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Lecture 1

ECON 212 Lecture 1: Micro Notes exam 3

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ECON 212

Micro Notes exam 3 1. Accounting Profit versus Economic Profit a. For an accountant, total cost are wages paid to labor, rent paid for buildings, interest paid on loans etc. b. If we have a restaurant as: i. $500,000 in revenue ii. $100,000 in food cost iii. $100,000 in labor cost iv. $200,000 in rent building v. $50,000 in equipment rental expenses vi. How much is this firm’s pre-tax profit? vii. Revenue of $500,000 minus expenses for $450,000 viii. Pre-tax accounting profit of $50,000 2. Economic Profit a. Economist have a different measure of profit. b. Economists include opportunity cost in their calculation of profit c. Economic Profit is then $500,000 - $450,000 in explicit cost and $100,000 in implicit cost give us economic profit of negative $50,000 d. This does not mean that the firm is not making money e. But it is saying that it probably doesn’t make sense to run the firm because you could have been making more money f. If economic profit is positive, then it does make sense to run this firm because you are making more than what you could be making in other pursuits 3. Cost of production in the Short run a. TC=FC+VC b. TC=PkK+PlL 4. Fixed cost a. FC=TC-VC b. Cost of inputs which do not vary with the level of output c. Cost that are spent and cannot be changed in the short run 5. Variable cost a. VC=TC-FC b. Cost which vary with the level of output 6. Average total cost a. ATC=AFC+AVC b. Average total cost= total cost/output c. AFC=FC/Q d. AVC=VC/Q 7. Marginal Cost a. Are the most important cost in determining how much to produce i. MC= ∆TC/∆Q b. Relationship between the Marginal cost and Average Cost Curves i. Marginal cost curve goes through the minimum point of the ATC curve and minimum of the AVC curves 8. Relationship between Productivity and Costs a. Cost curves are mirror images of corresponding production curves b. When MP of labor is rising, marginal cost will be falling c. When MP of labor is falling, marginal cost will be rising 2. Cost of production: The Long Run 1. In the short run you can hire and fire workers, but you can’t change the size of your plant and equipment 2. In Long Run, you can change the size of the plant and equipment. Therefore, in the long run all inputs are variable. 3. The long run average cost curve (LRAC) is an envelope of the short-run average total cost curves 4. Each Short-run average total cost curve represents cost with a given plant or fixed capital investment 5. In the short run, the firm can increases output but will incur increased cost from diminishing returns.. this encourages them to add capital Economies of Scale 1. Diminishing Returns to the Variable input is a short run concept related to production 2. Economies of Scale is a long run concept and exists when per unit output costs decrease as output increases 3. Economies of scale are reflected in the shape of the long run average cost cure when per unit cost are failing a. Adam Smith and Economies of Scale i. Adam smith gave a good explanation for Economies of Scale ii. Specialization and Division of Labor iii. Larger firms can hire more workers who can become more efficient through specialization b. Other examples of Economies of Scale i. Purchasing: Larger firms can but in bulk and receive lower prices as a result ii. Financial: Larger firms can often obtain lower interest rates from banks iii. Technological: larger firms can purchase more equipment that can reduce production cost c. Diseconomies of Scale i. Diseconomies of Scale exist when the per unit cost of production increase as output increases ii. Diseconomies of scale are reflected in the shape of the Long run average cost curve when per unit cost are rising. d. Explanations for Diseconomies of Scale i. Monitoring Costs Increases: A large firm has large costs involved in seeing that work gets done. ii. Team Spirit or Morale: Large scale production may lead to alienated workers iii. Duplication of Effort: Large firms with thousands of employees can suffer from duplication of effort e. Constant Returns to Scale i. Constant Returns to Scale occurs when output increases do not change long run average costs 4. A single firm can have Economies of Scale 5. A single Firm can have Diseconomies of Scale 6. A single firm can have Constant returns to scale 7. A single firm can display Economies, diseconomies, and Constant returns to scale Next Topic 1. The Firm under Perfect Competition a. Conditions for perfect competition i. Numerous Participants (no single buyer or seller can affect prices.) ii. Homogeneous Product (no product differentiation exists.) iii. Freedom of Exit and Entry (No unusual capital expenditures, legal impediments) iv. Perfect information (consumers have perfect information about prices and quality) 2. The market demand curve versus an individual firm’s demand curve a. The Market demand curve is downward sloping b. But the demand curve facing each individual firm in a competitive market is horizontal and equal to the market price c. The demand curve facing each individual firm in a competitive market is perfectly elastic 3. Demand Curve and Marginal Revenue Curve a. Demand curve is perfectly elastic b. Marginal revenue curve is identical to the demand curve under perfect competition c. MR=D=P (only under perfect competition) 4. Economic Profit and Normal Profit a. Firms are said to “break even” when they are making a “normal profit” b. Normal profits are profits that cover average total costs 5. The firms short run supply curve a. In the short run, the firm will continue to produce as long as the price (MR) meets Average Variable Cost (at the profit max level of output) b. If price were less than average variable cost, firm would shut down even in the short run. c. So the supply schedule for the firm is the marginal cost curve above the Average Variable Cost. 6. In the Long Run . . . If economic profit exists a. The number of firms is not fixed. There is exit and entry of firms based upon the existence of economic profit. b. If there is Economic profit, firms will enter an industry, output will increase, shifting the industry supply schedule outward. c. There will then be downward pressure on prices until economic profits are eliminated. 7. Adjustment in perfect competition a. As the Price falls, economic profit will diminish b. Eventually, there will be no economic profit in a perfectly competitive industry 8. Things to Remember about Perfect Competition a. The profit maximizing condition is i. MC=MR=P b. The firms will Shut down if the price is less than the average variable costs. c. A perfectly competitive firm will have zero economic profit in the long run. 9. Forgot my laptop last Tuesday and wrote notes in notebook march 28 th 10. March 30 th 11. Monopoly and Breaking Even, Operating at a Loss, and Economic Profit a. Notebook ----> 12. Reasons for Monopoly a. Legal Restrictions, Government Franchises b. Intellectual Property Protections, Patents c. Control over Scarce Resources d. Natural Monopoly and Economies of Scale 13. Legal Restrictions a. Franchise which is typically a contract between a business and a governmental unit. EX) cable TV 14. Intellectual Property Protections, Patent a. To encourage inventions and innovations b. Make it possible for a person to apply for and obtain the exclusive right to produce a cer
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