Unit 3:
Perfect Competition
1
Production is
Analyzing
Converting inputs into output
Production
2
Production Simulation
1 stapler, 1 scissors, 1 table, and plenty of paper
Fold into ½  Cut  Fold into ¼  Cut 
Wrap  Staple  Add more links
Production Simulation
Rules
• There will be several rounds and each round last 2 min.
• One additional worker will be hired at each round.
• Workers have to fold & cut ONE paper at a time.
• Workers can only fold the new paper AFTER the pervious
one is cut.
• Workers can only add links to one side of the chain.
Responsibilities
• The manager will hire the workers.
• Each worker has to be assigned to do some job.
• The inspector will make sure each worker is following the
rules and product is made to specifications.
Production Simulation
Complete the chart for your firm:
# of Workers
(inputs)
0
1
2
3
4
5
6
Total Product
(output)
Marginal
Product
Production Simulation
# of
Total
Marginal
Workers Product Product
(inputs) (output)
Products
0
1
2
3
4
5
6
Workers
Production Analysis
• What happens to the Total Product as you hire
more workers?
• What happens to marginal product as you hire
more workers?
• What would happen to total output if every
student in the room tried to make links given
only one stapler (limited resource)?
The Law of Diminishing Marginal Returns
As variable resources (workers) are added to fixed
resources (machinery, tool, etc.), the additional output
produced from each new worker will eventually fall.
Too many cooks
in the kitchen!
7
Graphing Production
“I always gives 110% to my job. 40% on Monday, 30% on Tuesday,
20% on Wednesday, 15% on Thursday, and 5% on Friday.”
The Law of Diminishing Marginal Returns
is NOT the results of laziness, it is
the result of limited fixed resources.
8
Three Stages of Returns
Stage I: Increasing Marginal Returns
MP rising. TP increasing at an increasing rate.
Specialization.
Total
Product
Total Product
Stage I
Marginal
and
Average
Product
Average Product
Marginal Product
9
Three Stages of Returns
Stage II: Decreasing Marginal Returns
MP Falling. TP increasing at a decreasing rate.
Fixed Resources. Each worker adds less and less.
Total
Product
Total Product
Stage I
Marginal
and
Average
Product
Stage II
Average Product
Marginal Product
10
Three Stages of Returns
Stage III: Negative Marginal Returns
MP is negative. TP decreasing.
Workers get in each others way
Total
Product
Total Product
Stage I
Marginal
and
Average
Product
Stage II
Stage III
Average Product
Marginal Product
11
Calculate MP and AP
Identify the three stages of returns
Stage I: Increasing Marginal Returns
# of
Workers
(Input)
Total Product
(TP)
PIZZAS
Marginal Product
(MP)
Average Product
(AP)
0
0
-
-
1
10
10
10
2
25
15
12.5
3
45
20
15
4
60
15
15
5
70
10
14
6
75
5
12.5
7
75
0
10.71
8
70
-5
8.75
12
Identify the three stages of returns
Stage I: Increasing Marginal Returns
Stage II: Decreasing Marginal Returns
# of
Workers
(Input)
Total Product
(TP)
PIZZAS
Marginal Product
(MP)
Average Product
(AP)
0
0
-
-
1
10
10
10
2
25
15
12.5
3
45
20
15
4
60
15
15
5
70
10
14
6
75
5
12.5
7
75
0
10.71
8
70
-5
8.75
13
Identify the three stages of returns
Stage I: Increasing Marginal Returns
Stage II: Decreasing Marginal Returns
Stage III: Negative Marginal Returns
# of
Workers
(Input)
Total Product
(TP)
PIZZAS
Marginal Product
(MP)
Average Product
(AP)
0
0
-
-
1
10
10
10
2
25
15
12.5
3
45
20
15
4
60
15
15
5
70
10
14
6
75
5
12.5
7
75
0
10.71
8
70
-5
8.75
14
Identify the three stages of returns
Stage I: Increasing Marginal Returns
Stage II: Decreasing Marginal Returns
Stage III: Negative Marginal Returns
# of
Workers
(Input)
Total Product
(TP)
PIZZAS
Marginal Product
(MP)
Average Product
(AP)
0
0
-
-
1
10
10
10
2
25
15
12.5
3
45
20
15
4
60
15
15
5
70
10
14
6
75
5
12.5
7
75
0
10.71
8
70
-5
8.75
15
Costs of Production
16
Accountants
Economists
Only look at EXPLICIT
COSTS
Look at the EXPLICIT
COSTS and the IMPLICIT
COSTS
Explicit costs are the
traditional “out-of pocket
costs” of decision making.
Implicit costs are the
opportunity costs such as
forgone time and forgone
income.
Forgone Wage, Forgone
Rent, Time
Rent, Wages, Materials,
Electricity Bills
Accounting
Profit
Total
Revenue
Accounting Costs
(Explicit Only)
Economic
Profit
Total
Revenue
Economic Costs
(Explicit + Implicit)
17
Production Costs
What do you need to open a pet store?
18
Definitions
Fixed Costs:
Costs for fixed resources that DON’T change with
the amount produced
Ex: Rent, Insurance, Managers Salaries, etc.
Average Fixed Costs = Fixed Costs
Quantity
Variable Costs:
Costs for variable resources that DO change as
more or less is produced
Ex: Raw Materials, Labor, Electricity, etc.
Average Variable Costs = Variable Costs
Quantity
Different Economic Costs
Total Costs
TP = Total Product
FC = Total Fixed Costs
VC = Total Variable Costs
TC = Total Costs
Per Unit Costs
AFC = Average Fixed Costs
AVC = Average Variable Costs
ATC = Average Total Costs
MC = Marginal Cost
20
• Total Product (TP)- total output or quantity
produced
• Marginal Product (MP)- the additional
output generated by additional inputs
(workers).
Δ Total Product
Marginal Product =
Δ Inputs
• Average Product (AP)- the output per unit
of input
Total
Product
Average Product =
Units of Labor
“Short-Run” Production Cost
Short-Run is NOT a set specific amount of
time.
The short-run is a period in which at least
one resource is fixed.
– Ex. Plant capacity/size is NOT changeable
In the long-run ALL resources are variable
– NO fixed resources
– Plant capacity/size is changeable
22
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
24
35
54
77
FC
10
TC
MC
AVC AFC ATC
23
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
24
35
54
77
FC
10
10
10
10
10
10
10
10
TC
MC
AVC AFC ATC
24
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
24
35
54
77
FC
10
10
10
10
10
10
10
10
TC
10
20
26
31
34
45
64
87
MC
AVC AFC ATC
25
TOTAL COSTS GRAPH
TC
150
50
VC + FC = TC
VC
FC
Cost dollars
140
40
130
30
What is the TC,
FC, & VC for
producing 4 units?
120
20
110
10
FC
100
0
1
2
3
4
5
6
7
8
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
24
35
54
77
FC
10
10
10
10
10
10
10
10
TC
10
20
26
31
34
45
64
87
MC
10
6
5
3
11
19
23
AVC AFC ATC
27
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
24
35
54
77
FC
10
10
10
10
10
10
10
10
TC
10
20
26
31
34
45
64
87
MC
10
6
5
3
11
19
23
AVC AFC ATC
10
8
7
6
7
9
11
28
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
24
35
54
77
FC
10
10
10
10
10
10
10
10
TC
10
20
26
31
34
45
64
87
MC
10
6
5
3
11
19
23
AVC AFC ATC
10
10
8
5
7
3.3
6
2.5
7
2
9
1.6
11
1.4
29
TP
0
1
2
3
4
5
6
7
VC
0
10
16
21
24
35
54
77
FC
10
10
10
10
10
10
10
10
TC
10
20
26
31
34
45
64
87
MC
10
6
5
3
11
19
23
AVC AFC ATC
10
10
20
8
5
13
7
3.3 10.3
6
2.5 8.5
7
2
9
9
1.6 10.6
11
1.4 12.4
30
Per-Unit COSTS (Average & Marginal)
How much does the 9th unit costs?
Costs (dollars)
12
11
10
9
8
7
6
5
4
3
2
1
ATC and AVC get
closer and closer
but NEVER touch
MC
ATC
AVC
Average
Fixed Cost
AFC
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity
32
Per-Unit COSTS (Average & Marginal)
Costs (dollars)
At
TC
VC
FC
output Q, what area represents:
(
)    ADQ0
(
)    BEQ0
(
)    ADEB or CFQ0
A
B
C
0
D
Fixed Cost
E
Total Cost
Variable Cost
F
Fixed Cost
Q
Quantity
33
Why is the MC curve U-shaped?
MC
Costs (dollars)
12
11
10
9
8
7
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity
34
Why is
the MC curve U-shaped?
When MP is increasing, MC falls.
When MP falls, MC increase.
 MP & MC are mirror images of each other.
Marginal Cost
Marginal Cost
Marginal Product
Marginal Product
Quantity of labor
Quantity of output
35
 The MC curve falls and then rises because of
Diminishing Marginal Returns.
 Example:
 Assume the fixed cost is $20 and the ONLY variable
cost is the cost for each worker ($10)
Workers
Total
Product
Marginal
Product
Total Cost
0
0
-
$20
1
5
5
$30
2
13
8
$40
3
19
6
$50
4
23
4
$60
5
25
2
$70
6
26
1
$80
Marginal
Cost
36
 The MC curve falls and then rises because of
Diminishing Marginal Returns.
Marginal Cost =
Δ Total Cost
Δ Total Product
Workers
Total
Product
Marginal
Product
Total Cost
Marginal
Cost
0
0
-
$20
-
1
5
5
$30
10/5 = $2
2
13
8
$40
10/8 = $1.25
3
19
6
$50
10/6 = $1.6
4
23
4
$60
10/4 = $2.5
5
25
2
$70
10/2 = $5
6
26
1
$80
10/1 = $10
37
 The additional cost of the first 13 units produced falls
because workers have increasing marginal returns.
 As production continues, each worker adds less and less
to production so the marginal cost for each unit
increases.
Workers
Total
Product
Marginal
Product
Total Cost
Marginal
Cost
0
0
-
$20
-
1
5
5
$30
$2
2
13
8
$40
$1.25
3
19
6
$50
$1.6
4
23
4
$60
$2.5
5
25
2
$70
$5
6
26
1
$80
$10
38
Cost (dollars)
The MC curve intersects the ATC curve at its lowest point.
 The average income in the room is $50,000.
 An additional (marginal) person enters the room: Bill Gates.
 If the marginal is greater than the average it pulls it up.
 Notice that MC can increase but still pull down the average.
MC
ATC
Quantity of output
 Why is the ATC
curve U-shaped?
 When the marginal cost
is below the average, it
pulls the average down.
 When the marginal cost
is above the average, it
pulls the average up.
40