Microeconomics

Microeconomics study guide

Chapter 6 Notes: Firms and Production

A firm converts inputs into outputs
What firms want:
1. Profit : π = R - C
2. efficient production to maximize π
-efficient production alone is not sufficient to ensure a firm’s π is maximized

How they are organized
1. information exchange
2. incentives for workers

Production Function q = f(L,K) relationship b/w quantities of inputs used & max quantity of output that can be produced given current knowledge about technology & organization various ways inputs can be transformed into outputs shows only maximum amount of output that can be produced from given levels of L & K b/c it includes only efficient production processes

Short Run: a period of time so brief that @least 1 factor of production can’t be varied
-fixed input: can’t be varied in the short run
-variable input: quantity can be changed readily by firm during relevant time period

-in short run, we assume capital K is a fixed input, and labor L is variable -in this case, a firm can increase output only by increasing amount of labor used -in the production function, K is “K bar” (fixed # of units of capital) _ q=f(L, K)

Marginal Product of Labor: change in total output, ∆q, resulting from using an extra unit of labor ∆L, holding other factors constant
MPL = ∆q/∆L

Average Product of Labor: ratio of output, q, to the # of workers, L, used to produce that output
APL = q/L

Relationship of the Product Curves:
1. if an extra worker adds more output (worker’s MPL) than APL of initial workers, that extra worker raises APL
2. if MPK of new workers is less than former APL, APL falls

Law of Diminishing Marginal Returns: if a firm keeps increasing its output, holding all other inputs and technology constant, the corresponding increases in outputs will eventually become smaller

Long Run: enough period of time that all inputs can be varied
Long Run Production Function both L & K are variable inputs it’s possible to substitute one input for the other while holding output constant the firm can sub one input for another while continuing to produce the same level of output, in much the same way that a consumer can maintain a given level of utility by subbing one good for another

Isoquants: curve that shows efficient combinations of labor & capital that can produce a single level of output; shows flexibility that a firm has in producing given level of output
_
q = f(L,K) curves do not cross slope downward the greater level of output is farther from the origin shows how readily one firm can sub one input from another
Perfect subs: isoquant curves are straight lines q = x+y
Complements form a right angle curve
Imperfect sub b/w inputs: convex lines -unlike perf curves of straight lines, these do not have the same slope at every point

Marginal Rate of Perfect Substitution: how much a firm can increase one input & lower the other while still staying on the same isoquant
-negative b/c isoquants slope downward
-firm can produce given level of output by subbing more capital for less labor (or vice versa)
MRTS= -(∆K/∆L)= -(MPL/MPL)
→ also equals slope of isoquant

Returns to Scale: idea is to quantify whether large firms are more profitable than small firms constant returns to scale (crs): property of production funx whereby when all inputs are increased by a certain percentage, output increases by that same percentage
CRS: f(2L, 2K) = 2f(L, K)

increasing returns to scale (IRS): Property of a production function whereby output rises more than in proportion to an equal increase in all inputs
-IRS if doubling inputs more than doubles output
IRS: f(2L, 2K) > 2f(L, K)

decreasing returns to scale (DRS): output increases less than in proportion to an equal percentage increase in all inputs
DRS: f(2L, 2K) < 2f(L, K)

Cobb-Douglas Production Function q = AL^αK^β γ=α+β determines the returns to scale.
Cobb-Douglas reflects production of many industries

-When a firm is small, increasing labor & capital allows for gains from cooperation b/w workers & greater specialization of worker & equipment (returns to specialization), so there are increasing returns to scale
-As firm grows, returns to scale are eventually exhausted
**spacing of isoquant curves reflects returns to scale

Chapter 7 Notes: Costs

7.1; Nature of Costs
Key Points:
· There is a two-step method to cost maximization o First, find q to produce output technologically efficiently o From the technologically efficient processes one must find processes that are economically efficient
Key vocabulary:
Economically efficient: minimizing the cost of producing a specified amount of output 7.2; Short-Run Costs
Key Factors/Equations:
· L and K o K represents a fixed cost
· Average costs:
AFC=F/q
Lowers with increasing q
AVC=VC/q
Used to help determine shutdown
AC=C/q
Falls, stops (min), rises If AC >P firm should shutdown in the longrun
· MARGINAL COST (MC)= ∂C/∂q o Used to decide whether efficiency is being reached or if changed should be made to reach a profit maximizing q o This q must be economically efficient at this point but does not have to be technologically efficient
Production Functions and the shape of cost curves:
· VC=wL o L is the only variable able to change in the short-run o L increase with diminishing marginal return as output increases o Same shape curve as MC
· MC=∂VC/∂q = (w)∂L/∂q

Effects of Taxes on Costs:
· Lump-sum: C(q)=VC+F+t
· Specific tax: o Ex: C(q)= 0.25q^2 + (50 + t)q + 175
Key vocabulary:
Fixed costs (F): a production expense that does not vary with output
Variable cost (VC): a production expense that changes with the quantity of output produced
Cost (total cost/ C): the sum of the firms VC and F
Marginal cost: the amount by which a firm’s cost changes if the firm produces one more unit of output 7.3; Long-Run Costs
Key concepts:
· All variables maybe adjusted in the long*-run so cost of production is as low as possible
*very long
· F is avoidable rather than sunk (ex: renting rather than purchasing to own)
· Key: C, AC, MC
Input Choice
· Concept is much like the process of choosing indifference bundles
· Technologically efficient bundles are based on C = wL + rK
K=C /r – w/rL
Slope: ∂K/∂L=-w/r =MRTS
Combining cost and production life
· Combine info about the isocost and isoquant to find the point with the lowest C to produce
· 3 approaches: o lowest-isocost rule: pick the bundle of inputs where the lowest isocost line meets the isoquant o tangency rule: point of tangency between isocost and isoquant o last-dollar rule: pick the bundle of inputs whee the last dollar spent on one input gives as much extra output as the last dollar spent on any other input
Factor price changes
· the one factor the
Key Vocabulary:
Isocost line: all combinations of inputs that require the same total expenditure
Isoquant line: curvature of efficient combinations of labor and capital
Expansion path: the cost-minimizing combination of labor and capital for each output level
No economies of scale: increase in output has not effect on the AC, so the curve is flat and AC is constant
Economies of scale: property of a cost function whereby the average cost of production falls as output expands
Diseconomies of scale: property of a cost function whereby there are cost of production rises when the output increase 7.4; Lower costs in the long-run
Long-Run Average Cost as the [common] Envelope of Short-Run Average Cost Curves
· LRAC < SRAC* (* from the smallest possible plant)
· LRAC curve is the solid, scalloped sections of a series of short-run cost curves: o 3 size options in the short-run:

Short-Run and Long-Run Expansion Path
· Long-run cost is lower than in the short-run b/c the firm has more flexibility

7.5; Cost of Producing Multiple Goods
Key Vocabulary:
Economies of scope: situation in which it is less expensive to produce good jointly than separately Key concept/equation:
SC: C(q1, 0) + C(0,q2) – C(q1,q2)/ C(q1,q2) Chapter 8 Notes: Competitive Firms and Markets
Definitions

1. Perfect competition: a market where there are a large number of firms and consumers willing to trade at a certain price for a product that is almost identical to the competitions products. Information is readily available and transaction costs are cheap. The firm faces a very elastic demand curve which causes it to be a price taker. 2. Profit Maximization: when maximizing profit you have to: -decide how much to produce -whether to produce at all 3. Short run competition: In the short run the variable costs that impact the
4. Long Run Competition: in the long run means that all of the inputs can be followed along even if you’re not on ko
5.

Residual Demand Curve: this curve lets you know that amount The market demand -residual demand curve: D(p)=D(p)-S°(P) -in short we can think of the residual demand as the difference between the market demand curve and the supply curve of other firms
6. Economic Profit: Economic Profit= Revenue – Costs where costs include both implicit (Opportunity Cost) and explicit (out of pocket costs).
6. Marginal Revenue: the change in revenue a firm gets from selling one more unit
7. Residual Supply Curve: the quantity that the market supplies that is not consumed by other demanders at any given price

Formulas
-residual demand curve: D(p)=D(p)-S°(P)
-Marginal Profit (q)= MR(q)-MC(q)
-MR=p
-Profit=R-VC-F
-Average Cost=p-AC Perfect Competition (Horizontal demand curve) · Large number of buyers and sellers
· Identical products
· Full information
· Lastly we just lol pictures
· Trans Costs (Low)

Two Steps to Maximizing Profit Step 1: First, you must decide what is the level of output (q*) that will maximize profit and minimizes loss Step 2: Decide whether to produce or shut down Output rules -the firm will set its output where its profit is maximized -It will also set its output where the marginal profit equals zero -Set the output where the MR=MC Shut Down Rule -the firm shuts down only if it can reduce its loss by doing so -Shut down if revenue is less than avoidable costs -*in the short run, the firm has fixed costs which is it capital , but it can vary the variable costs (labor and materials) -Sunk costs in this case are irrelevant because they cannot be changed, the firm has to pay them whether it produces or not Factor Prices and the Short-Run Supply Curve -a firm can face an increase in input prices -this causes the supply curve or MC to move to the left -The AVC will shift up -*An increase in factor prices causes the production costs to rise -Ex: if wage, price of energy or price of oil seeds increase the MC and AVC shift left and up
Moreover….
-when either the costs of labor or capital changes the firll wil adjust its inputs to make up for the change Ex: if one of the inputs such as labor becomes cheaper, then the firm would use more of it, so a change in price affects the mix of inputs Competition in the Long Run
· all outputs are avoidable by shutting down
· inputs that were fixed in the short term become variable in the long-run
Tax
· A tax will shift the marginal cost and the average cost by the amount of the tax
· After a tax the firm will produce les units
· Both profits and quantities decrease
Lump Sum
· Will shift the MC and AC up (you just add it to the production function)
Long Run Competitive Profit Max Short Run:
An increase in demand leads to an increase in the price and the firms in the market currently make a profit which is the average profit per unit times the output amount p-ACxunits=Profit Long Run:
Other firms can enter the market this will increase supply prices will remain the same and the market quantity will decrease Long-Run Firm Supply Curve -Firm can choose its capital in the long run, so the firms long run supply curve will more than likely be very different to the short run supply curve -In the short run, the firm will make a profit -In the long run the firm does not operate at a loss
Exit and Entry -A firm enter the market if it can make a long-run profit, Profit is > 0 -A firm exits the market to avoid a long-run los, Profit