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 all you are on your way to acing your next exam if you need a little more help head down to the links below where there are lots of games and activities from reviewe eon.com to help you study and practice the skills you need for that next exam if you want to support this channel make sure you like And subscribe and then head over to reviewe eon.com and pick up the total review booklet with everything you need to know to pass your final exam or AP economics exam thank you very much I'll see you guys next time