AgEconCagmatReviewer3 dAD ADWDAD ADADA A

AgEconCagmatReviewer3.pdf

1. REVIEW FOR LICENSURE
EXAMINATION FOR
AGRICULTURIST
PPT PRESENTATION OF DR.
ADEL LAURETO

2. is the study of how households
and firms make decisions and
how they interact in markets.

3. What Economics Is All About
•Scarcity: the limited nature of society’s
resources
•Economics: the study of how society manages
its scarce resources, e.g.
–how people decide what to buy,
how much to work, save, and spend
–how firms decide how much to produce,
how many workers to hire
–how society decides how to divide its resources
between national defense, consumer goods,
protecting the environment, and other needs

4. General Type of economic resources:
1.Natural resources (land, forest, mines, other product of nature)

2.Human resources ( physical and mental abilities of people)

3. Man-made or manufactured resources (tools, machineries,
buildings, and other forms of capital
SCARCITY AND CHOICE
 Scarcity is the main obstacle which economics aims to
hurdle. Because of scarcity, there is a need to decide
how to allocate resources and make choices on the
goods to be produced

5. Important Concepts Related to Scarcity:
Opportunity Cost
refers to the value of the best foregone alternative.
Production Possibilities
This is reflected by the production possibilities frontier (PPF).
The PPF shows, for each output of one good, the maximum
amount of the other good that can be produced using all
available resources. The frontier displays a trade-off; more of
one commodity implies less of the other.
To illustrate, assume the following:
-Only 2 goods are produced: Food (F) and Clothing (C).
-Resources are limited ( in fixed supply)
-Technologies for the 2 goods are also given.

6. Suppose if all the resources are used the following are
the possible combinations:
POSSIBILITY FOOD
(MT)
CLOTHING
(Million meters)
∆ F ∆ C
A 0 15
B 1 14 1 -1
C 2 12 1 -2
D 3 9 1 -3
E 4 5 1 -4
F 5 0 1 -5
Opportunity cost of Food – the amount of clothing that must be given
up to produce an extra unit of food.

7. As more and more food are produced the amount of
clothing that must be given up increases ---- the Principle of
increasing opportunity cost.
C
0
*K
*M
F
Points along the
production
possibilities frontier
(PPF) implies efficient
use of resources.
Production efficiency
means more output of
one good can be
obtained only by
sacrificing output of
other good.

8. Points inside the frontier
implies Inefficiencies – not
all the resources are fully
employed and/or not using
the best techniques. Can be
corrected by increasing the
production of any of the two
goods or both.
Points outside the frontier –
Infeasible, not unless there
is increased in the
quantities of resources
and/or improvement in
technologies.
Alternative Economic Systems
1.Custom Economy – functioning of the economy is governed by customs,
beliefs, and traditions.
2. Command Economy – public ownership of resources and with a centralized
decisions on the allocation of resources.
3. Market/Capitalist Economy – private ownership of resources and decision
on the allocation of resources is made through market interaction.
4. Mixed Economy – combination of the first three mentioned economies.
Most economies today are mixed economies

9. The Key Economic Problems:
CONSUMPTION RELATED – What to produce; How much to
produce

PRODUCTION RELATED – How shall the goods and services be
produced

DISTRIBUTION RELATED – For whom shall the goods and services
be distributed

GROWTH OVER TIME – what resources can be spared today for
the need of future generation

10. Assumptions & Models
•Assumptions simplify the complex world,
make it easier to understand.
•Model: a highly simplified representation
of a more complicated reality. Economists
use models to study economic issues.
Our First Model:
The Circular-Flow Diagram
•The Circular-Flow Diagram: a visual model of
the economy, shows how dollars flow through
markets among households and firms

11. FIGURE 1: The Circular-Flow Diagram
Households:
Own the factors of production,
sell/rent them to firms for income
Buy and consume goods & services
Households Firms
Firms:
Buy/hire factors of production,
use them to produce goods and
services
Sell goods & services

12. FIGURE 1: The Circular-Flow Diagram
Markets for
Factors of
Production
Households Firms
Income Wages, rent,
profit
Factors of
production
Labor, land,
capital
Spending
G & S
bought
G & S
sold
Revenue
Markets for
Goods &
Services

13. The Market Forces of
Supply and Demand
A market is a group of buyers and sellers of a
particular product.
A competitive market is one with many buyers
and sellers, each has a negligible effect on price.
In a perfectly competitive market:
All goods exactly the same
Buyers & sellers so numerous that no one can
affect market price – each is a “price taker”
In this chapter, we assume markets are perfectly
competitive.

14. Demand
•The quantity demanded of any good
is the amount of the good that buyers
are willing and able to purchase.
•Law of demand: the claim that the
quantity demanded of a good falls
when the price of the good rises, other
things equal

15. The Demand Schedule
•Demand schedule:
a table that shows the
relationship between the
price of a good and the
quantity demanded
•Example:
Helen’s demand for lattes.
Price
of
lattes
Quantity
of lattes
demanded
$0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4
Notice that Helen’s
preferences obey the
Law of Demand.

16. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 Price of
Lattes
Quantity
of Lattes
Helen’s Demand Schedule & Curve
Price
of
lattes
Quantity
of lattes
demanded
$0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4

17. Market Demand versus Individual Demand
•The quantity demanded in the market is the sum of the
quantities demanded by all buyers at each price.
•Suppose Helen and Ken are the only two buyers in the Latte
market. (Q
d
= quantity demanded)
4
6
8
10
12
14
16
Helen’s Q
d

2
3
4
5
6
7
8
Ken’s Q
d

+
+
+
+
=
=
=
=
6
9
12
15
+ = 18
+ = 21
+ = 24
Market Q
d

$0.00
6.00
5.00
4.00
3.00
2.00
1.00
Price

18. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 510152025 P
Q
The Market Demand Curve for Lattes
P
Q
d

(Market)

$0.00 24
1.00 21
2.00 18
3.00 15
4.00 12
5.00 9
6.00 6

19. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 51015202530 P
Q
Suppose the number
of buyers increases.
Then, at each P,
Q
d
will increase
(by 5 in this example).
Demand Curve Shifters: # of Buyers

20. •Demand for a normal good is positively
related to income.
–Increase in income causes
increase in quantity demanded at each price,
shifts D curve to the right.
(Demand for an inferior good is
negatively related to income. An increase
in income shifts D curves for inferior goods
to the left.)
Demand Curve Shifters: Income

21. Two goods are substitutes if an increase in the
price of one causes an increase in demand for the
other.
Demand Curve Shifters: Prices of Related Goods
Two goods are complements if an increase in the
price of one causes a fall in demand for the other.
Demand Curve Shifters: Tastes
Demand Curve Shifters: Expectations
Example:
If people expect their incomes to rise, their
demand for meals at expensive restaurants may
increase now.

22. Summary: Variables That Influence Buyers
Variable A change in this variable…
Price …causes a movement
along the D curve
# of buyers …shifts the D curve
Income …shifts the D curve
Price of
related goods …shifts the D curve
Tastes …shifts the D curve
Expectations …shifts the D curve

23. Supply
•The quantity supplied of any good is the
amount that sellers are willing and able to
sell.
•Law of supply: the claim that the quantity
supplied of a good rises when the price of
the good rises, other things equal

24. The Supply Schedule
•Supply schedule:
A table that shows the
relationship between the
price of a good and the
quantity supplied.
•Example:
Starbucks’ supply of lattes.
Notice that Starbucks’ supply
schedule obeys the
Law of Supply.
Price
of
lattes
Quantity
of lattes
supplied
$0.00 0
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
6.00 18

25. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 1015 Starbucks’ Supply Schedule & Curve
Price
of
lattes
Quantity
of lattes
supplied
$0.00 0
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
6.00 18
P
Q

26. Market Supply versus Individual Supply
•The quantity supplied in the market is the sum of
the quantities supplied by all sellers at each price.
•Suppose Starbucks and Jitters are the only two sellers in
this market. (Q
s
= quantity supplied)
18
15
12
9
6
3
0
Starbucks
12
10
8
6
4
2
0
Jitters
+
+
+
+
=
=
=
=
30
25
20
15
+ = 10
+ = 5
+ = 0
Market Q
s

$0.00
6.00
5.00
4.00
3.00
2.00
1.00
Price

27. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
05101520253035 P
Q
Suppose the
price of milk falls.
At each price,
the quantity of
Lattes supplied
will increase
(by 5 in this
example).
Supply Curve Shifters: Input Prices

28. Supply Curve Shifters: Technology
A cost-saving technological improvement has the
same effect as a fall in input prices, shifts S curve
to the right.
Supply Curve Shifters: # of Sellers
An increase in the number of sellers increases the
quantity supplied at each price, shifts S curve to the
right.
Supply Curve Shifters: Expectations
In general, sellers may adjust supply
*
when their
expectations of future prices change.
(
*
If good not perishable)

29. Summary: Variables that Influence Sellers
Variable A change in this variable…
Price …causes a movement
along the S curve
Input Prices …shifts the S curve
Technology …shifts the S curve
# of Sellers …shifts the S curve
Expectations …shifts the S curve

30. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
05101520253035 P
Q
Supply and Demand Together
D S
Equilibrium:
P has reached
the level where
quantity supplied
equals
quantity demanded

31. D S $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
05101520253035
P
Q
Equilibrium price:
P Q
D
Q
S
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
the price that equates quantity supplied
with quantity demanded

32. D S $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
05101520253035
P
Q
Equilibrium quantity:
P Q
D
Q
S
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
the quantity supplied and quantity demanded
at the equilibrium price

33. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
05101520253035 P
Q
D S
Surplus (a.k.a. excess supply):
when quantity supplied is greater than
quantity demanded
Surplus
Example:
If P = $5,
then
Q
D
= 9 lattes
and
Q
S
= 25 lattes
resulting in a
surplus of 16 lattes

34. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
05101520253035 P
Q
D S
Surplus (a.k.a. excess supply):
when quantity supplied is greater than
quantity demanded
Facing a surplus,
sellers try to increase
sales by cutting price.
This causes
Q
D
to rise
Surplus
…which reduces the
surplus.
and Q
S
to fall…

35. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
05101520253035 P
Q
D S
Surplus (a.k.a. excess supply):
when quantity supplied is greater than
quantity demanded
Facing a surplus,
sellers try to increase
sales by cutting price.
This causes
Q
D
to rise and Q
S
to fall.
Surplus
Prices continue to fall
until market reaches
equilibrium.

36. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
05101520253035 P
Q
D S
Shortage (a.k.a. excess demand):
when quantity demanded is greater than
quantity supplied
Example:
If P = $1,
then
Q
D
= 21 lattes
and
Q
S
= 5 lattes
resulting in a
shortage of 16 lattes
Shortage

37. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
05101520253035 P
Q
D S
Shortage (a.k.a. excess demand):
when quantity demanded is greater than
quantity supplied
Facing a shortage,
sellers raise the price,
causing Q
D
to fall
…which reduces the
shortage.
and Q
S
to rise,
Shortage

38. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
05101520253035 P
Q
D S
Shortage (a.k.a. excess demand):
when quantity demanded is greater than
quantity supplied
Facing a shortage,
sellers raise the price,
causing Q
D
to fall
and Q
S
to rise.
Shortage
Prices continue to rise
until market reaches
equilibrium.

39. Terms for Shift vs. Movement Along Curve
•Change in supply: a shift in the S curve
occurs when a non-price determinant of supply
changes (like technology or costs)
•Change in the quantity supplied:
a movement along a fixed S curve
occurs when P changes
•Change in demand: a shift in the D curve
occurs when a non-price determinant of demand
changes (like income or # of buyers)
•Change in the quantity demanded:
a movement along a fixed D curve
occurs when P changes

40. ELASTICITIES OF DEMAND AND SUPPLY
Importance of Elasticity
-is a very important concept in economic analysis
-It gives quantifiable measure of the responsiveness of
economic variable to changes.
-It is a useful indicator for producers who want to have a
guide as to the likely effect(s) of a price change to their total
revenue.
-In the same manner, it gives guide to consumers as to what
will happen to their total expenditures if there is a change in
price of the commodity.
ELASTICITY
-Refers to the responsiveness of quantity demanded/
supplied to changes in any of the factors affecting them.

41. Measurement of Elasticity
Point elasticity measurement
 elasticity is measured for a single point of the demand
curve or supply curve.
Arc elasticity measurement
elasticity is measured for two points along the demand
curve or supply curve.
Types of Elasticity
 Own Price Elasticity of Demand/Supply
 Cross-price Elasticity of Demand
 Income Elasticity of Demand

42. The elasticity values ( in absolute terms) can range from zero to
infinity; each with definite interpretation as follows:
Elasticity Value Description/Interpretation
IƸI = 0 Perfectly inelastic; the demand curve is
vertical and at any price level, the same
quantity will be demanded; ∆Q is zero
IƸI < 1 Inelastic; % ∆Q < %∆P, quantity demanded is
relatively insensitive to price changes
IƸI = 1 Unitary elastic; %∆Q = %∆P
IƸI > 1 Elastic; %∆Q > %∆P
IƸI = ∞ Perfectly Elastic; demand curve is horizontal;
at a given price, quantity demanded could
range from zero to infinity

43. Own Price Elasticity of Demand / Supply
This refers to the percentage change in quantity
demanded/supplied for every one percent change in own
price.
Ƹ
d=
%∆&#3627408452;??????
%∆&#3627408451;

Where: Ƹ
d is own price elasticity
of demand;
Q
d is quantity demanded
Same formula is used for elasticity of supply, except that quantity
supplied is used instead of quantity demanded.
Ƹ=
&#3627408452;
2
−&#3627408452;
1
&#3627408452;
2
+&#3627408452;
1
÷
&#3627408451;
2
−&#3627408451;
1
&#3627408451;
2
+&#3627408451;
1

Working Formula for Arc Elasticity

44. Determinants of Price Elasticity of Demand
the availability of good substitutes for the commodity;  more
substitutes, more elastic

the number of uses the good can be put into  more uses, more
elastic

the price of the good relative to the consumer’s purchasing power
 if the good takes a large share of the budget the more likely to
be more elastic

the time frame under consideration  the longer period of time,
the more elastic

location along the demand curve

45. Application of Own Price Elasticities of Demand and Supply
Own Price Elasticity of Demand and Total Revenue
Total Revenue (TR) = Price of the good x Quantity
If Price increases  Quantity demanded decreases but the
effect on TR is uncertain unless Ƹ
d is known.
If demand is Price Elastic:
P ↑; % ↓ in Q
d > % ↑P  ↓ TR
If demand is Price Elastic:
P↑; % ↓ in Qd < % ↑ P  ↑ TR
If demand is Unit Elastic:
P↑; % ↓ in Qd = % ↑ P  TR does not change

46. Cross Price Elasticity of Demand (Ƹ
ij)
Consider two goods i and j, the cross price elasticity
measures the percentage change in the demand for
commodity i for every one percent change in the price of
commodity j.
Ƹ
&#3627408470;&#3627408471;=
%∆&#3627408452;&#3627408470;
%∆&#3627408451;&#3627408471;

Explanation:
If Ƹ
ij > 0, the goods are substitutes.
Ex. Ƹ
ij = 0.80, a one percent increase
(decrease) in the price of good j
will result in a 0.80 percent
increase(decrease) in the demand
for good i.

If Ƹ
ij < 0, the goods are complementary.
Ex. Ƹ
ij = - 0.75, a one percent increase (decrease) in the price of
good j will result in a 0.75 decrease (increase in the good
for good i.

47. Income Elasticity of Demand (Ƹ
y)
This measures the percentage change in demand for a good for
every one percent change in income.
Ƹ
??????=
%∆&#3627408452;??????
%∆??????

If Ƹ
y > 0, the good is normal, a one percent
increase (decrease) in income will result in a
percentage increase (decrease) in the
demand for a good.

Qualifier:
If 0 < Ƹ
y < 1, the good is a necessity:
Ex: Ƹ
y = 0.60
If Ƹ
y > 1, the good is a luxury item.
Ex: Ƹ
y = 2.50
If Ƹ
y < 0, the good is inferior, a one percent increase (decrease) in
income, will result in a percentage decrease (increase) in the
demand for a good.

48. Some Applications of Market Equilibrium
Minimum Price Policy
If the government feels that
the market price of a
commodity is too low, it can
institute a FLOOR PRICE,
i.e. set up a price support.
Floor Prices are usually
imposed on certain
agricultural commodities to
help farmers
To be effective, a floor price
is set up above the market
equilibrium price. As such,
it will always result in
excess supply or surplus
0
Q
1 Q
2 Q
*
Q

P*
P
f
P

Q
d
Q
S
surplus
FLOOR PRICE

49. Maximum Price Policy
A PRICE CEILING policy is
usually imposed if the
government thinks that the
market price of a
commodity is too high.
The objective of this policy
is to extend a price subsidy
to consumers
If the price ceiling is
effective, it will result in
excess demand or shortage.
This shortage can be
eliminated by rationing,
importing, and injecting
buffer stocks to the market.
0
Q

P

Q
d
Q
S
Q
*
P*
P
c
Q
1 Q
2
Shortage
PRICE CEILING

50. Elasticities of Demand and Supply and Tax Incidence
Imposition of a tax affects consumption and production. The tax
could be a specific/excise tax or ad valorem tax.
Specific tax or Excise tax
Tax per unit of the
product
Ad valorem tax
Tax as percentage of
the selling price
Who bears the greater portion of the tax? Is it the
consumer or the producer?
The tax is likely to raise the equilibrium price, but by an amount
less than the tax.

Sharing of the tax burden depends on the own price elasticities
of demand and supply.

51. If demand is more elastic than supply, the greater
portion of the tax is likely to be shouldered more
by the producers.
If demand is less elastic than supply, the
consumers pay a greater portion of the tax.
If demand is perfectly inelastic, the consumers pay
100% of the tax.
If demand is perfectly elastic, the producers pay
100% of the tax.

52. Consumer Surplus:
measures the amount a
consumer gains from a
purchase by the difference
between the price he is
willing to pay and what he
actually pays for the
product.

it is the area below the
demand curve and above
the equilibrium price.
Consumer’s Surplus and Producer’s Surplus
0
P
e
Q
e
D

CS
P
Q
Consumer’s Surplus

53. Producer Surplus
refers to the gains derived by
producer as measured by the
difference between the price
he is willing to sell/dispose
his product and the accrual
price he receives from the
sale.

is the area above the supply
curve and below the
equilibrium price of the
product.
0
P
e
Q
e
P
Q
S
PS
Producer’s Surplus

55. THEORY OF CONSUMER’S BEHAVIOR
UTILITY  the measurement of satisfaction derived
from the consumption of a good services.
Measurement
Cardinal Utility Measurement
 assumes that an individual can assign absolute values
or numbers for the satisfaction derived.
Ordinal Utility Measurement
 no need to assign value or number for the satisfaction,
instead can rank his/her preferences

56. Total Utility (TU)
 Refers to the overall level of satisfaction derived from
consuming a good or service. Generally, it increases as
the amount of a commodity consumed increases but only
up to a certain maximum level which we can call the
saturation point. Beyond this point, total utility will tend to
decline.
Marginal Utility
Is the additional satisfaction that an individual derives
from consuming an additional unit of a good or service. It is
also the change in total utility per unit change in the good
or service consumed.
Diminishing Marginal Utility
 As more and more of a good are consumed, the process of
consumption will (at some point) yield smaller and smaller
additions to utility.

57. Consumer Equilibrium or Law of Comparison
 If the consuming good or services, the consumer is faced
with the following constraints: price of the goods and
income
To maximize satisfaction the consumers should follow the
Equi – Marginal Principle  the consumer maximizes
satisfaction by equating the marginal utility per peso spent
on the goods.
INDIFFERENCE CURVE
 Locus of points, each
point representing
combinations of goods,
say X and Y, form which
the consumer derives
the same level of utility.


A

I

B

Qty. of
Good X
Qty. of
Good Y 0

58. INDIFFERENCE MAP
 Is a set or collection of
indifference curves which
represents various levels of
satisfaction or utility.
Specifically, an indifference
curve, that lies above and to
the right of another indicates a
higher level of utility
Quantity
of good Y

Quantity
of good X



I
1
I
2


I
0


D

C

A

59. BUDGET LINE
Locus of points, each point
representing combinations of
the maximum amounts of goods
and services that a consumer
can purchase given his/her level
of income and the prices of the
commodities.

It serves as a boundary between
the feasible and non-feasible
combinations of goods and
services that are available to the
consumer and which s/he can
buy existing prices, given his/her
income level.
Quantity
of good Y

Quantity
of good X

A

B

C

D

60. CONSUMER EQUILIBRIUM
A consumer will maximizes the
satisfaction that will be derived
from consuming goods, X and Y,
given the prices of such goods
and the income by choosing that
combination of X and Y that must
be completely exhaust the
budget and at which the amount
of Y that this consumer is willing
to give up is equal to the amount
of Y that will be required by the
market.

Graphically, equilibrium occurs at
the point where the indifference
curve is tangent to the budget
line
Quantity
of good Y

E

Qty.Of
Good X


I
1

61. INCOME AND SUBSTITUTION EFFECT
Substitution Effect
Is the impact of a pure price change on the quantity
demanded of a certain commodity.

When the price of one good increases, as the income and
prices of other goods remain the same, now it becomes
relatively more expensive than the rest of the goods in the
consumer’s basket.

Thus, the consumer shifts to or substitute lower priced
goods for the good whose prices has increased in order to
maintain his utility level.

62. INCOME EFFECT

Impact on the quantity demanded of a change in
purchasing power.

By purchasing power, we mean the quantity of goods
that can be bought with a given income level and
prices of the commodities.

Thus, when the price of a good increases, with the
consumer’s income remaining constant, the purchasing
power or real income decreases. This then translate to
a lesser amount of goods that can and will be bought.

63. The Costs of Production
Total Revenue, Total Cost, Profit
We assume that the firm’s goal is to maximize profit.
Profit = Total revenue – Total cost
the amount a
firm receives
from the sale
of its output
the market
value of the
inputs a firm
uses in
production

64. Costs: Explicit vs. Implicit
Explicit costs require an outlay of money,
e.g., paying wages to workers.
Implicit costs do not require a cash outlay,
e.g., the opportunity cost of the owner’s time.
Economic Profit vs. Accounting Profit
Accounting profit
= total revenue minus total explicit costs
Economic profit
= total revenue minus total costs (including explicit
and implicit costs)
Accounting profit ignores implicit costs, so it’s higher
than economic profit.

65. The Production Function
A production function shows the
relationship between the quantity of inputs
used to produce a good and the quantity of
output of that good.
It can be represented by a table, equation, or
graph.
Example:
–Farmer Jack grows wheat.
–He has 5 acres of land.
–He can hire as many workers as he wants.

66. 0
500
1,000
1,500
2,000
2,500
3,000
0 1 2 3 4 5
No. of workers

Quantity of output

Example : Farmer Jack’s Production Function
3000 5
2800 4
2400 3
1800 2
1000 1
0 0
Q
(bushels
of wheat)
L
(no. of
workers)

67. Marginal Product
If Jack hires one more worker, his output rises
by the marginal product of labor.
The marginal product of any input is the
increase in output arising from an additional
unit of that input, holding all other inputs
constant.
Notation:
∆ (delta) = “change in…”
Examples:
∆Q = change in output, ∆L = change in labor
Marginal product of labor (MPL) =
∆Q
∆L

68. 3000 5
2800 4
2400 3
1800 2
1000 1
0 0
Q
(bushels
of wheat)
L
(no. of
workers)
EXAMPLE 1: Total & Marginal Product
200
400
600
800
1000
MPL
∆Q = 1000 ∆L = 1
∆Q = 800 ∆L = 1
∆Q = 600 ∆L = 1
∆Q = 400 ∆L = 1
∆Q = 200 ∆L = 1

69. MPL equals the
slope of the
production function.
Notice that
MPL diminishes
as L increases.
This explains why
the production
function gets flatter
as L increases.
0
500
1,000
1,500
2,000
2,500
3,000
0 1 2 3 4 5
No. of workers

Quantity of output

EXAMPLE : MPL = Slope of Prod Function
3000 5
200
2800 4
400
2400 3
600
1800 2
800
1000 1
1000
0 0
MPL
Q
(bushels
of wheat)
L
(no. of
workers)

70. Why MPL Diminishes
Farmer Jack’s output rises by a smaller and
smaller amount for each additional worker. Why?
As Jack adds workers, the average worker has
less land to work with and will be less productive.
In general, MPL diminishes as L rises
whether the fixed input is land or capital
(equipment, machines, etc.).
Diminishing marginal product:
the marginal product of an input declines as the
quantity of the input increases (other things equal)

71. EXAMPLE : Farmer Jack’s Costs
•Farmer Jack must pay $1000 per month
for the land, regardless of how much
wheat he grows.
•The market wage for a farm worker is
$2000 per month.
•So Farmer Jack’s costs are related to how
much wheat he produces….

72. EXAMPLE 1: Farmer Jack’s Costs
$11,000
$9,000
$7,000
$5,000
$3,000
$1,000
Total
Cost
3000 5
2800 4
2400 3
1800 2
1000 1
$10,000
$8,000
$6,000
$4,000
$2,000
$0
$1,000
$1,000
$1,000
$1,000
$1,000
$1,000 0 0
Cost of
labor
Cost of
land
Q
(bushels
of wheat)
L
(no. of
workers)

73. EXAMPLE 1: Farmer Jack’s Total Cost Curve
Q
(bushels
of wheat)
Total
Cost
0 $1,000
1000 $3,000
1800 $5,000
2400 $7,000
2800 $9,000
3000 $11,000 $0
$2,000
$4,000
$6,000
$8,000
$10,000
$12,000
0 100020003000
Quantity of wheat
Total cost

74. Marginal Cost
•Marginal Cost (MC)
is the increase in Total Cost from
producing one more unit:



∆TC
∆Q
MC =

75. EXAMPLE : Total and Marginal Cost
$10.00
$5.00
$3.33
$2.50
$2.00
Marginal
Cost (MC)
$11,000
$9,000
$7,000
$5,000
$3,000
$1,000
Total
Cost
3000
2800
2400
1800
1000
0
Q
(bushels
of wheat)
∆Q = 1000 ∆TC = $2000
∆Q = 800 ∆TC = $2000
∆Q = 600 ∆TC = $2000
∆Q = 400 ∆TC = $2000
∆Q = 200 ∆TC = $2000

76. Why MC Is Important
•Farmer Jack is rational and wants to maximize
his profit. To increase profit, should he produce
more or less wheat?
•To find the answer, Farmer Jack needs to
“think at the margin.”
•If the cost of additional wheat (MC) is less than
the revenue he would get from selling it,
then Jack’s profits rise if he produces more.

77. Fixed and Variable Costs
•Fixed costs (FC) do not vary with the quantity of
output produced.
–For Farmer Jack, FC = $1000 for his land
–Other examples:
cost of equipment, loan payments, rent
•Variable costs (VC) vary with the quantity
produced.
–For Farmer Jack, VC = wages he pays
workers
–Other example: cost of materials
•Total cost (TC) = FC + VC

78. Recall, Marginal Cost (MC)
is the change in total cost from
producing one more unit:
Usually, MC rises as Q rises, due
to diminishing marginal product.
Sometimes (as here), MC falls
before rising.
(In other examples, MC may be
constant.)
EXAMPLE : Marginal Cost
620 7
480 6
380 5
310 4
260 3
220 2
170 1
$100 0
MC TC Q
140
100
70
50
40
50
$70
∆TC
∆Q
MC = $0
$25
$50
$75
$100
$125
$150
$175
$200
01234567
Q
Costs

79. EXAMPLE : Average Fixed Cost
100 7
100 6
100 5
100 4
100 3
100 2
100 1
14.29
16.67
20
25
33.33
50
$100
n/a $100 0
AFC FC Q Average fixed cost (AFC)
is fixed cost divided by the
quantity of output:
AFC = FC/Q
Notice that AFC falls as Q rises:
The firm is spreading its fixed
costs over a larger and larger
number of units. $0
$25
$50
$75
$100
$125
$150
$175
$200
01234567
Q
Costs

80. EXAMPLE : Average Variable Cost
520 7
380 6
280 5
210 4
160 3
120 2
70 1
74.29
63.33
56.00
52.50
53.33
60
$70
n/a $0 0
AVC VC Q Average variable cost (AVC)
is variable cost divided by the
quantity of output:
AVC = VC/Q
As Q rises, AVC may fall initially.
In most cases, AVC will
eventually rise as output rises. $0
$25
$50
$75
$100
$125
$150
$175
$200
01234567
Q
Costs

81. EXAMPLE : Average Total Cost
88.57
80
76
77.50
86.67
110
$170
n/a
ATC
620 7
480 6
380 5
310 4
260 3
220 2
170 1
$100 0
74.29 14.29
63.33 16.67
56.00 20
52.50 25
53.33 33.33
60 50
$70 $100
n/a n/a
AVC AFC TC Q Average total cost
(ATC) equals total
cost divided by the
quantity of output:
ATC = TC/Q
Also,
ATC = AFC + AVC

82. Usually, as in this example,
the ATC curve is U-shaped.
$0
$25
$50
$75
$100
$125
$150
$175
$200
0 1 2 3 4 5 6 7
Q
Costs

EXAMPLE : Average Total Cost
88.57
80
76
77.50
86.67
110
$170
n/a
ATC
620 7
480 6
380 5
310 4
260 3
220 2
170 1
$100 0
TC Q

83. EXAMPLE : The Various Cost Curves Together
AFC
AVC
ATC
MC
$0
$25
$50
$75
$100
$125
$150
$175
$200
0 1 2 3 4 5 6 7
Q
Costs

84. $0
$25
$50
$75
$100
$125
$150
$175
$200
0 1 2 3 4 5 6 7
Q
Costs

EXAMPLE : Why ATC Is Usually U-Shaped
As Q rises:
Initially,
falling AFC
pulls ATC down.
Eventually,
rising AVC
pulls ATC up.
Efficient scale:
The quantity that
minimizes ATC.

85. EXAMPLE : ATC and MC
ATC
MC
$0
$25
$50
$75
$100
$125
$150
$175
$200
0 1 2 3 4 5 6 7
Q
Costs

When MC < ATC,
ATC is falling.
When MC > ATC,
ATC is rising.
The MC curve
crosses the
ATC curve at
the ATC curve’s
minimum.

86. Costs in the Short Run & Long Run
Short run:
Some inputs are fixed (e.g., factories, land).
The costs of these inputs are FC.
Long run:
All inputs are variable
(e.g., firms can build more factories,
or sell existing ones).
In the long run, ATC at any Q is cost per unit
using the most efficient mix of inputs for that
Q (e.g., the factory size with the lowest ATC).

87. EXAMPLE : LRATC with 3 factory Sizes
ATC
S
ATC
M
ATC
L
Q
Ave
Total
Cost
Firm can choose
from 3 factory
sizes: S, M, L.
Each size has its
own SRATC
curve.
The firm can
change to a
different factory
size in the long
run, but not in the
short run.

88. EXAMPLE : LRATC with 3 factory Sizes
ATC
S
ATC
M
ATC
L
Q
Ave
Total
Cost
Q
A Q
B
LRATC

To produce less
than Q
A, firm will
choose size S
in the long run.
To produce
between Q
A
and Q
B, firm will
choose size M
in the long run.
To produce more
than Q
B, firm will
choose size L
in the long run.

89. A Typical LRATC Curve
Q
ATC
In the real
world, factories
come in many
sizes,
each with its
own SRATC
curve.
So a typical
LRATC curve
looks like this:
LRATC

90. How ATC Changes as
the Scale of Production Changes
Economies of
scale: ATC falls
as Q increases.
Constant returns
to scale: ATC
stays the same
as Q increases.
Diseconomies of
scale: ATC rises
as Q increases.
LRATC

Q
ATC

91. How ATC Changes as
the Scale of Production Changes
Economies of scale occur when increasing
production allows greater specialization:
workers more efficient when focusing on a
narrow task.
–More common when Q is low.
Diseconomies of scale are due to
coordination problems in large organizations.
E.g., management becomes stretched, can’t
control costs.
–More common when Q is high.

92. Firms in Competitive Markets
Characteristics of Perfect Competition
1. Many buyers and many sellers.
2. The goods offered for sale are largely the
same.
3. Firms can freely enter or exit the market.
Because of 1 & 2, each buyer and seller is
a “price taker” – takes the price as given.

93. The Revenue of a Competitive Firm
•Total revenue (TR)
•Average revenue (AR)
•Marginal revenue (MR):
The change in TR from
selling one more unit.
∆TR
∆Q
MR =
TR = P x Q
TR
Q
AR = = P

94. Calculating TR, AR, MR
94
Fill in the empty spaces of the table.
$50 $10 5
$40 $10 4
$10 3
$10 2
$10 $10 1
n/a $10 0
TR P Q MR AR
$10

95. Answers
95
Fill in the empty spaces of the table.
$50 $10 5
$40 $10 4
$10 3
$10
$10
$10
$10 $10 2
$10 $10 1
n/a
$30
$20
$10
$0 $10 0
TR = P x Q P Q
∆TR
∆Q
MR =
TR
Q
AR =
$10
$10
$10
$10
$10
Notice that
MR = P

96. MR = P for a Competitive Firm
A competitive firm can keep increasing its output
without affecting the market price.
So, each one-unit increase in Q causes revenue to
rise by P, i.e., MR = P.
MR = P is only true for
firms in competitive markets.

97. Profit Maximization
•What Q maximizes the firm’s profit?
•To find the answer, “think at the margin.”
If increase Q by one unit, revenue rises by
MR, cost rises by MC.
•If MR > MC, then increase Q to raise
profit.
•If MR < MC, then reduce Q to raise profit.

98. Profit Maximization
50 5
40 4
30 3
20 2
10 1
45
33
23
15
9
$5 $0 0
Profit =
MR – MC
MC MR Profit TC TR Q At any Q with
MR > MC,
increasing Q
raises profit.
5
7
7
5
1
–$5
10
10
10
10
–2
0
2
4
$6
12
10
8
6
$4 $10
(continued from earlier exercise)
At any Q with
MR < MC,
reducing Q
raises profit.

99. P
1
MR
MC and the Firm’s Supply Decision
At Q
a, MC < MR.
So, increase Q
to raise profit.
At Q
b, MC > MR.
So, reduce Q
to raise profit.
At Q
1, MC = MR.
Changing Q
would lower profit.
Q
Costs
MC
Q
1 Q
a Q
b
Rule: MR = MC at the profit-maximizing Q.

100. P
1
MR

P
2 MR
2
MC and the Firm’s Supply Decision
If price rises to P
2,
then the profit-
maximizing quantity
rises to Q
2.
The MC curve
determines the
firm’s Q at any
price.
Hence,
Q
Costs
MC
Q
1 Q
2
the MC curve is the
firm’s supply curve.

101. A Firm’s Short-run Decision to Shut Down
Cost of shutting down: revenue loss = TR
Benefit of shutting down:
cost savings = VC (firm must still pay FC)
So, shut down if TR < VC
Divide both sides by Q: TR/Q < VC/Q
So, firm’s decision rule is:
Shut down if P < AVC

102. The firm’s SR
supply curve is
the portion of
its MC curve
above AVC.
Q
Costs
A Competitive Firm’s SR Supply Curve
MC
ATC
AVC
If P > AVC, then
firm produces Q
where P = MC.
If P < AVC, then
firm shuts down
(produces Q = 0).

103. A Firm’s Long-Run Decision to Exit
•Cost of exiting the market:
revenue loss = TR
•Benefit of exiting the market:
cost savings = TC (zero FC in the long run)
•So, firm exits if TR < TC
•Divide both sides by Q to write the firm’s
decision rule as:
Exit if P < ATC

104. A New Firm’s Decision to Enter Market
•In the long run, a new firm will enter the
market if it is profitable to do so: if TR >
TC.
•Divide both sides by Q to express the
firm’s entry decision as:
Enter if P > ATC

105. The firm’s
LR supply curve is
the portion of
its MC curve
above LRATC.
Q
Costs
The Competitive Firm’s Supply Curve
MC
LRATC

106. Example
Identifying a firm’s profit
106
Determine
this firm’s
total profit.
Identify the
area on the
graph that
represents
the firm’s
profit.
Q
Costs, P
MC
ATC
P = $10

MR
50

$6
A competitive firm

107. Answers
107
profit
Q
Costs, P
MC
ATC
P = $10

MR
50

$6
A competitive firm
Profit per unit
= P – ATC
= $10 – 6
= $4
Total profit
= (P – ATC) x Q
= $4 x 50
= $200

108. Example
Identifying a firm’s loss
108
Determine
this firm’s
total loss,
assuming AVC
< $3.
Identify the
area on the
graph that
represents
the firm’s loss.
Q
Costs, P
MC
ATC
A competitive firm
$5
P = $3

MR
30

109. Answers
109
loss
MR P = $3

Q
Costs, P
MC
ATC
A competitive firm
loss per unit = $2
Total loss
= (ATC – P) x Q
= $2 x 30
= $60
$5
30

110. Market Supply: Assumptions
1) All existing firms and potential entrants
have identical costs.
2) Each firm’s costs do not change as other
firms enter or exit the market.
3) The number of firms in the market is
–fixed in the short run
(due to fixed costs)
–variable in the long run
(due to free entry and exit)

111. The SR Market Supply Curve
As long as P ≥ AVC, each firm will produce
its profit-maximizing quantity, where MR =
MC.
Recall that:
At each price, the market quantity supplied
is
the sum of quantities supplied by all firms.

112. The SR Market Supply Curve
MC
P
2
Market
Q
P
(market)
One firm
Q
P
(firm)
S

P
3
Example: 1000 identical firms
At each P, market Q
s
= 1000 x (one firm’s Q
s
)
AVC
P
2
P
3
30

P
1
20
10

P
1
30,000

10,000
20,000

113. Entry & Exit in the Long Run
In the LR, the number of firms can change
due to entry & exit.
If existing firms earn positive economic
profit,
–new firms enter, SR market supply shifts right.
–P falls, reducing profits and slowing entry.
If existing firms incur losses,
–some firms exit, SR market supply shifts left.
–P rises, reducing remaining firms’ losses.

114. The Zero-Profit Condition
•Long-run equilibrium:
The process of entry or exit is complete –
remaining firms earn zero economic profit.
•Zero economic profit occurs when P = ATC.
•Since firms produce where P = MR = MC,
the zero-profit condition is P = MC = ATC.
•Recall that MC intersects ATC at minimum
ATC.
•Hence, in the long run, P = minimum ATC.

115. Why Do Firms Stay in Business if Profit = 0?
Recall, economic profit is revenue minus
all costs – including implicit costs, like the
opportunity cost of the owner’s time and
money.
In the zero-profit equilibrium,
–firms earn enough revenue to cover
these costs
–accounting profit is positive

116. The LR Market Supply Curve
MC
Market
Q
P
(market)
One firm
Q
P
(firm)
In the long run,
the typical firm
earns zero profit.
LRATC
long-run
supply

P =
min.
ATC
The LR market supply
curve is horizontal at
P = minimum ATC.

117. S
1
Profit
D
1
P
1
long-run
supply

D
2
SR & LR Effects of an Increase in Demand
MC
ATC
P
1
Market
Q
P
(market)
One firm
Q
P
(firm)
P
2 P
2
Q
1 Q
2
S
2
Q
3
A firm begins in
long-run eq’m…
…but then an increase
in demand raises P,… …leading to SR
profits for the firm.
Over time, profits induce entry,
shifting S to the right, reducing P…
…driving profits to zero
and restoring long-run eq’m.
A
B
C

118. A monopoly is a firm that is the sole seller
of a product without close substitutes.

The key difference:
A monopoly firm has market power, the
ability to influence the market price of the
product it sells. A competitive firm has no
market power.
Oligopoly: only a few sellers offer similar or
identical products.
Monopolistic competition: many firms sell
similar but not identical products.

119. Comparing Perfect & Monop. Competition
yes none, price-taker firm has market power?
downward-
sloping
horizontal D curve facing firm
differentiated identical the products firms sell
zero zero long-run econ. profits
yes yes free entry/exit
many many number of sellers
Monopolistic
competition
Perfect
competition