11 - Cost & Competition - Ch. 13, Ch. 14

ucla | ECON 1 | 2022-12-02T16:19

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Table of Contents

• Definitions
• Big Ideas
  • Costs
    • Explicit vs Implicit Cost
    • Economic vs Accounting Profit
    • Fixed vs Variable vs Total Cost
  • Production Function
    • Marginal Product
    • Diminishing Marginal Product
    • Marginal Cost (MC)
  • Cost Curves
    • Relationships
    • Short and Long Run
    • ATC and Scale
  • Profit Maximization
    • Perfect competition
    • Revenue
    • Profit Maximization
    • Shutdown vs Exit
    • Long Run Decisions
    • Profit Maximization
  • Supply Curve
    • SR Market Supply
    • Zero Profit Condition
  • Profit Maximization Summary
• Resources

Definitions

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Big Ideas

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Costs

Explicit vs Implicit Cost

• explicit costs
  • require an outlay oof money
  • e.g. wages
• implicit costs
  • other than cash outlay
  • e.g. OC of owner’s time

Economic vs Accounting Profit

• accounting profit
  • totaal revenue - explicit costs
• economic profit
  • total revenue - total costs

Fixed vs Variable vs Total Cost

• fixed cost (FC)
  • do not vary with quantity of output produced
• variable cost (VC)
  • cost varies with quantity produced
• total cost (TC)
  • TC = FC + VC

Production Function

• a graph of the relationship between the quantity of inputs use to produce a good and the quantity of output of the good
• inputs can be considered as labor (workers and/or hours)
• outputs can be considered as quantity produced

• e.g. farmer jack

Marginal Product

• the increase in output due to additional units of input, holding all other inputs constant
• denoted $\mathrm{\Delta }$

• Marginal Product of Labor (MPL) denotes the slope of the labor-quantity production function
• $MPL=\frac{\mathrm{\Delta }Q}{\mathrm{\Delta }L}$

• e.g. farmer jack

Diminishing Marginal Product

• the marginal product of an input declines as the quantity of input increases
• MPL has diminishing returns on the basis of inputs
• i.e. the slope of the product function decreases as inputs increase

Marginal Cost (MC)

• the increase in Total Cost (TC) from producing an additional unit
• $MC=\frac{\mathrm{\Delta }TC}{\mathrm{\Delta }Q}$

• e.g. farmer jack
• MC tends to increase as quantity of product increases

Cost Curves

• e.g. FC vs VC vs TC

• e.g. Marginal Cost

• e.g. average fixed cost (AFC)

• e.g. average variable cost (AVC)

• e.g. average total cost (ATC): U-shaped

  • ATC =AFC + AVC
  • ATC = TC/Q

• All

Relationships

• MC < ATC $⟹$ATC is falling
• MC > ATC $⟹$ ATC is rising
• MC = ATC $⟹$ ATC is at minimum

Short and Long Run

• short run
  • some inputs fixed (factories, land) $⟹$ FC

  • e.g. ATC by factory size
• long run
  • all inputs are variable (buy more land/factories) $⟹$ VC

  • e.g. ATC

ATC and Scale

• Economies of scale - when increasing production allows more specialization → increases efficiency
  • occurs when Q output is low (early ATC)
• Diseconomies of scale - due to uncoordinated management → stretches management thin
  • occurs when Q output is high (late ATC)

Profit Maximization

Perfect competition

• large/dense market
• goods offered are similar in quality
• producer entry cost is low
• $⟹$ buyers and sellers are “price takers” (take price as given)

Revenue

• total revenue (TR)
  • $TR=P\times Q$
• average revenue (AR)
  • $AR=\frac{TR}{Q}=P$
  • because market makers are price takers
• marginal revenue (MR)
  • $MR=\frac{\mathrm{\Delta }TR}{\mathrm{\Delta }Q}$
• perfect competition characterized by $MR=P$ (price takers)

Profit Maximization

• MR > MC = increase Q output to increase profit
• MR < MC = reduce Q output to increase profit

• e.g. table

• e.g. graph

Shutdown vs Exit

• sunk costs
  • costs that have been committed and cant be recovered
• shutdown
  • short-run (SR) decision to halt production due to market conditions
  • FC cost remains
  • when $TR<VC$
  • when $P<AVC$
• exit
  • long-run (LR) decision to leave market
  • zero costs remain

• e.g. visual

Long Run Decisions

• P < ATC
  • a firm will exit the market
• P > ATC
  • a firm will enter the market

Profit Maximization

• Identifying LR profit

• identifying LR loss

Supply Curve

SR Market Supply

• LR - firms can enter and exit the market
  • economic profit is positive: SR Supply shifts right
  • economic profit is negative: SR supply shifts left

Zero Profit Condition

• long-run equilibrium - process of entry/exit is completed → remaining firms earn 0 economic profit
• when $P=MC=ATC$ i.e. minimum ATC
• firms produce at $P=MR=MC$
• then, firms stay in the market for a positive accounting profit

• e.g. zero-profit condition

• e.g. causal relationship of LR and SR S/D
• $⟹$ LR supply slopes upward when assumptions are not met
  • all firms have identical costs
    • $⟹$ if P = ATC for one firm → profit = 0, a low cost firm has profit > 0
  • costs do not change as other firms enter/exit
    • not always true in real life

Profit Maximization Summary

• profit maximized when $MC=MR$
• perfect competition when $P=MR$
• in competitive equilibrium $P=MC$

Resources

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**SUMMARY
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