Microeconomics Unit 3: Production and Perfectly Competitive Markets

Overview

• Focus on production and perfectly competitive markets and firms.
• Content accompanies ReviewEon.com booklet and video.

Production Function

• Shows the relationship between labor quantity and output quantity.
• Table Example:
  • 1 Unit of Labor: 10 Units of Output
  • 2 Units of Labor: 25 Units of Output
  • 3 Units of Labor: 36 Units of Output
  • 4 Units of Labor: 46 Units of Output
  • 5 Units of Labor: 50 Units of Output
  • 6 Units of Labor: 48 Units of Output
• Marginal Product (MP):
  • Calculated by change in total product divided by change in quantity.
  • Initial rise (increasing returns), then fall (diminishing returns), then negative (negative returns).

Law of Diminishing Marginal Returns

• Phases:
  1. Increasing Returns: Specialization causes MP to rise.
  2. Diminishing Returns: MP falls as more workers are hired.
  3. Negative Returns: Adding more workers decreases total product.
• Graphed as a marginal product curve.

Costs in Production

• Fixed Costs: Do not change with output (e.g., capital, land).
• Variable Costs: Change with output (e.g., labor, electricity).
• Total Costs: Sum of fixed and variable costs.

Cost Curves

• Fixed cost is horizontal on a graph.
• Variable cost initially steep, levels, then steepens again.
• Marginal Cost (MC) is change in total cost over change in quantity.
• Average Costs:
  • Average Variable Cost (AVC): VC divided by quantity.
  • Average Total Cost (ATC): TC divided by quantity.
  • Average Fixed Cost (AFC): Gap between ATC and AVC.
  • Graphs show distinct relationships where curves intersect at minimum points.

Long Run Costs

• All costs are variable.
• Long run average total cost curve shows economies of scale, constant returns, and diseconomies of scale.

Profit

• Accounting Profit: Total revenue minus explicit costs.
• Economic Profit: Total revenue minus both explicit and implicit costs.
• Normal Profit: Economic profit equals zero.

Profit Maximization

• Found where Marginal Revenue (MR) equals Marginal Cost (MC).
• Graph: Intersection of MR and MC curves indicates profit-maximizing quantity.

Perfect Competition

• Many firms selling identical products.
• Low barriers to entry, price takers.
• Zero economic profit in the long run.

Market and Firm Graphs

• Market Graph: Downward-sloping demand, upward-sloping supply.
• Firm Graph: MR curve is horizontal due to market price.
• Economic profit indicated if ATC is below MR at profit-maximizing quantity.

Efficiency in Perfect Competition

• Allocative Efficiency: Price equals marginal cost.
• Productive Efficiency: Minimum ATC in the long run.

Short Run Supply Curve

• Firm's supply curve is MC above AVC.

Less Common Topics

• Increasing Cost Industries: Costs rise with more firms.
• Long Run Supply Curve: Horizontal at minimum ATC, perfectly elastic in perfect competition.

Conclusion

• Mastery of these concepts is crucial for exams.
• Additional resources available at ReviewEon.com.