AP Economics October 17 2017 1 Unit II

AP Economics October 17, 2017 1. Unit II Exam Scores and Solutions 2. Begin Unit 3: Theory of the Firm 3. Lesson 3 -1: Introduction to Unit 2

AP Economics October 17, 2017 1. Lesson 3 -1: Costs, Profits, Etc. 2. Unit 3 Vocabulary 3. Quiz: Unit 3, Lesson 1: Thursday 4. Unit 3 Exam: November 30/December 1

Theory of the Firm • 35 -50% of AP Micro Exam: The Heart of Microeconomics. • Theory of the Firm: Concept that states that firms make decisions in order to maximize profits. • Goes along with theory of the consumer that consumers seek to maximize their overall utility.

• • • Cost Definitions Firms face Economic Costs: Payments made to obtain and keep a resource. Explicit Costs: Monetary payments used to buy resources. Wages, Rent, Capital. 2 Kinds of Explicit Costs: Fixed Costs: Costs that are consistent and independent of output (rent, buildings, machinery) Variable Costs: Costs that vary with output (wages, utilities, materials used in production) Explicit Costs = Total Fixed Costs (TFC) + Total Variable Costs (TVC) Implicit Costs: Cost that is represented by the Opportunity Cost of not doing something else with a resource. ) Economic Costs= Explicit Costs + Implicit Costs

• • Profit Definitions Accounting profit = Total Revenue – Explicit Costs Economic Profit =Total Revenue – Economic Costs If economic profit is positive, keep doing it… Normal Profit = Difference between Accounting and Economic Profit (Same as Implicit Costs which is same as opportunity costs )

Profit Example • You spend $100 to build a fancy lemonade stand, and you earn $160 by selling lemonade. Your accounting profit would be: • Explicit costs, $100, subtracted from revenue, $160 • Accounting profit = $60. • Let’s say you have a job at the movie theater that pays $15 an hour. In four hours, you could make $60 working at theater. Using this new opportunity cost, we can calculate the economic profit of our lemonade stand: • $160 in revenue – $100 in cost – $60 in IMPLICIT COST = $0 in Economic Profit. • Normal Profit = $60.

Do You Get It or Nah? • You are a farmer and you earn $22, 000 a year in total revenue. Your explicit farm costs are $10, 000 a year. If you weren't a farmer, you could be earning $11, 000 a year at Wal-Mart. • What is your accounting profit? • What is your economic profit? • What is your normal profit? • Should you continue farming or go work at Wal Mart?

Do You Really Get It or Nah? • The owner of a local grocery store has an offer to be a manager of a clothing store at a salary of $55, 000 a year if he agrees to take the job. Also, if the grocery store owner would have invested his own savings in the bank instead of at his store, he could have earned $8, 000 last year in interest payments. Let’s assume he does not take the job offer and remains the proud owner of his own business. Last year, his total revenue was $125, 000 at his grocery store and his explicit costs were $62, 000. • What is his accounting profit? • What is his economic profit? • What is his normal profit? • Should he continue owning his own business or go work at the clothing store?

Last One… • John is a dentist who earns an annual salary of $75, 000 a year. He also has $50, 000 of his own money invested in a savings account which gave him $4, 000 in interest income last year. John also owns a small building which he leased out to someone last year for $20, 000. John decides to leave his job as a dentist to become a full time personal trainer. He takes his $50, 000 out of savings to assist with the costs of gaining his Personal Training license and decides to use the building he owns as his gym for training. In his first year of Personal Training, John brings in a Total Revenue of $250, 000 and spends $150, 000 for things like equipment, utility bills, and an assistant to work the front desk. What is John’s Accounting, Economic, and Normal Profit of his first year of Personal Training? • Accounting: $100, 000 • Economic: $1, 000 • Normal: $99, 000

October 18, 2017 1. Continue Lesson 3 -1 2. HW: Activities 3 -2 and 33 (yes, we skipped activity 3 -1) 3. Quiz Tomorrow on Lesson 3 -1

Short Run and Long Run • • Short Run: At least one factor of production (input: labor, capital, etc. ) is fixed (capital) while all other inputs are variable (labor. ) • • • Long Run: All inputs/resources are variable NEITHER IS A SPECIFIC TIME PERIOD!

Measures of Resource Productivity Definitions • Three productivity measures: 1. Total Product (TP): Total Output of Good/Service 2. Average Physical Product (AP): This is a measure of labor productivity: TP/Units of Labor 3. Marginal Physical Product (MP): Change in TP/Change in Unit of Labor • Law of Diminishing Productivity: In SHORT RUN, as firms provide more of a variable input with a fixed input, the MP of the variable input eventually declines.

Total, Marginal, and Average Product: The Law of Diminishing Returns (1) Units of the (2) Variable Resource Total Product (TP) (Labor) 0 25 3 45 4 60 5 70 6 75 7 75 8 LO 2 10 2 (4) Average Product (AP) 0 1 (3) Marginal Product (MP) 70 7 -13

Total, Marginal, and Average Product: The Law of Diminishing Returns (1) Units of the (2) Variable Resource Total Product (TP) (Labor) (3) Marginal Product (MP) 0 - 1 10 10 2 25 15 3 45 20 4 60 15 5 70 10 6 75 5 7 75 0 8 LO 2 0 70 (4) Average Product (AP) -5 7 -14

Total, Marginal, and Average Product: The Law of Diminishing Returns (1) Units of the (2) Variable Resource Total Product (TP) (Labor) (3) Marginal Product (MP) (4) Average Product (AP) 0 - - 1 10 10 10. 00 2 25 15 12. 50 3 45 20 15. 00 4 60 15 15. 00 5 70 10 14. 00 6 75 5 12. 50 7 75 0 10. 71 8 LO 2 0 70 -5 8. 75 7 -15

Q

Short Run Per Unit Production Costs • Average Fixed Costs AFC = TFC/Q • Average Variable Costs AVC = TVC/Q • Average Total Costs ATC = TC/Q • Marginal Costs MC = ΔTC/ΔQ • These cost curves on a graph form the foundation for the analysis of short-run, profit-maximizing production by a firm!

• • • Output FC VC TC AFC AVC ATC MC 0 $500 $ 0 $500 1 500 200 700 2 500 300 800 3 500 420 920 4 500 580 1, 080 5 500 800 1, 300 6 500 1200 1, 700 7 500 1900 2, 400

Cost Curves • • • Output FC VC TC AFC AVC ATC MC 0 500 0 500 0 1 500 200 700 500 2 500 300 800 250 3 500 420 920 167 4 500 580 1080 125 500 800 1300 100 6 500 1200 1700 83 7 500 1900 2400 71

Cost Curves • • • Output FC VC TC AFC AVC ATC MC 0 500 0 500 0 1 500 200 700 500 200 2 500 300 800 250 150 3 500 420 920 167 140 4 500 580 1080 125 145 500 800 1300 160 6 500 1200 1700 83 200 7 500 1900 2400 71 271

Cost Curves • • • Output FC VC TC AFC AVC ATC MC 0 500 0 500 0 1 500 200 700 500 200 700 2 500 300 800 250 150 400 3 500 420 920 167 140 307 4 500 580 1080 125 145 270 500 800 1300 160 260 6 500 1200 1700 83 200 283 7 500 1900 2400 71 271 343

Cost Curves • • • Output FC VC TC AFC AVC ATC MC 0 500 0 500 0 1 500 200 700 500 200 700 200 2 500 300 800 250 150 400 100 3 500 420 920 167 140 307 120 4 500 580 1080 125 145 270 160 5 500 800 1300 160 260 220 6 500 1200 1700 83 200 283 400 7 500 1900 2400 71 271 343 700

Cost Curve Analysis • • • AFC Curve: Constantly Decreasing ATC ALWAYS lies above AVC ATC, AVC are ALWAYS U-Shaped MC Looks like Nike Swoosh MC ALWAYS intersects AVC and ATC at their LOWEST point- Basic law of averages. When AVC is declining, MC is less than AVC; When AVC is increasing, MC is greater than AVC. Small quantities of output= Increasing Marginal Returns (Increasing Marginal Product) Larger quantities of output = Diminishing Marginal Returns (Decreasing Marginal Returns) Gap between ATC and AVC is AFC.