by the change in
quantity since the change in quantity is
just one worker all the way through the
chart we're just looking at the change
in total product as a result of hiring
one more worker let's calculate it for
that first worker our total product goes
from zero up to 10 that's a marginal
product of 10 units of output for the
second worker our marginal product is 15
because we go from 10 total product up
to 25 total product keep on going and
our marginal product goes all the way
down to that last worker where we've got
-2 if we look at these numbers we see
three phases of the law of diminishing
marginal returns at the top those first
few workers that are hired we see
increasing Returns the total product is
increasing at an increasing rate
marginal product is rising we call that
increasing returns and it is as a result
of
specialization next we see the marginal
product starts to fall we call that
diminishing returns as we hire more
workers the marginal product Falls total
product is rising but at a decreasing
rate finally we see negative returns
that is where adding more workers
actually decreases total product
marginal product is negative let's take
a look at the graph here we have a
marginal product curve based on similar
numbers to what we just saw as you hire
more workers in the beginning the
marginal product increases then as you
hire more workers diminishing return
sets in and marginal product begins to
fall finally you have negative returns
as the marginal product is negative
those are the three phases of the law of
diminishing marginal returns in graph
form we can use the marginal product of
labor to calculate the marginal cost of
Labor in order to find that you take the
wage that you are paying your workers
and divide it by the marginal product of
those workers on the graph the marginal
cost of Labor looks like a flipped
upside down version of the marginal
product curve as the marginal cost of
Labor is downward sloping that is the
increasing returns phase of the marginal
product curve here we have
specialization causing the downward
slope of that marginal product of labor
curve as diminishing return sets in the
marginal cost of Labor curve upward
slopes that's diminishing returns now
we're going to look at two main
categories of cost for businesses first
we have fixed cost fixed costs are the
costs associated with production that
don't change with output producing zero
quantity of output is the same cost as
producing 100,000 quantity of output
Capital land those are both fixed costs
at least in the short run variable costs
on the other hand change with the co
quantity of output producing zero units
of output will have zero variable costs
producing five units of output will have
a much lower variable cost than
producing 100,000 units of output they
increase as more quantity of output is
produced things like labor electricity
those are variable costs and there are
lots of others total costs are fixed
costs and variable costs added together
two of those together give you your
total costs of production here we have a
table showing the values of fixed costs
variable cost and total costs for a firm
you'll notice the fixed costs don't
change the variable costs do change and
the total costs are always the fixed
cost and variable costs added together
if we graph it out it'll look something
like this the fixed cost is horizontal
because it doesn't change with the
quantity of output the variable cost
does change it starts off steep levels
off a bit and then tends to get steep
again generally speaking and you add
those two the variable cost and the
fixed cost together and that gives us
our total cost what that tells us is the
gap between the variable cost and the
total cost is the fixed cost here we see
in math form what marginal cost looks
like marginal cost is the change in
total cost divided by the change in
quantity here we're looking at the cost
of producing one more unit of output we
see our marginal cost of the first unit
is eight because our total cost goes
from $10 up to
$18 here we keep on going and we get the
overall marginal cost of production for
this firm if we graph it out it's going
to look like a Nike Swoosh it downward
slopes and then upward slopes next we're
going to calculate the average variable
cost how do you find the average of
anything divide by the quantity variable
cost of eight divided by a quantity of
one gives you a average variable cost of
eight keep on going down and you see
that all the way at six units the
average variable cost is $15 90 /
6 on the graph when we add the average
variable cost you'll notice that the
average variable cost intersects the
marginal cost curve at its minimum Point
make sure you notice that relationship
and remember it when you take your test
next we're going to look at the average
total cost just like before we're taking
the total cost and dividing by the
quantity because the average of anything
is the total of that thing divided by
the quantity here for
$18 with a quantity of one the average
total cost is 18 going all the way down
until we get to that sixth unit we're at
$16.70 worth of average total cost if we
add it to the graph we'll notice that
there's a similar relationship between
the average total cost and that marginal
cost as the marginal cost curve is below
the average total cost the average total
cost is falling once that marginal cost
is above the average total cost the
average total cost is rising that
relationship is important and make sure
you remember it on your next test and
that means that the average total cost
intersects the marginal cost curve at
its minimum point one thing to note is
the quantity at the minimum point of the
average total cost curve is called
productively efficient that is the
quantity that has the lowest average
cost of production productively
efficient so how do you find the average
fixed cost for this firm well the
average fixed cost is the gap between
the average total cost and the average
variable cost so that Gap right there is
your average fix cost you can find it at
any quantity so how would you be able to
find the total cost when you have a
graph like this showing average cost and
marginal cost well the total cost of
anything is the average of that thing
times the quantity so pick a quantity
and there we can go on up at this q1
point we have our average variable cost
there at P1 that gives us this square
right here of variable cost we could
calculate the area of that if there were
numbers and that would give us our total
variable cost if we keep on going up to
P2 at the average total cost there
calculate the area of that rectangle and
we will have our total cost how do we
find the fixed cost well it's the gap
between the two that rectangle there is
our fixed cost for q1 now those cost
curves can shift if there's a change in
production cost if there's a change in
fixed cost like advertising new
production equipment being purchased
that would move the average total cost
curve only only up with an increase down
with a decrease if we have a change in
variable cost that'll move the average
total cost curve the average variable
cost curve and the marginal cost curve
now let's look at long run costs in the
long run all costs are variable variable
costs are variable but fixed costs are
also variable because in the long run I
can buy new plants and equipment I can
also open up new stores new factories or
whatever it may be in the short run we
can change the rate of production I can
hire more workers I can speed up my
production I can slow down my production
I can produce more or less in the short
run long run changes are about capacity
of production if I'm opening up new
businesses opening up new plants or
factories that is a change in the
maximum production level of my business
and that is a capacity long run change
here's what long run costs look like on
the graph we get a long run average
total cost curve as a business EXP
expands into a larger and larger
business opening up new factories and
plants we see a downward sloping portion
of the long run average total cost curve
here average costs are falling we call
that economies of scale mathematically
we could call it returns to scale
doubling all of the inputs land labor
and capital will get more than double in
new output and we call that increasing
returns of scale average costs are
falling as this firm continues to expand
it's going to have a horizontal portion
of its long run total cost curve and
there we have constant returns to scale
as this firm continues to produce more
and more output it is doubling its
inputs and getting exactly double output
we call that constant returns to scale
average costs are staying constant most
businesses will eventually reach a point
where average costs in the long run
begin to rise the business is now
growing too large and it's becoming an
inefficient bureaucracy
here we call this diseconomies of scale
long run average costs are beginning to
increase as production is expanded we
call that decreasing returns to scale
mathematically you double your inputs
and get less than double for output next
we're going to look at profit remember
profit maximization is a basic
assumption in AP economics firms seek a
profit there are two types of profit the
first one is called accounting profit
the second one is called economic profit
now obviously since this is economics
that e economic profit is probably more
important but accounting profit shows up
on exams and you need to know it here's
the formula for accounting profit you
take the total revenue price times
quantity then you subtract your explicit
costs that's money paid by the
entrepreneur to operate their business
it's money directly out of their pocket
now economic profit is a lower number
and the reason why is because economists
will subtract not just the explicit cost
from total revenue but also the implied
costs entrepreneurs have opportunity
costs and we need to subtract those
opportunity costs to find the true
economic profit just so you're aware
there are explicit and implicit variable
costs and fixed costs so in those cost
curves we already looked at before there
are explicit and implicit costs within
all of those you may see a term normal
profit on your next exam normal profit
means that economic profit is zero it
means that accounting profit is equal to
the implicit costs of production next
we're going to look at production
decisions for individual businesses or
firms this is an application of marginal
analysis that you already learned about
back in unit one remember marginal
benefit equals marginal cost that is
your benefit maximizing Behavior but for
businesses we don't really look at
marginal benefit in business a firm's
benefit is revenue marginal revenue is
the change in total revenue divided by
the change in quantity this is the
Revenue brought in for producing one
more unit of output The Profit
maximizing quantity for a firm is found
and make sure that you write this down
because it's important it is found where
marginal revenue equals
margin where marginal revenue equals
marginal cost make sure you remember
that it shows up on the exam over and
over and over here's what it looks like
on the graph we have our marginal
revenue curve for a perfectly
competitive firm and we have our
marginal cost curve at lower quantities
here the marginal cost is less than the
marginal revenue that means this firm
will increase profit by continuing to
produce more units of output at higher
units of output we see that the marginal
cost is now greater than the marginal
revenue there the firm is losing profit
by increasing production they should
produce less The Profit maximizing point
is where marginal revenue equals
marginal cost it's where those two
curves intersect make sure you remember
that and jot it down because it'll be on
your test for sure now we're on to our
last topic this is perfect competition
you've already learned a little bit
about perfect competition it's the
supply and demand graph that you learned
back in unit 2 here are the qualities of
a perfectly competitive market we have
lots and lots of firms within this
Market they're also selling identical
products that means there's no name
brands or advertisements to distinguish
between the different products that are
available we also have low barriers to
entry that low barriers to entry means
that firm firms enter when others are
making profit and firms exit when others
are suffering economic losses that means
there is zero economic profit in the
long run for perfectly competitive firms
the last thing is that these firms have
no influence on price they are price
takers that means the market equilibrium
Price sets the price that each firm can
charge within a perfectly competitive
market you've already seen the market
graph for perfect competition we have a
downward sloping demand curve upward
sloping supply curve and that
intersection between those two curves
gives us our equilibrium price that
equilibrium price goes on over to the
firm graph and gives us our marginal
revenue curve it's the demand for the
firm that firm can sell as many units of
output as it wishes at that market price
that gives us our demand average revenue
and price we call it Mr darp now let's
throw on the other cost curves we
learned earlier at the intersection
between the marginal cost and the
marginal revenue curve we get a profit
maximizing quantity labeled qf here
since this firm's average total cost
curve is below the marginal revenue
curve at that profit maximizing quantity
this firm is earning an economic profit
you can always tell that a firm is
making an economic profit if the average
total cost is less than the equilibrium
price from the market at the firm's
profit maximizing quantity here we have
another firm and this firm is earning
economic losses the reason we know that
is because the average total cost curve
is greater than the equilibrium price
from the market now we have another
graph here this firm is earning zero
economic profit it's breaking even it's
earning a normal profit all of those are
the same thing and we call this long run
equilibrium because firms will earn zero
economic profit in a perfectly
competitive market in the long run so in
the long run the price from the market
equals the minimum of the average cost
curve make sure you know how to draw all
three of these graphs profit loss and
breaking even which is long run
equilibrium
next we're going to look at how firms
get to that long run equilibrium if they
are earning economic profits to start
this firm here is earning an economic
profit that economic profit is going to
cause firms to seek that profit firms
enter the market as a result in the
market that causes the supply curve to
shift to the right driving the price
down and increase in the quantity in the
market for the firm that causes the
marginal revenue demand average revenue
and price Mr darp to fall downward until
it reaches the minimum of the average
total cost curve special note when
you're drawing these graphs it goes
further than the bottom of that profit
box next we're going to look at a firm
that is earning economic losses those
economic losses will cause firms to exit
the market in the long run as firms exit
the market that causes the supply curve
to shift to the left driving the price
up and decreasing the equilibrium
quantity within the market back on the
firm graph the increase in the
equilibrium price from the market shifts
the Mr Dar marginal revenue demand
average revenue and price upward until
it hits the minimum of the average total
cost curve and there we are back at long
run equilibrium the firm is earning a
normal profit once again next we're
going to talk about efficiency for
perfectly competitive firms there are
two types of efficiency don't forget
there's allocative efficiency and
there's productive efficiency perfectly
competitive firms are allocatively
efficient in the long run and the short
run because price always equals marginal
cost for productive efficiency perfectly
competitive firms are productively
efficient in the long run because they
produce at the minimum average total
cost in the long run in the short run
that isn't true when the firm is earning
either economic losses or economic
profits the firm's average total cost is
greater than the minimum average total
cost we're going to take a step back for
just a moment and look at a firm's short
run supply curve here we have a graph
for a firm and we have the profit
maximizing quantity of qf at the current
equilibrium price the firm is currently
in Long Run equilibrium we're going to
add a point here because this is the
quantity that this firm would produce at
the current equilibrium price that is
one of the points on this firm's supply
curve if the price goes up the firm will
be earning economic profits in the short
RM run and they will produce a higher
quantity at that higher price that's our
second point on the firm's short run
supply curve if there was a decrease in
the equilibrium price from the market
The Firm would now be producing a lower
quantity qf there at the new lower price
this firm is now earning economic losses
but they aren't going to shut down
because these economic losses are less
than they would be if they shut down
because if the firm shuts down it has to
pay its fixed costs and the fixed costs
are larger than the current economic
losses that means that if the price is
above the average variable cost this
firm loses less than its fixed cost so
the firm should go ahead and operate if
the price Falls a little bit further now
we are at the minimum of the average
variable cost this is the lowest price
this firm would willingly produce that
is the last point on our supply curve
for this firm this firm's supply curve
is the marginal cost curve above the
minimum of the average variable cost
before we finish up we're going to go
over two less common topics the first
one of those is increasing cost
Industries if you ever see any questions
about that and they're rare just know
that if there's an increase in the
number of firms within the market each
individual firms cost curves shift up
that's an increasing cost industry the
next thing we're going to look at is the
long run supply curve in a perfectly
competitive market it's not the upward
sloping supply curve we have there and
here's why because here is our current
equilibrium output and price we're going
to go ahead and put a point there that
is one of the points on our long run
supply curve because this firm is
currently in Long Run equilibrium let's
say there's an increase in demand
in this market when the demand increases
that causes an increase in the
equilibrium price causing the firm to
earn economic profits in the short run
in the long run firms are going to enter
the market driving the price back down
to where it was previously we now have a
higher quantity at the exact same price
that is our second point on our long run
supply curve let's go back to where we
started for a moment and this time we
are going to show a decrease in demand
that causes the price in the market to
fall on the firm graph that causes the
firm to earn an economic loss in the
short run those economic losses Drive
firms out of the market that causes the
supply curve to shift back to the left
bringing the price back to where it was
previously where we have a new lower
quantity at the same price that gives us
a third point on this long run supply
curve for this Market connect all of
those points together and that gives us
a horizontal long run supply curve it is
at the minimum of the average total cost
curve for the firm that's where you find
the markets long run supply curve it's
perfectly elastic because in the long
run a perfectly competitive market will
produce any output at that
price we got through it that was a lot
of information there and if you knew it
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