Highlights for Exam 3

1. Highlights for Exam 3

2. Production Function and Cost Curve Output Cost $ # of Workers Output (Quantity)

3. Cost Curves Cost Why do MC, ATC, and AVC slope up, and how do they relate? MC Why does MC cross ATC and AVC at their lowest point? Why does AVC converge to ATC? ATC AVC Why does AFC decline to zero? AFC Quantity of Output

4. ATC in Long Run and Short Run (U Shape for Different Reasons) Short Run ATC with small plant Cost Short Run ATC with large plant Short Run ATC with medium plant Long Run ATC Economies of Scale Diseconomies of Scale Quantity Constant Returns to Scale

5. Summary of Costs

6. Profit Max Decision Costs and Revenue MC Producing here MC > MR so don’t ATC MC = MR so profit maxed AVC P = MR = AR Producing here MC < MR so produce more Q* Quantity

7. MC Curve as Supply Curve Costs and Revenue MC ATC P2 AVC P1 Q1 Q2 Quantity

8. Short Run Supply Curve Costs ATC MC In short run firms produce on the MC curve if P > AVC AVC Quantity In short run firms shut down if P < AVC

9. Firm with Profits Firm with Losses AVC AVC MC MC Profit P Loss AVC AVC P Q* Q* Profit Maximizing Q Cost Minimizing Q

10. Long Run Supply Curve Costs ATC MC In long run firms produce on MC curve if P > ATC Firms exit market if P<ATC Quantity

11. Market Supply Curve • In short run # of firms fixed • Each firm supplies where P = MC • Each firms supply curve is the MC curve above their AVC curve (otherwise 0) • For market supply just add up horizontally S1 S2 S - Market + =

12. Long Run Market Supply Multiple Firms with identical cost curves Add up supply at MC = ATC level for each to get Market Supply Price Price MC ATC P = Min ATC Supply Quantity Quantity

13. Some Caveats And perhaps it could still slope up if by increasing market size they bid up the cost of inputs. This would cause latte entering firms to have higher cost curves. P P Actual Supply would be more like this, with holes and dots denoting when different firms enter. That is it would not be a smooth line. Or some firms could just be better at it, thus having lower cost curves. But either way LR flatter than SR. Q Q

14. Demand Curve Faced By Competitive Firm Demand Curve Faced By Monopoly P P Demand Demand Q Q Since competitive firms are price takers they in effect face a horizontal demand curve at the market price. Since monopolies are the sole producer they face the actual market demand curve. If a monopoly wants to sell more they have to lower the price, competitive firms can sell as much as they want at the market price. But monopolies can raise the price (and sell less) whereas competitive firms cannot raise the price.

15. P Mathematic reason for MR < Demand: P = A + B*Q (equation of demand curve) Revenue = P*Q Revenue = (A + B*Q)*Q = A*Q + B*Q2 MR = Derivative of Revenue MR = A + 2*B*Q So MR curve is twice as steep as the demand curve so falls twice as fast MR Demand Q Intuition behind MR < Demand: Because the price on all units sold must be lowered to sell more the MR curve falls faster than the demand curve on which only the last units price must be lower.

16. P Then that Q up to the demand curve shows the price consistent with that quantity MC PM Monopolist (as all producers) choose quantity where MR = MC ATC Demand MR Q* Q

17. P Deadweight Loss MC MR PM Note: It is not the fact that the monopolist charges a higher price that leads to the inefficiency, it is that they produce less than the efficient quantity. Demand QM QE Q Since the monopolist produces less than the efficient level, it leads to a deadweight loss, because some consumers who value the good more than the MC don’t get to consume it.

18. Monopolistic competition • Like a monopolist, but not really • Have to differentiate their product • Role of advertising • Oligopoly • Incentive to collude and act like monopolist • Also an incentive to cheat • Strategic interaction • Game theory (two player game) • Dominated strategy • Nash equilibrium

19. Production Function Low Marginal Productivity Quantity of Output Production function flattens out because as more input (labor) is used it becomes less productive, and so each new unit of labor leads to less units of output High Marginal Productivity Quantity of Input (labor)

20. VMPL Marginal Benefit Where MC = MB is profit max quantity Market Wage Rate Value of marginal product of labor = demand for labor (just like demand for any good is also the value curve of that good) Marginal Cost Profit Maximizing Quantity of Labor Quantity of Labor

21. Upward Sloping Labor Supply as a Community or an Individual Wage Worker with low leisure value enters first even if wages low. OR You’re willing to give up your first hour of leisure for lower wage because leisure not as valuable Worker with highest leisure value enters last only when wages are high. OR You only give up your last (16th) hour of work if the wage is really high because the value of that leisure hour is high. Quantity Labor