Unit 2 - Microeconomics

1. Unit 2 - Microeconomics Looking at the economy through a microscope Part 2: Business Cost Curves • Microeconomics looks at how individuals and businesses make decisions about the FoP’s • Individuals/business incentives are to make profits • Individual - lowest price paid • Business - highest profit • Profit - what is left after cost are met • Money is NOT profit - you can make money and still not make a profit • You sell a car for $100 but it costs $500 to fix beforehand

2. Hi Packet on your table. We’ll do what needs to be done today (Review of Learning Goal 1, then Learning Goal 2) and then finish whatever needs to be done with the tests at the end. I’m going to ask you to keep questions to yourself (jot down ?s in the study guide to ask when I’m done)… not trying to be mean, but given the nature of this unit, need continuous quiet to progress through the information.

3. Learning Goal 1 I will be able to: Define and explain money including the functions of it Define Elasticity and summarize the responses to it from Businesses (I) and Consumers (C) Define costs Describe/Define/Explain Fixed and Variable Costs

4. Money Economic view of money has 3 functions • 1. Means of exchange - accepted as a method of payment of debt • 2. Store of Value - keeps it value over time - allows you assess your wealth • 3. Unit of Accounting - specific denominations => increased value • Liquidity - how easily wealth can be transferred from one kind to another - Money is very liquid

5. functions of money allow it to measure some of the benefit/cost of choices (Trade) If you benefit from an exchange => positive trade If a trade costs you => negative trade • (Don’t get this confused with international balance of trade which shows imports and exports) • Individuals can use money to tell if their trade was positive or negative • Other reasons to trade?

6. Individuals will show their preference for trade thru demand elasticity • Inelastic demand shows you are willing to buy a product even if prices rise • Elastic Demand shows you are very aware of changes in price • Both Individuals (C) and Businesses (I) use Price elasticity to determine their economic choices • The am’t they buy or quantity the produce is related to Prices shown in “How much money will this cost” • The effects on Demand elasticity are already listed; income, substitute and complementary good prices

7. He-Man needs an IV … Horizontal = Elastic Inelastic = Vertical

8. Business face different reasons • Most important is the cost of resources • Land, labor, Capital, Entrepreneurs • Economists call this the Costs of Production “CoP” • If CoP rise businesses => less likely to produce • if CoP falls businesses => more likely to produce • Economists divided specific CoP into different kinds

9. Types of Costs to Businesses Explicit costs - those costs which directly relate to production - CoP • Indirect Costs or Hidden Costs- unintended costs associated with production • Indirect costs can be paid by the individual firm or society • Implicit costs - cost assoc. with using a resource for one good - can’t be used for something else • Can also be costs associated with use of resources or production - coal use => acid rain, cutting rain-forests for farms => soil depletion, erosion

10. Implicit costs affect when an Entrepreneur will continue to take a risk • viewed as Normal Profit - min payment an entrepreneur must receive otherwise he should stop producing • Entrepreneurs (businesses) look at costs in Long and Short Term • Short Term - time period is too short to make major changes to plant size • Can increase or decrease current production • Shows how intensively resources are being used

11. With the person/people around you, give me a specific company that could/would see a clear diminishing marginal return as they increase their units of resources used. Be sure to be able to explain how.

12. Long Run (LR) - Time period where business can change capacity - build new plants increase labor change tech or increase land usage Can also go out of business or start a new business Costs of Production are looked at in both SR and LR Diminishing Marginal Returns - concern of businesses - each new unit of resources used increases production to a point then begins to become less productive

13. Costs of Production (CoP) are divided into several different kinds • Fixed Costs (FC) cost that stay the same no matter the level of production • Remain constant in the short run - (6 mths to 1 yr) • Land rental, Mortgage, interest on loans, salaries, Debt, Insurance • Often called Overhead • Variable Costs (VC) - Costs that vary with the level of production • to make more you need more resources => increased costs • Total Cost of Production- total CoP - FC + VC = CoP

14. Shows FixedCosts don’t change with production Shows Variable Costs increase with production

15. Shows TC are FC + VC Graphically

16. Learning Goal 2 – Page 6 I will be able to: Define/Explain Diminishing Marginal Returns in regards to business costs and inflection Explain the shape of a Variable Costs curve Define/Explain Average Costs (Fixed AND Variable) Explain the shape of the AVC curve

17. Graphs show a constant rate or return on production • Diminishing Marginal Returns shows that returns are not linear but change with Production • After Pt H Diminishing Marginal Returns

18. Another view shows that B2 - C2 is the point of INFLECTION Shows where Diminishing Marginal Returns begin

20. Average curves shapes dependent on Diminishing Marginal Returns • Resources are not easily added- each unit can cost a little more • resources are not easily exchangeable • While there is great benefit early from each additional unit of resource - those benefits decline over time • so costs fall at first then slowly rise with each new unit

21. B/c of Diminishing Marginal Returns Variable costs are NOT linear

23. Now lets look at Cost/ unit or Average Costs • AFC - Avg. Fixed Cost/Unit made • FC/Q • Business call this “Spreading the Overhead”

24. AVC - Costs of producing each unit • Reflect Dim Mar Returns • As Production Increases resources are used more effectively • Point of Inflection shows where Mar returns are maximized - After this you get Dim Mar Returns • AVC = VC/Q • Graphically it is a downward sloping saucer shaped curve

25. Average Total Costs - Total Costs/Q • FC + VC/Q or TC/Q • Resembles the AVC cost curve

28. Hi Make sure your HW is done, on your table, with your name at the top. If you were not here yesterday, you have until Monday to do it. -Look at graph at bottom of page 10 -On a piece of computer printer paper (I have it if you need it), graph the table from the top slide on page 11. Use the graph on page 10 to set up the X and Y Axes -You can use different colors, solid/bold/dashed curves, etc. It doesn’t matter to me. Page 11

29. Learning Goal 3 I will be able to: -Define/Explain marginal costs -Summarize the MC Curve -Use MC to determine business production decisions

30. Sit where you were on Friday If you’ve changed your “employer”, perhaps you’re sitting somewhere different. There are people in America today working for a different company than they did on Friday. Maybe you’re one of them! You’re getting a handout shortly. EVERYTHING goes on a separate piece of paper. Notebook, computer printer, graph, it doesn’t matter. EVERYONE will be turning one in!

31. Marginal = additional Power over additional production • Marginal Costs shows the cost of making each new unit • Most controllable cost to business • Cost of making one more or cost saved by producing one less • Marginal Costs tell the firm when to stop producing • Marginal Costs = Change in TC/ Change in Q • TC of making that unit - MC of making the last unit • Graphically it looks like this Typically stop when too exp.

32. Notice that MC always crosses the AVC and the ATC at their lowest points

33. Shape of MC relates to Dim Mar Returns • Each additional unit of resource increases productivity to a point then falls • Crosses AVC and ATC at their lowest pt • Shows the lowest Average cost of each additional unit or resource and production • These curves are used in the Short Run and should be used with the Marginal revenue curves at a latter date Cooks in kitchen, clay to sculptor, “bowling pins”, etc.1 = 10, 2 = 24, 3 = 39, 4 = 56

34. AVC = $10, I’ll keep producing ifcan do it for $8/good, bring down • General Rule: • IF MC < AVC => Increase Production • IF MC < ATC => Increase Production • IF MC > AVC or ATC => decrease production • OR • Move to a larger plant => use Long Run Costs to reduce MC Same…if ATC = $10, and my costof add’l good is $8, keep making If my AVC and ATC for shirts is $12/shirt, and my cost to produce each add’l shirt is $14, I’m not as likely to increase prod unless other factors change.

35. 120 Possible Extra Credit Points 1 Firm guarantees that you all get same amount of extra credit points added to the previous test. 2 Firms guarantees that there is competition. Winning firm gets 100% of the extra credit points to be distributed between them whereas losing firm gets 0% of the extra credit to be distributed. 3 Firms further guarantees competition. Winner gets 55% of the extra credit points to be distributed, 2nd place gets 45%, 3rd place gets nothing. 4 Firms even further guarantees competition. Winner gets 50%, 2nd gets 30%, 3rd gets 20%, loser nothing 5 = 35, 30, 20, 15, 0 6 = 30, 25, 20, 15, 10, 0 10 = 23, 18, 16, 12, 11, 8, 6, 4, 2, 0 Everyone for themselves=

36. Determine if AC is increasing, Decreasing or remaining unchanged as Q increases using this Formula if MC < AC the AC is increasing and if MC < AC the AC is falling, if MC = AC then there is no change • On separate piece of paper… • 1. MC = $12 and AVC = $15…b/c2. MC = $15 and AVC = $103…b/c3. MC = $20 and ATC = $25…b/c4. MC = $12 and AVC = $10 and ATC = $20…b/c5. MC = $12 and AVC = $10 and ATC = $18…b/c6. MC = $15 and AVC = $15 and ATC = $12 …b/c

37. True or False and tell why • 1. ATC never ever falls below AVC2. AVC only falls when MC is falling3. ATC only falls when MC < ATC4. AVC rises if MC > TC5. AFC is at its minimum if AFC = MC6. AVC are at their minimum if  MC = AVC7. AFC fall with Diminishing Marginal Returns

38. 1. Funkadelic Enterprises has the following cost structures    Q        TC    0        $500    1        $1400    2         $1800    3        $2400    4        $3600Use the chart below to figure these costsWhat is the FC for Funkadelic?What is the lowest ATC?What is the lowest AVC?Q        TC        FC        VC        ATC        AVC0        $5001        $1400                $900    $1400      $9002        $1800                        $9003        $2400                                $6334        $3600                $3,100 Produce how many? MC

39. Learning Goal 4 I will be able to: -Define/Explain marginal costs -Summarize the MC Curve -Use MC to determine business production decisions

40. Fill in this tableQ    MC     VC      FC     TC    AVC    AFC      ATC0      -                        -           -       - -1    162                            15                   713            424                     160

41. 1. The production of aluminum takes a large amount of energy    a. If the price of electricity goes up how will this affect the entrepreneurs MC, AVC AFC and ATC? b. Assume that an economic downturn will affect the firm in such a way that its’ able to renegotiate their mortgage to a lower rate - how will this affect their MC. AVC, AFC and ATC? • 2. Suppose that fertilizer has constantly rising marginal production where it raise wheat production with every additional unit of fertilizer If the smallest unit of land is an acre. What is the optimum farm size where it has the lowest ATC?   How much wheat will this farm produce? • 3. Mr Jones was told by the saleman “this new contraption will do half of your work.” Good said Mr. Jones “I’ll take 2 and retire” • What’s wrong with Mr. Jones’ logic in economic cost terms?

42. In the long run (LR) companies can readjust their production to take advantage of current market rises and falls LR>12 mos. • Small plants can expand to become large ones and vice versa • Large plants are more efficient up to a point • Called - Economies of Large Scale production or Economies of Scale Economies of Scale more pop • But LR increases are also subject to Dim Mar Returns • At some point a larger plant isn’t worth it • Larger plants increase costs at various levels of production & resources used • Businesses use their ATC curves to decide when to expand,contract, or shut down

43. Businesses costs are also affected by Economies of scale • Economies of Scale are the benefits a company can get by expanding • Companies can benefit from Internal or external economies of scale • Expanding often reduces costs/unit => increased profit • Internal - Benefit from expanding your firm • Economies of scale lower short run costs => more profits/unit • lower costs by; buying in bulk, organize more efficiently, specialize jobs, typically lower AFC by spreading them out

44. When the ATC begin to rise, a firm should increase in size to take advantage of economies of scale spread out costs • The long Run ATC shows the lowest Cost/unit if the firm has a chance to change in size • For instance Plant A has the lowest costs /unit up to 20 units then they start to increase • By moving to a new plant or expanding the current plant they can lower ATC up to the production of 30 units • They should then expand up to where their ATC start to rise - maybe 50 units canbe made at a bigger plant at lower costs/unit cost/benefit analysis

45. 50 Units 20 units 70 Units 30 units 80 Units As you can see the LR - TC shape is also saucer shaped At 20 units, increasing up to 50 units decreases TC by increasing size – Economies of Scale but after 50 we get LR - Diseconomies of Scale – TOO BIG

47. Economies and Diseconomies of scale - related to the efficient use of the resources and Diminishing Marginal Returns on those resources • Reasons for Economies of Scale • Labor specialization - increasing plant size allows you to hire more specialized labor who are more efficient (Granted they cost more but they outweigh this in their productivity/unit • Managerial specialization - inefficient to use a manager capable of managing 25 workers in a plant w/ only 10 • Efficient use of capital and tech. Large scale operations can use larger more advanced technologies • Use of By Products - can utilize the by-products to make other things or sell them => reducing costs

48. If the LR curve is long - can increase slowly in size and still be competitive – industry has room to expand • If the LR curve is short - increases only benefit up to a point • This means that the shapes of LR curves are different

49. External Costs /Benefits from • expanding the entire industry or • reducing the number of competitors • Expanding the sales of the industries => larger profits/unit • Reducing competitors => more control over price => more profit • Diseconomies of scale can also occur • Marginal Costs of adding new workers increases with more production

50. Review Keys • CoP include Explicit and Implicit Costs • Normal levels of Profit keep Entrepreneur working - Cover at least FC • In the SR - Capacity is fixed - shows intensity of resource usage • Law of Diminishing Returns affects the productivity of resources • In the SR - Fixed Costs are not affected by the level of Production • Variable costs are affected by production • Total Costs = FC + VC • Average costs look at the costs of production of each unit AFC = FC/Q, AVC = VC/Q, ATC = TC/Q