ECON 221Final Exam Study Guide Lectures: 16 - 21Lecture 16 (October 30)Production - Understanding how firms can maximize profitso Profits = Total Revenue – Total Costso Both revenue and cost depend on quantity produced Quantity produced depends on “inputs” Inputs:- Land - Labor- Capital - Inputs -> Production Function -> Output o Net Benefit = Total Benefit – Total Cost- Production function o Q = F(K,L) = √K * √Lo Suppose capital (K) is fixed at K = 1 and just think about changes in laboro Now we can draw “total product curve”o Total product (TP) curve represents relationship between total output and the quantityof one of the inputs (while holding the other fixed)o Diminishing returns: each additional unit of input adds less to TP than the last – each new person is a little less productive than the one before. o Marginal product of labor: How much more we can produce if we hire one more worker  MPL = Change in Q / Change in L o Realistic Total Product Curve  Often realistic for TP to be upward sloping in the beginning- but still (for the most part) diminishing returns to laboro Production Function Q (K,L) describes our relationship between inputs and outputs Our goal to understand profits: Profit = TR (Q,(K,L)) – TC (Q,(K,L)) Revenue is just price times quantity- TR (Q,(K,L)) = P*Q (K,L)  Total cost consists of: fixed cost and variable cost- Fixed Cost – cost of fixed inputs (or inputs that firms cannot change in the short run)- Variable Cost- Cost of variable inputs (inputs that firms can change any time)o VC entirely depends on Qo So, TC(Q,(K,L)) = FC + VC(Q(K,L))o Total cost has to be a function of how much is being produced  Example: A pizza shop has to decide at the beginning of the year how many ovens to rent for $10,000, but can hire workers at any time for $20,000.- Here, ovens are a fixed cost and workers are a variable cost.- So if they rent one oven and hire two workers - TC = $10,000 + 2(20,000)o Here capital (ovens) was fixed and labor was variableo All inputs are variable in the long-runo In the short run, most things will be fixed o Total Cost Close relationship between total cost and total production  Ex. Wages = $20,000; Oven = $10,000 Rent one oven – workers can vary. - TC & MC Summaryo Total cost curve- plots relationship between output and total costo For most of the curve – because of diminishing returns to inputs, as we increase output, each additional unit costs more to produceo That is, for most of the curve, marginal costs are increasing- Average total costso ATC = TC/Q Whereas marginal cost measures how much one more unit costs to produce, average total cost measures how much each unit costs on average. Lecture 17 (November 6) Production (Continued) and Perfect Competition- Big goal- Understand how prices and quantities are determined when markets aren’t perfectly competitive.- Understand how firms react to different types of competition (monopoly, oligopoly)- Build a more detailed model how individual firms… o Total product curve – relationship between Q and a factor of production – usually labor(holding other factors fixed)o Firms will maximize profits by choosing Q such that MR = MC o Defining characteristic – for the most part, diminishing return to labor (or other factor) Demonstrated by: Marginal product curve (of labor) MP = Change in output / change in labor o Total cost curve – relationship between output and cost TC = FC + VCo Defining characteristic- - for the most part, increasing marginal costs Demonstrated by: Marginal cost curve MC = change in cost / change in output- Average total cost curve - ATC = total cost/ total output- MC always intersects ATC at minimum of ATC  Average Total Cost (ATC) = TC/Q- So, TC = ATC*Q - Just like, Total Revenue (TR) = P*QShort run vs. Long run costs- Thus far, holding the fixed input fixed – short run- Long run all inputs are variable- Over time a firm can adjust its fixed cost (buy more capital) to accommodate the amount it expects to produce- What happens when you expand capitalo Higher fixed costs Spend to rent/upkeep new machines, factories, etc.o But potentially lower variable costs More capital yields more room for workers to be more productive, lowering costs - Varying fixed costso At low levels of output, increasing fixed inputs can lead to lower minimum ATC Increased possibilities of specialization  Called “Increasing Returns to Scale”o Eventually, increasing fixed inputs leads to higher minimum ATC “Decreasing Returns to Scale” Difficult to maintain, manageo Always choose the ATC curve that gives you the lowest cost for the amount you are willing to produceo Illustrated by “long-run average total cost curve” (LRATC)- General questions for the next few lectureso Firm behavior and consequences  How much to produce in order to maximize profits? What impact does firms’ profit-maximizing behavior have on the market? Depends on the market structure we are talking about: - Number of sellers?- Identical products?- Market structureo Perfect competition Many buyers Many sellers o Monopolistic competitiono Oligopolyo Monopoly - Profit maximization- choose Q where MR = MCo Profit = TR(K,L)) – TC(Q(K,L))o A firm wants to produce one more unit of a good if it will add profito That is, increase production if:  TR(Q+1)-TC(Q+1) > TR(Q)-TC(Q) [TR(Q)+MR(Q)]-TC(Q)+MC(Q)] > TR(Q)-TC(Q)MR(Q) > TC(Q) - TR – Total Revenue- TC – Total Cost - MR – Marginal Revenue- MC – Marginal Cost o So for PC firms, produce more if P > MC(Q); stop at the Q where P = MC(Q)- Perfect competitiono Many buyers and sellers o Selling identical productso Free entry & exit of firms o Seller and Buyers are “price-takers” Firm is a price-taker = firm can’t impact prices The firm always receives the market price when it sells a unit of a good MR always = price, regardless of quantity produce (for perfectly competitive firms)Lecture 18 (November 11)Monopolies- A market with a single seller- Product does not have close substitute- Barriers to entry- can’t just jump into marketo Control of a scarce resourceo Government  Patents, copyrights, etc Consider the alternative… “Natural Monopolies”o “Natural Monopolies” More effective to only have one company producing something  Ex. Phone lines, cable television Very high fixed costs, but low cost of increasing