Unit 3 Costs of Production and Perfect Competition

Unit 3: Costs of Production and Perfect Competition Copyright ACDC Leadership 2015 1

NAME THAT CONCEPT 1. Law of Demin. Marginal Returns 2. Fixed Cost 3. Low Barriers 4. Price Taker 5. MR = MC Copyright ACDC Leadership 2015

NAME THAT CONCEPT 1. Variable Costs 2. Shut Down Rule 3. MR=D=AR=P 4. Normal Profit 5. Economies of Scale (Mr. Darp) Copyright ACDC Leadership 2015

Review 1. Draw and label a perfectly competitive firm making a profit 2. Draw and label a perfectly competitive firm making a loss 3. Why is that firm considered a “price taker”? 4. How do firms determine what output to produce? 5. On your graph, identify the shut down point 6. On your graph, identify the firms supply curve 7. What happens in the industry if there is a profit? 8. What happens in the industry if there is a loss? 9. List 10 rides at Disneyland 4

Four Market Structures Perfect Competition Monopolistic Competition Oligopoly Monopoly Imperfect Competition Characteristics of Perfect Competition: Examples: Corn, Strawberries, Milk, etc. • Many small firms • Identical products (perfect substitutes) • Low Barriers- Easy for firms to enter and exit the industry • Seller has no need to advertise • Firms are “Price Takers” The seller has NO control over price. Copyright ACDC Leadership 2015 5

Shifting Cost Curves A change in fixed costs change ATC and AFC (but not MC) A change in variable costs change ATC, AVC, and MC Copyright ACDC Leadership 2015 6

Changes in fixed costs don’t change output

Changes in variable costs change output Copyright ACDC Leadership 2015

Efficiency Copyright ACDC Leadership 2015 9

In general, efficiency is the optimal use of societies scarce resources • Perfect Competition forces producers to use limited resources to their fullest. • Inefficient firms have higher costs and are the first to leave the industry. • Perfectly competitive industries are extremely efficient There are two kinds of efficiency: 1. Productive Efficiency 2. Allocative Efficiency Copyright ACDC Leadership 2015 10

Productive Efficiency- Producing at the lowest possible cost (minimum amount of resources are being used) Graphically it is where price equals the minimum ATC Allocative Efficiency- Producing at the amount most desired by society (allocating resources towards the products society wants) Graphically it is where price equals marginal cost Copyright ACDC Leadership 2015 11

Short-Run Profit P Not Productively Efficient MC MR=D=AR=P ATC $10 Q 1 Copyright ACDC Leadership 2015 Notice that Q 1 is NOT being made at the lowest possible cost (ATC not at lowest Q point). 12

Short-Run Loss P Not Productively Efficient MC ATC MR=D=AR=P $5 Q 2 Copyright ACDC Leadership 2015 Notice that Q 2 is NOT being made at the lowest possible cost (ATC not at lowest Q point). 13

Long-Run Equilibrium P Productively Efficient in the Long-Run MC ATC MR=D=AR=P $8 Q 3 Copyright ACDC Leadership 2015 In the long-run, Q 2 IS being made at the lowest possible cost (ATC at lowest point) Q 14

Short-Run Profit P Allocatively Efficient MC MR=D=AR=P ATC $10 Q 1 Copyright ACDC Leadership 2015 Notice that the price people are willing to pay equals the additional cost to Q produce Q 1 (Price = MC) 15

Short-Run Profit P NOT Allocatively Efficient MC MR=D=AR=P ATC $10 $5 At Q 2, the price is greater than the MC so society wants more output produced Q 2 Copyright ACDC Leadership 2015 Q 16

Long-Run Equilibrium P MC ATC MR=D=AR=P $8 Q 3 Copyright ACDC Leadership 2015 A perfectly competitive profit maximizing firm is always allocatively Q efficient 17

Summary Perfectly competitive firms are allocatively and productively efficient in the long-run In the short-run, they are always allocatively efficient, but they are not productively efficient. Copyright ACDC Leadership 2015 18