Rachel Gordon
EC 201
Paper 2
Chapter 4
In economics our profits are calculated by subtracting our total revenue by the total cost.
Therefore one might think to maximize both you must increase both, total revenue and total cost.
Unfortunately it is not that simple; profits depend on multiple things though it is calculated so
simply. To accurately calculate profits you have to incorporate a couple factors: Fixed costs,
costs that do not rise with production, production costs, costs that change with the making
product/service and revenue from those services. Q is the number of things you make/do. So
profit = (Revenue - Production costs)*(number of things you make/do) - (Fixed costs)*(number
of things you make/do).
If a firm is not producing anything, one may think that there would be no cost, but this is
not true, total fixed costs are still present. As the quantity of production of the firm rises the
production cost rises as well as the revenue. If a firm is producing less than expected, the firm is
not effectively using existing staff and facilities. This means that the revenue will not be as great
because they are not using staff and facilities effectively while still paying for them/it. The cost
of your facilities and staff is completely dependent on the output level of production.
A firm is only able to output little over what was expected or planned for because the
staff and facility would not be equipped to produce more. If a firm wants to achieve more output,
the firm can better use staff or increase staff. By increasing use of staff the facilities will also
have an increase of use. unfortunately the greater output will also result in greater labor costs and
equipment repair due to the firms facilities not being equipped to handle this much output.
Therefore the increase of production cost will be greater than revenue.
The average total cost is measured by the total cost divided by the quantity. Through this
equation we know that the average total cost when there is a smaller output will be greater and
the average total cost when the output is great will be large as well.
When the output of production increases there is also an increase in total cost, marginal
cost measures the relationship increase of both. On a graph this measurement would be the slope
of the line, with one variable meaning production, and the other variable being cost. We know
when the output increases so does the average cost therefore since the marginal cost measures by
one unit, marginal cost can detect when average total cost will rise.
Marginal cost, average total cost, and average variable cost all increase at steady rates
when the quantity of production is increased. The costs of these three will never be exactly the
same, though they are similar. This is due to the average fixed cost, the average fixed cost effect
the other costs, and is never zero, and therefore the other three costs will never be exactly the
same.
For every projected amount of output, which producers can choose depending on the use
of technology, staff, and facilities, there is an average total cost curve. For this curve the
producers need to know an average output so that the cost they put into equipment and labor can
effectively produce the average output, this is important due to losing revenues because your
firm is over qualified or over prepared for such little production.
As shown in figure 4-6, the average total cost curve for three different firms can be
totally different though their production level is the same. This is due to one firm being
unprepared for the quantity of production, and one firm being over prepared for the quantity of
production. The goal is to achieve the lowest total cost for a certain firm, meaning it is equally
bad financially to be underprepared or over prepared for the quantity of production. A firm has
the lowest average total cost when they are in the middle of the two.
If the total cost is decreasing, and the production quantity is where is was projected, than
your production is becoming more efficient. Firms are able to decrease total cost by cutting cost
in labor, facility of production, a cut in prices of materials, or energy, and a few other
miscellaneous things. Also firms are able to cut costs by changing facilities that better fit their
needs, i.e diminishing unnecessary equipment. Finding new technologies that increase output,
but not labor, also decrease total cost of a firm.
Chapter 5
The indifference curve in Figure 5-1 represents to a consumer is the total benefit that they
will receive by either moving up or down the curve. Wherever the consumer moves along the
curve, they will be receiving the same benefit, regardless of increasing Y and decreasing X, or
increasing X and decreasing Y. The reason the same benefit results along the curve is because as
the consumer loses amounts of X or Y, it is expected that the consumer will increase amounts of
X or Y to offset the losses.
In applying what we learned in figure 5-1, all combinations of X and Y on the curve
result in the same benefit. Figure 5-2 applies this same definition, but shows the effects of
having three indifference curves that cannot touch or cross one another. What is learned from
this diagram is that the higher curve will result in greater benefits than any of the curves below it.
For example, if you look at Figure 5-2, you can see that curve 3 will result in more benefits than
curve 2 or curve 1.
Figure 5-3 represents indifference curves in regards to a customer’s budget constraint.
The straight line in the figure shows all of the combinations between Goods Y and Good X
available for purchase. A consumer’s greatest benefit is reached when the budget constraint line
touches an indifference curve at a single point.
The absolute slope, or marginal rate of substitution, shows the rate that a consumer is
willing to take more of one good in exchange for less of the other good. In relation to what was
learned in Figure 5-1, you can see from this rate that as Good Y increases, Good X will decrease.
In regards to Figure 5-4 and the slope of the budget constraint line, the figure shows that if prices
for a product rise, the consumer will look for a similar, but less expensive product on a lower
indifference curve (red line) because they are no longer as affordable. These causes are known
as the substitution and income effect. These effects can sometimes result in inferior goods,
which are goods lower income consumers may typically buy, but would not if their incomes
were higher.
If prices change, the price elasticity of demand (PED) helps measure the effects it has on
quantity demanded by using percentages. Demand is price elastic if it positively responds to
price change; so, the higher percentage in demand will increase demand for products. However,
if percentage in demand is lower than the percentage in price, then demand for products will
decrease and respond negatively. Perfectly price inelastic products are when quantity demanded
is not affected by prices, and the curve is vertical. A horizontal demand curve is considered
perfectly price elastic because quantity demanded is affected by price changes. In a negativelyslanted demand curve, elasticity varies, but is unit elastic in the exact middle of the curve.
However, as you move down the curve, demand becomes more and more inelastic as price
elasticity of demand increases. Moving up the curve has an opposite effect on demand as it
becomes more and more elastic as price elasticity of demand decreases.
It is important to remember that substitutes are important factors when determining price
elasticity of products. For example, gas has a low PED because of its lack of substitutes.
However, goods like luxury cars have a high PED because there are various substitutes. PED and
total revenue also share a relationship because total revenue is affected when demand is either
elastic or inelastic. Price and total revenue have opposite effects on each other when demand is
elastic. However, price and total revenue move in the same direction as one another when
demand is inelastic.
Uniform pricing occurs when product units are sold at the same price. This unit price
will equal the average revenue (AR) gained for every unit sold. The demand curve helps a seller
find the highest price they can sell each unit, while still able to sell every unit available. Since
there is an AR curve, there must always be a marginal revenue (MR) curve which will lie
beneath the AR curve. The MR curve helps in maximizing profits because it increases total
revenues for every unit sold.
Chapter 6
A commodity market is the closest market to a real world market that could become a
perfect market. In a commodity market suppliers and demanders both have input in the price of
an item. Suppliers and demanders come to a price by finding a medium between the twos desired
price.
In a commodity market each demander is independent, meaning one demander cannot
change the total demand on one product, by increasing or decreasing their individual demand of
one product. Just alike the suppliers cannot increase or decrease the markets supply of a product.
Figure 6-1 shows that units sold after Q1 will not reach potential profits. From zero to Q1
the firm would reach economic profits, displayed in the shaded area of the graph. Producing
more than Q1 would result in negative profits because the marginal cost would be greater than
the marginal revenue. A firm should never produce more than when the marginal cost curve,
quantity of production and marginal revenues connect.
If a firm that is projected to operate at Q1 is trying to operate at Q2, its profits would
become negative because the more you produce the higher your average total cost, marginal cost,
and average variable cost are. This results in a great increase in cost, and not its total revenues.
Though its total revenue is negative, the firm would still be making enough profit to cover
average variable cost, as shown in Figure 6-2
A firm’s supply curve links the price of product and the output of that period. The curve
that can represent a supply curve is the marginal cost curve, when and only when the marginal
cost curve sits above the lowest point on the average variable cost curve. If a supply curve does
sit below the AVC then the firm would be profiting more if the firm was shut down.
Unlike a short run, in a long run a firm has time to reduce cost and make ATC decreases.
One may think by finding a more efficient facility, the firm would produce more quantity, more
efficiently which in return would maximize profits. Unfortunately this is not true for every
scenario. Though the firm is at peak efficiency the marginal revenue is not equal to marginal cost
because though the firm raised their efficiency of production the firm has not increased their
production to Q1 rather than Q2. Figure 6-6 shows the profits being maximized by shifting
production over to Q2.
Long Runs are able to adjust quantity of production and facilities to equal and sustain
maximum profitability; this is why long runs seem more attractive to others. Being attractive as a
firm can result in more completion, and more investors. Though the firm is creating more
competition the market is so big that it would take many firms entering the market to lower the
price of a product. Figure 6-7 shows what would happen if the price was lowered to a single
firm. There would be a decrease in profits, and the economic profits would me smaller as well,
shown in the shaded area of the graph. Although the profits are now substantially lower,
competition will likely increase until the profits result to zero or negative profits. At this point
decrease in price will stop. Through these changes the firm must adapt by changing facility or
quantity of production to reach peak efficiency and maximum profitability. The changes in a
firm are demonstrated in figure 6-8.
The outcome of the firm’s adaption results in: average revenue = marginal revenue =
marginal cost = average total cost = LRATC. This outcome results in the lowest price of a
product which benefits the buyers. It also results in a high supply because there are multiple
suppliers. This outcome is the best scenario for buyers. This outcome may not be the best
scenario for sellers, but if sellers are still running peak efficiency and receiving highest
profitability than that is the best for the firm at the given time.