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Principles of Microeconomics – Mr. LillyTopic 5 Skills
1. Know the following facts about supply curves: that a market supply curve shows the aggregate amount of a commodity sellers would produce and supply to the market at various prices; and that a supply curve reflects the (1) production functions and (2)input prices faced by suppliers, but contains no information about consumers. Know that the starting point in our analysis of firm behavior is an assumption that firms act (1) rationally and (2) monolithically; and more specifically, that they seek to maximize total profit subject to their production functions and the input prices they face. Ok 2. Know that the four things* that must be assumed to be constant in order to draw a supply curve are: (1)the time period, (2)the production functions of the firms, (3)the input prices faced by the firms, and (4)the number of firms. Know that a change in the first factor will make a supply curve steeper or flatter and a change in any of the other three factors will shift a supply curve. Given a description of a change in any of the latter three factors, be able to say whether supply would increase or decrease. 3. Know that a movement along a supply curve is referred to as an “increase (or decrease) in the quantity supplied” and that a shift in the supply curve is called an “increase (or decrease) in supply.” Know that an “increase in the quantity supplied” can only occur in response to a change in the price of the item, so that if anything else changes and that change has an impact on the supply for this product, we can conclude that we are witnessing an “increase (or decrease) in supply,” not an “increase (or decrease) in the quantity supplied.” Know that when we say “supply increased,” it means that producers in aggregate are willing to produce more of the product at every price. Know that if the supply curve shifts to the right (or down,) we say “supply increased” and that if the supply curve shifts to the left (or up,) we say “supply decreased.” (ok) 4. Know what a fixed factor of production is and be able to recognize some common ones. Know what a variable factor of production is and be able to recognize some common ones. Know the meaning of the expressions “short run” and “long run.” Know the definitions of the expressions “fixed costs” and “variable costs” and be able to recognize some typical components of each. Know that fixed costs plus variable costs equal total costs. Know that profits are by definition, total revenue minus total costs. Know that revenue equals price times quantity sold. (Slide 8) A firm will experience increasing marginal cost whenever some of its factors of production are FIXED. Generally, we assume that in the short run, the amount of capital (land, machines, building) is fixed. Most supply curves that we draw in this class will be SHORT RUN SUPPLY CURVES. (136) fixed costs = costs of production that do not depend on the quantity of production (136) variable costs = costs of production that vary with the quantity of production. Total costs = Fixed Costs + Variable Costs Profit = Total Revenue – Total Costs Revenue = Price x Quantity Sold (134) profits = total revenue received from selling the product minus the total costs of producing the product. (134) total revenue = the price per unit times the quantity the firm sells. (135) total costs = the sum of variable costs and fixed costs.
(Slide 13) Total revenue = P x Q. Profit = Total Revenue – Total Cost. This table corresponds to the vertical line at Q=2 in Figure 6.6
5. Know what the expressions “price-taker” and “competitive market” mean. Know what a monopoly is. Know that in a competitive market, all firms end up charging the same price, because goods in the market are assumed to be homogenous and consumers are assumed to have perfect information about the quality and prices of goods in the marketplace. (133) price-taker = any firm that takes the market price as given; this firm cannot affect the market price because the market is competitive. (133) competitive market = a market in which no firm has the power to affect the market price of a good. Monopoly?
6. Know that a production function shows the relationship between a variable input and output. Given a graph of a firm’s production function (such as figure 6.3) that is unlabeled except for the axes, be able to recognize it as a production function. Know what the marginal product of labor is and how it can be determined from a graph of the production function such as figure 6.3 or a production table such as the first two columns of table 6.2(p.137, slide6). Know what diminishing returns to labor are and be able to recognize at what level of labor input a production function begins to exhibit diminishing returns to labor given a production table such as the first two columns of table 6.2. (135) production function = a relationship that shows the quantity of output for any given amount of input. (135) marginal product of labor = the change in production due to one-unit increase in labor input. (Slide 4) Imagine that you are the owner and manager of a firm. To keep things simple, suppose that your firm grows pumpkins on a pumpkin patch. The patch has good soil and gets plenty of rain. Your firm is one of many specializing in growing and selling pumpkins. As owner and manager of the firm, you must pay rent at the start of each growing season to the landlord who owns the land. During the season, you hire workers to tend the patch. The more workers tending the pumpkins, the more pumpkins you can grow on the patch; but the relationship between workers hired and pumpkins produced is not linear. Instead, it is a downward-sloping function. You enjoy a higher marginal product of labor (change in units of output per additional worker hired) at low levels of labor input than at high levels of labor input. If you input 2 hours of labor per season, you get 1 crate of pumpkins. If you input 5 hours of labor, you get 2 crates of pumpkins. The figures are in the first 2 columns of table 6.2 on page 120, which I’m going to show in 2 slides. (136) diminishing returns to labor = a situation in which the increase in output due to a unit increase in labor declines with increasing labor input; a decreasing marginal product of labor.
7. Know what marginal cost is. Understand that increasing marginal cost is due to the diminishing marginal product of labor (also known as diminishing returns to labor.) Understand that firms will always experience increasing marginal costs in the short run, because the short run is by definition a period short enough that at least some factors of production are fixed. Understand how, from a visual inspection of a total cost curve, you can determine if marginal cost is increasing or decreasing, because marginal cost is the slope of the total cost curve at any output level. Given a firm’s fixed costs and a table of their marginal costs (such as the first and third columns only of table 6.3,) be able to compute a firm’s total costs. Given in addition the price of the firm’s output, be able to compute the firm’s profit. (137) marginal costs = the change in total costs due to one-unit change in quantity produced. (Slide 7) Marginal cost is the EXTRA cost a firm had to incur to produce the last unit of output. It is equal to the CHANGE IN TOTAL COST. Notice how marginal cost increases. This corresponds to the TOTAL COST CURVE GETTING ever-steeper. Marginal cost = slope of the total cost curve
8. Understand that, to derive a firm’s supply curve, we assume that a firm chooses to produce where profits are at a maximum. Given an output price and a table of a firm’s marginal costs (such as the first and third columns only of table 6.3,) be able to determine the profit-maximizing output for the firm. Know the price equals marginal cost rule. Understand that the price equals marginal cost rule, together with an assumption that firms act rationally to maximize profits, means that a competitive firm’s supply curve is its marginal cost curve. (140) profit maximization = an assumption that firms try to achieve the highest possible level of profits – total revenue minus total costs – given their production function. (Slide 12) The Price Equals Marginal Cost Rule “A firm in a perfectly competitive market will always maximize profit by producing the quantity at which price equals marginal cost.” •A perfectly competitive firm has no ability to influence the price. •This has nothing to do with the ethical choices of its owners or managers. •Perfect competition means ¨many sellers〃 competitive firmˇs supply curve = marginal cost curve 9. Know that the market supply curve is obtained by summing the quantities produced by all firms at each price, a process known as ¨horizontal summation.〃 Understand why ¨vertical summation〃 would NOT yield a valid market supply curve. (Slide 10) If fractional units of production are allowed, and if the firmˇs marginal cost climbs smoothly between the known whole-unit amounts, the individual firmˇs supply curve will look like this. (Slide 11) But this is exactly the same curve as the firmˇs marginal cost curve!!! (Slide 24) For the Perfectly Competitive Firm, the Marginal Cost Curve Tracks the Supply Curve
10. Know the four things that shift supply curves to the right. (Lecture only 𩐝 slide 5-19.) Understand that all four operate by shifting the production functions of firms upward, which in turn shifts their marginal cost curves (and hence their individual supply curves) to the right (which is the same as downward.) See slides 5-20 to 5-24 for an example. (Slide 19) Four Things That Shift Supply Curves to the Right 1. Increases in worker skills(improvement in skill) 2. Increased investment in machines (capital formation) 3. Improvements in technology, and(technology advancement) 4. Better economic organization, e.g. 𩐝 Better enforcement of contracts 𩐝 Better enforcement of private property rights (including but not limited to patents and copyrights) 𩐝 Reduced government regulation (most often overlook) 𩐝 Reduced tax rates (Slide 27) ¨The four sources of income growth are (a) Improvements in worker skills (b) Capital formation (c) Technological advancements, and (d) Better economic organization.〃 • Income growth is synonymous with ¨greater amounts of value being created each year〃 in the economy. • Whenever greater amounts of value are created in the economy, it will show up as increased consumer surplus, increased producer surplus, or both. 11. Know what producer surplus is. Given a graph of a supply curve and a price line, be able to identify the portion of the diagram the area of which provides a measure of producer surplus. (See figures 6.10 and 6.11.) Understand why a firmˇs producer surplus minus its fixed costs equals the firmˇs profit. (148) producer surplus = the difference between the price received by a firm for an additional item sold and the marginal cost of the itemˇs production; for the market as a whole, it is the sum of all the individual firmsˇ producer surpluses, or the area above the market supply curve and below the market price. Firmˇs Profit = producer surplus 𩐝 fixed costs
12. Know the meaning of the terms and expressions shortage, surplus, equilibrium price, equilibrium quantity, and market equilibrium. Given a graph of the supply and demand curves in a competitive market, be able to determine the equilibrium price and quantity. Given either a graph (such as figure 3.9) or a table (such as table 3.3) of market demand and supply, be able to determine whether, at any given price, there will be excess demand, excess supply, or neither. Be able to explain why, if the price is any price other than the market equilibrium price, there will be pressure on the price to either rise or fall. (upper triangle is consumer surplus, lower triangle is producer surplus) (G8) shortage=excess demand, (G9) surplus = excess supply equilibrium price, equilibrium quantity, and market equilibrium?
13. If the market supply curve shifts to the right (or to the left,) be able to predict what will happen to the equilibrium price and quantity in that market. Also, be able to predict what will happen to the amount of economic surplus generated in the economy per time period. When the demand curve shifts to the right (or to the left,) be able to predict what will happen to the equilibrium price and quantity in that market. (See figure 3.9.) *The book adds a fifth factor, ¨expectations of future prices,〃 but you will not be responsible for learning or remembering this factor. See pages 52-53 of the Taylor text. Also, the book lists ¨government taxes, subsidies, and regulations〃 as a separate factor on page 58, but in lecture I presented it as one of the four factors that operates through the firmˇs production function. (See slides 5-25 to 5-27.)
(55) Supply = a relationship between price and quantity supplied (55) quantity supplied = the quantity of a good that firms are willing to sell at a given price. (55) supply schedule = a tabular presentation of supply showing the price and quantity supplied of a particular good, all else being equal. (55) law of supply = the tendency for the quantity supplied of a good in a market to increases as its price rises. (55) supply curve = a graph of supply showing the upward-sloping relationship between price and quantity supplied.
(132) firm = an organization that produces goods or services. (143) marginal revenue = the change in total revenue due to a one-unit increase in quantity sold.
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