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AGEC 2003 Study Guide, LSU (kennedy)
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Exam 1 1/22/10 9:42 AM
Chapter 1
Ag Econ: an applied social science dealing with how humans choose to use
technical knowledge and scarce productive resources such as land, labor,
capital and management to produce food and fiber and distribute it for
consumption to various members of society over time.
-Goes from input, buyer, farm, to product.
W.M. Hays and Andrew Boss, University of Minnesota
First ag economists were actually trained agronomists.
Established a route system for collecting cost and input data such
as labor costs as well as management practices from a number of
farmers.
H.C. Taylor, University of Wisconsin and T.N. Carver, Harvard
Created first ag econ book.
Agribusiness: The sum total of all operations involved in the manufacture
and distribution of farm supplies; production operations on the farm; and the
storage, processing, and distribution of farm commodities, and items made
by them.
Scarcity: The condition created when society (individual) has unlimited
wants or needs but limited resources in order to satisfy these wants or
needs.
Opportunity Costs: The costs of alternative opportunities foregone or
sacrificed.
(If you have a dollar and you spend it on candy, you can’t spend it
on ice cream.) You give up one thing for another thing.
Law of Diminishing Marginal Utility: The principle that the more of a
good we have, the less we value an additional (marginal) unit of it because
we receive less satisfaction for each addition unit of a good we consume.
The satisfaction (utility) we receive from consuming the 1st ice
cream cone is greater compared to the satisfaction from consuming
the 10th ice cream cone (after already consuming 9 cones earlier)
Microeconomics: Field of econ that studies the decision making of a single
economic entity.
A consumer or a producer. Producer wants to produce more so they
can have more money, and a consumer wants to own, do, ect more
things.
Macroeconomics: Field of economics that studies the larger economic
system and the impact that changes in policy have on the major aggregate
economic variables of the economies such as employment, unemployment,
and national income (GDP).
Economic Model: A simplification of reality where assumptions are made to
explain or predict economic behavior. Economic models may be simple if-
then statements, a word description, a diagram or graph relating two
variables, or a complex mathematical equation.
Uses price and quantity, and finds the relationship between them.
Could be simple as if the number of teachers decrease at LSU, the
number of students in classes will increase.
Positive Economics: What is or what can be.
Looks specifically at numbers, and says if “this” happens, then
“this” will happen. Doesn’t have any value judgment; looks at data.
Normative Economics: What ought to be or what should be done.
Has to deal with someone’s value judgment. Obama would be
someone who would say Healthcare will benefit the people, and that
they should have it (based on his opinions).
Dependent Variable: A variable in which its magnitude is reliant upon one
or more independent variables.
Independent Variable: A variable which influences or impacts the
magnitude of the dependent variable in an economic model.
The amount of studying you do will depend on how many courses
you are taking. Dependent= amt of studying Independent= # of
courses.
Ceteris Paribus: “all other things remaining equal” or “constant.”
Used by economists a lot because they just look at models, or at
things that have happened historically. Trying to keep everything
constant.
Parity: keeping everything constant.
o The way it works in the NFL, the teams that do well during the
season, get low talented members while the not so well teams
get the higher talented members so that the playing field is
even.
Chapter 2**pick a parish and go to the USDA website and write information about it.
Family Farms
Family farms are incorporated for 3 reasons
A corporate form of organization can be used to transfer farms to
others (father to son) at a lower cost than other forms of business
organization.
Employee benefits such as social security and unemployment
insurance are tax deductible for the corporation, but not an
individual proprietorship.
A corporation can separate management from ownership in or to
reduce liability of both management and owners. (you can separate
things so if you get sued for one thing, it won’t affect the others.)
Classifying farms by value of farm products sold.
Sales >$100,000 (expanding class) produce 82% output, received
62% of government support payments, off-farm income $37,392 per
farm.
Sales between $20,000 and $99,000 only produce 14% output,
receives 26% of government payments, off-farm income is $63,396
per farm.
Sales less than $20,000 is considered a Non-commercial class. Off-
farm income $49,678.
Vertical Coordination: the linking of successive stages in the marketing
and production of a commodity in one decision entity. (Vertical Integration)
Cooperatives: A business that is organized, capitalized, and manages for its
member patrons furnishing or marketing goods and services to the patrons
at cost. Member patrons receive patron dividends which are a return of the
profits or net savings of the cooperative. They are often returned based on
the magnitude of transaction made between the cooperative and the farmer.
The most common types of cooperatives are supply and marketing
cooperatives.
Trends in Farm Characteristics and Output
Number of farms decreasing, but much larger.
Farm workers have declined due to ag productivity increases.
ERS County Typologies
Farming Dependent
o 15% or more of earnings from farming or 15% or more of
residents in farming occupations between 1998-2000 (440
total counties, 403 rural counties)
Mining Dependent
o 15% or more of earnings from mining activities between
1998-2000 (128 total counties, 113 rural counties)
Manufacturing Dependent
o 25% or more of earnings from manufacturing activities
between 1998-2000 (905 total counties, 585 rural counties)
Federal/State Government Dependent
o 15% or more of earnings from government activities between
1998-2000 (381 total counties, 222 rural counties)
Service Dependent
o 45% or more of earnings from service activities (retail trade,
finance, insurance, real estate and other services) between
1998-2000 (340 total counties, 114 rural counties)
Non-specialized
o All counties that do not fall in the other classifications
between 1998-2000 (948 total counties, 615 rural counties)
Farm Production by Commodity Type
Livestock Farmers are greatest in number. They account for 35% of
farms with sales of $5000 or more.
Cash Grain is the second highest in number.
Other large producing commodity types include Other Field Crops
and Dairy.
Agribusiness: Agribusiness includes not only commodity production but
includes value-added commodity processing, marketing, transport, and
wholesale/retail activities.
Agribusiness Sector
Cattle Farmer
Sugar Cane Farmer
Crawfish Farmer
Cargill
ADM
Mc Donalds
International Paper
JB Hunt
Agribusiness
Agricultural commodities are a growing export for the US from 7.25
billion in 1970 to 51.83 billion in 1998.
Simultaneously, increase in imports from 5.77 billion in 1970 to
37.07 billion in 1998.
Much of the increased exports and imports due to increasing level
of free and lower-cost trade of agricultural commodities from free
trade agreements.
Trade major impact on agriculture with 23% of all farm income
derived from agricultural products exports.
Gross National Product: Total value of all finished goods and services
produced in the economy of a country in a given time period by all
businesses headquartered in this country whether these goods and services
were produced in the United States or overseas.
Gross Domestic Product: Total value of goods and services produced
within the United States by either foreign or domestic resources.
US Headquarters
o Raising Canes- (US) GDP & GNP
o Dell- (US) GDP & GNP (other country) GNP
Rest of World headquarters
o Toyota- (US) GDP
Calculating GDP
Expenditure Approach
Summing up the value of all purchases made by final consumers
(households).
Income Approach
Summing up all the incomes earned in the factor markets including
wages and salaries, interest, rents, and profits minus business
taxes, capital consumption, and US income earned overseas.
-profit and labor inputs= GDP for the income approach
-The difference between the total output and household spending (GDP) is
the double counting. For the expenditure approach, the double counting is
the sum of purchases made by producers from other producers in the
marketplace.
Monetary policy: Influences economic activity in the system through the
government’s actions in managing the money supply and interest rates.
Fiscal policy: Influences economic activity through the government’s
exercising of its taxing and spending activities.
http://www.ers.usda.gov/StateFacts/
Average farm size (acres) 2007- 269 acres
Top commodity 2007- Rice
Top Parish 2007- Union Parish
(for Louisiana) These 3 questions will be on the quiz.
Chapter 3
Utility: the “satisfaction” consumers get from consumption.
Marginal: additional utility you get.
Marginal Utility: Additional satisfaction from consumption.
Laws of Economics
Law of Diminishing Marginal Utility: When someone consumes
an additional amount of a good, assuming the consumption of all
other goods remains unchanged, satisfaction from the consumption
of that additional good decreases.
Ordinality of Utility
While it may be helpful to think of how many more “utils” you feel
by consuming an additional amount of the good, no one person
measure “utils” in the same way.
As a result, we measure utility by its order or ranking.
Understanding Ordinality
Example Beauty Pageant
o We may know who the winner is and 1st runner up and 2nd
runner up, but we don’t know how much the winner beat the
first runner up and the second runner up by.
Consumer Choice
In microeconomics, we desire to understand how consumers choose
to purchase one “bundle” of goods and over an alternative
“bundle.”
The tool we used to measure how consumers choose among two
different bundles of goods is known as an indifference curve.
Indifference Curve: A line that represents all the different
combinations of two goods that are consumed that provide the
consumer with the same level of utility.
Properties of Indifference curve
Downward sloping to the right
o If a consumer gives up some amount of one good, they must
be compensated with an additional amount of the other good
to keep the consumer with the same level of utility.
Convex to the origin
o The marginal rate of substitution decreases (in absolute
value) as one moves along the indifference curve from top left
to bottom right.
Indifference curves do not intersect
o Indifference curves above (below) a given indifference curve
represent bundles of two goods that provide higher (lower)
utility to the consumer.
Marginal Rate of Substitution (MRS)
MRS is the slope of the indifference curve. The rate at which one
good is substituted for another good while maintaining the same
utility.
MRSab=(the change in) b/(the change in) a
The marginal rate of substitution of good a for good b equals the
total change in good b divided by the total change in good a. It’s
always going to be negative.
A (8,10) B (16,6) MRS12= (6-10)/(16-8)=-4/8=-1/2
The consumer is willing to give up ½ unit of good B to get one more
unit of good A.
Another way to think of MRS is to think of the marginal (additional)
utility gained and lost moving from one bundle of consumption to
another.
From the last formula we can see that the Marginal Rate of
Substitution is equal to the ratio of the marginal utilities.
(the change in)X1MU1+(the change in)X2MU2=0
(the change in)X1MU1=(the change in)X2MU2
(the change in)X1/(the change in)X2=MU2/MU1
MRS: It is important to recognize that MRS measures the slope of
the indifference curve between any two points.
As a result, as we move down the indifference curve from top left to
bottom right, we move from large negative MRS values to small
negative MRS values.
This would make sense given that at the top left of a traditional
convex indifference curve, you are consuming a large amount of
good 2 and a small amount of good 1 and would be willing to give
up a large amount of good 2 to get one more unit of good 1.
Two extreme forms of substitution between goods.
o Perfect substitutes: Goods can always be substituted in the
same ratio.
o Perfect compliments: goods are only consumed in fixed
proportions.
Budget Line
Line on a graph showing all combinations of the consumption of two
goods given prices for the two goods and a level of income of the
consumer.
It shows the maximum amount a consumer can consume of two
goods given their budget constraint.
Constructing a Budget Line
Step One: Identify price of two goods to be consumed.
o Good 1: Raising Canes Chicken Fingers $5 Combo
Good 2: Izzo’s Super Burrito $10 Combo
o Indentify consumer’s income (weekly or monthly or yearly)
Step Two: Create two points in the top right quadrant of the graph.
o Calculating point 1- income of consumer divided by price of
good 1
$100 income/ $5box Raising Canes=20
Label horizontal axis as Raising Cane’s and vertical axis
Izzo’s and place point 1 at (20,0).
o Calculating point2- Income of consumer divided by price of
good 2
Step Three: Connect two points.
We have now introduced two lines.
Indifference Curve (Equal Satisfaction Line): A line identifying all
combinations of two goods that give us equal utility or satisfaction.
Budget Line (Equal Affordability Line): A line identifying all
combinations of two goods that we can consume given our budget
constraint.
When we put the two line together, we can identify the level of
consumption of the two goods that maximizes our utility or
satisfaction given the constraints on our budget.
Point of Tangency: Where the consumer’s utility is maximized given
a budget constraint.
Consumer Equilibrium
We can also represent consumer equilibrium mathematically.
o MRS
Equal to the ratio of the marginal utility of the two
goods. MU1/MU2=(the change in)X1/(the change in)X2
o Consumer equilibrium occurs where the ratio of the marginal
utilities for two goods equals the ratio of the price of the two
goods. (P=price) also shows slope of MU
MU1/MU2=P1/P2
Another way to think of consumer equilibrium is that the marginal
utility we receive per dollar of good one equals the marginal utility
we receive per dollar of good two.
Effect of Price Change
To find a consumer equilibrium, we assume a given price for each of
the two goods and an income in order to calculate a budget line.
What happens if the prices for the two goods change?
If Cane’s raises their price, our budget will decrease, so we will have
to draw another budget line. But because the price of chicken
fingers has gone up, they will have to decrease their consumption of
fingers, and the consumption of burritos will increase.
Substitution effect
o The price of fingers has become relatively higher than the
price of burritos before the price change. The result is the
consumer shifts away from the higher priced product to the
lower priced product.
Income effect
o The real income of the consumer has decreased.
o The $100 now will buy only 15 boxes of chicken fingers as
compared to 20 boxes before the price increase.
o The inflation has resulted in the consumer having less real
income to purchase goods.
Demand Curve: Shows the quantities of a good that an individual consumer
will buy at different prices for that good at a point in time, everything else is
unchanged.
Market Demand Curve: Shows the quantities of a good that all consumers
will buy at different prices for that good at a point in time, everything else
unchanged.
Demand Curves
Demand curves are downward sloping because each individual
consumer receives less additional utility for each additional amount
of a good consumed; hence the price of the good must fall in order
for the consumer to purchase more of it.
Price Elasticity of Demand: Measures the responsiveness of quantity
demanded to changes in price, ceteris paribus.
The price elasticity of demand is calculated as the percentage
change in quantity divided by the percentage change in price.
We sometimes call the price elasticity of demand the “own price
elasticity of demand” because the elasticity value calculated is
based on the change in the price of the good from which we are
calculating the elasticity.
Calculating Own Price Elasticity of Demand
E(d)=[(Q1-Q2)/(Q1+Q2)]/[(P1-P2)(P1+P2)]
Q1- quantity of first observation
Q2-quantity of second
P1-Price of first observation
P2-Price of second
E(d)-Price Elasticity of Demand
Categories of Price of Elasticity
If the demand for a good is price inelastic, for a one percent
increase (decrease) in price, there is a less than equal one percent
decrease (increase) in quantity demanded.
If the demand for a good is price elastic, for a one percent increase
(decrease) in price, there is a greater than one percent decrease
(increase) in quantity demanded.
If the demand for a good is price unitary elastic, for a one percent
increase (decrease) in price, there is a one percent decrease
(increase) in quantity demanded.
Factors influencing Price Elasticity
Greater number of substitute products higher elasticity.
Greater number of uses of a product higher elasticity.
More important the expenditure a product is in a consumer’s total
budget, higher elasticity
Changes in Demand
When the price of a good increases (decreases), the quantity
demanded of a good decreases (increases), other factors constant
(ceteris paribus)
o Results from the price change.
However, when the price of a good is held constant and other
factors change we have a shift in the demand curve.
o Results from the change of everything else (preference,
budget, ect)
Shifts in the Demand Curve
What drives a shift in the demand curve?
o Increase in demand for goods from an increasing population.
o Decrease in demand from tastes and preferences of
consumers.
Donut demand decrease due to Atkins craze.
Income Elasticity of Demand: measures the responsiveness of the
quantity of good demanded with changes in income, holding all other factors
constant.
Engel Curve: A curve showing how quantity demanded changes given
changes in a consumer’s income.
Chapter 4
Land: All the physical characteristics of this input to yield a product including
the soil and the natural environment it is contained within.
Labor: The physical act or effort of performing a task by humans.
Management: Humans who are responsible for decision making.
Includes entrepreneurial functions of
Risk bearing
Organizing resources
Resource decision choice
Capital: the physical or tangible resources used to aid
Production Function: the particular set or combination of resources (inputs)
used to produce a given level of product (output).
Formula for production function- Y=f(X1,X2..)
Y: product (output)
X1..: each of the resources (inputs) used to produce the given
product (output).
Production Function Example
If we want to grow more than 3 lbs of tomatoes, we can adjust the
resources (inputs) in one of two ways
Constant Proportion Increase
When output (Y) doubles when all inputs are doubled, this
relationship is know as constant returns (if we change the inputs by
some percent, we will have the same percent of change in the
output.)
Changing proportion Increase
Changing only one variable while everything else remains
unchanged.
o Y=f(X3|X1,X2…) The variable before the line is the one being
changed.
Graphing the Production Function
We can graph the relationship between inputs and output from the
production function.
Output depicted on the graph is known as “Total Physical Product”
(TPP)
(THERE IS A DIFFERENCE IN MAXIMIZING PRODUCT AND PROFIT.)
Total Physical Product
Output is measured on the vertical axis
Inputs are measured on the horizontal axis
GRAPH A REPRESENTS THE CONSTANT RETURNS CASE.
The shape of graph B indicates that the law of diminishing returns is
in effect.
Law of Diminishing Returns: As successive amounts of a variable
input are combined with a fixed input in a production process, the
total physical product will increase, reach a maximum and
eventually decline.
Marginal Physical Product (MPP): an amount added to total physical product
when another unit of the variable input is added.
MPP=delta (change in) TPP/delta (change in) X1 OR deltaY/delta X1
MPP= (245-75)/(20-10)
o As long as MPP is positive, the TPP is increasing.
Average Physical Product (APP):
Stage 1 (irrational): from zero to where MPP and APP intersect.
Stage 2 (rational): from the MPP and APP intersection, to where MPP
reaches zero. (maximum product)
Stage 3 (irrational): not smart to produce here.
Where MPP intersects with zero, TPP is at its maximum.
Where MPP=APP, APP is maximized.
Where TPP curve switches from a convex shape to a concave
(inflection point) is where MPP is maximized.
Technical vs Economic
TVP (Total Value Product): the number of the product produced
times its price.
AVP (Average Value Product): APP times price.
MVP (Marginal Value Product): MPP times price.
MFC (Marginal Factor Cost): MFC= the price of it.
Choosing Optimum
The optimum is reached where one more unit of the input adds to
the revenue just what it costs. MVP=MFC
(profit= revenue- cost)
Net Revenue=Total Revenue-Total cost
Total revenue=TVP
Calculating Optimum Input Levels from MVP, MFC table
Optimum level occurs right before MFC is greater than MVP.
Changes in Optimal
Quiz 4
-Rational stage=Stage 2
-Irrational= Stage 1 and 3
-The boundary between stages 1 and 2 of productions is at the point where
MPP is equal to APP-True
-The boundary between stages 1 and 2 of production is at the point where
MPP is maximized-false
-The boundary between Stages 2 and 3 of production is at the point where
MPP equals 0-true
-Stage 1 of productions is irrational because additional units of input will
cause TPP to decrease-false
-Stage 2 of production is irrational because additional units of input will
cause APP to decrease-false
-Stage 3 of production is irrational because additional units of input will
cause TPP to decrease-true
-Profit maximization occurs at the point where Marginal Revenue=Marginal
Cost and Marginal Value Product=marginal factor cost.
Key Points for Test
Do questions at the end of each chapter.
Chapters 3 and 4
-Construct budget line, importance of budget line. (formula) Represents
maximum quantity of goods given a specific income.
-Interpret and describe indifference curve, indifference curves do not cost.
downward sloping
-definition of marginal rate of substitution.
-Change in demand is a shift in the demand curve (income change) change
in quantity demanded (change in product price)
-calculate elasticity of demand
-know which stage is rational and irrational, know everything dealing with
the stages. What occurs at boundaries.
-know all the MPP, APP, ect.
-know material from quiz 4.
Chapters 1 and 2
-Know difference between positive and normative economics.
-understand difference between independent/dependent variables.
-understand “ceterus parabis”, law of diminishing marginal utility, trends in
ag industry recently (increase in # of farms, less # of farmers, don’t need as
much labor due to machines)
-scarcity refers to a condition created when society/individual has an
unlimited want and need. (society has unlimited wants, but limited
resources)
-know opportunity cost, ag business, cooperative
-agriculture is extremely dependent on the world market because we
produce more food than we can consume.
-don’t need to know avg size of farm, top commodity, ect.
Exam 2 1/22/10 9:42 AM
Chapter 5
Understanding Producer Decisions
In many cases, a producer faces the decision of varying multiple
inputs to produce a given output. (farmers using round-up on
plants) Factor-Factor relationship.
Two Variable Production Function
As the TPP curve was the representation of one factor, and isoquant
shows 2.
Isoquant: a curve that shows all combinations of the two variable inputs that
can be used to produce a given quantity of output. (isoquant=equal value)
An isoquant is the graphical equivalent in production economics to what the
indifference curve is to consumption economics. Increase in production when
moving towards top right, decrease moving towards bottom left.
Resource Substitution: the technical relationship that occurs when one input
can be substituted for another in production while yielding the same level of
output.
Perfect Substitutes: where one input can be exactly substituted for another
in production.
Perfect Compliments: where two inputs can only be used in production in a
fixed ratio and cannot be substituted for one another. (as we add one more
unit of this resource, we have to add on more unit of another resource).
Imperfect Substitutes: where larger and larger amounts of a second
variable resource (input) are required to replace……..
Marginal Rate of Substitution: the number of units of X2 that X1 can replace
without changing output. This is analogous to the indifference curve where
we choose different consumption bundles but the level of utility is held
constant.
Calculating the MRS along an isoquant is the slope of the curve.
(rise over run)
If you take part of production out, you have to add production
somewhere else to keep the same level of output. (if you decrease
X2, you have to increase X1 to keep output equal)(If you just reduce
X2 and not X1, you would have to refer to a lower isoquant.)
When we reduce the use of one input without increasing the other
input in production, we reduce the level of output by the Marginal
Physical Product (MPP) of the reduced input multiplied by the
magnitude change of that reduced input. Delta Y=MPP1xDeltaX1
As we move along an isoquant, the reduced level of output resulting
from decreased use of X2 is compensated by increased output from
the use of X1.
o (DeltaX2/DeltaX1)=(MPPX1/MPPX2)
Isocost Curve: Similar to the budget line. The isocost curve identifies all the
combinations of the two given inputs that can be afforded to produce a given
level of output.
Three pieces of info required-price of input X1 (Px1), prices of input
X2 (Px2), and the total amount of money to be spent on inputs.
Combining Enterprises
Agricultural commodity producers often have to decide what is the
optimal combination of commodities to produce maximum profit
and how much of each good should they produce?
Production Possibilities Curve: shows all possible combinations of two
products that can be produced given the set of resources in the firms
control.
Given the combination of two goods that can be produced for a
given enterprise and the prices per unit of the goods sold, we can
identify the optimal levels of production of the two goods to
maximize profit.
Marginal Rate of Product Substitution: (MRPS) Measures the differing rates at
which either product will replace (substitute for) the other along the
production possibilities curve.
Isorevenue Line: Shows all possible combinations of two products sold that
will bring the same total revenue.
Optimizing Output
The optimal combination of the two products to produce (this is the
level that maximizes profits) is to produce where the Marginal Rate
of Production Substitution is equal to the ratio of the output prices.
Different prices on the production possibility curve have different
revenue lines tangent to their point.
Expansion Path: Show the revenue (and profit) maximizing proportions of Y1
as the firm expands or contracts.
For example in ag, the expansion path would trace the profit
maximizing combinations of two commodities to produce given
increasing or decreasing farm size.
Chapter 6
Explicit Costs: Costs that have been incurred when money is spent to hire
labor, repair machinery, buy seed, ect. Tangible; obviously see.
Implicit Costs: A cost that has been incurred in using any resource for which
there is not direct cash outlay during the period the resource was being
used.
Depreciation costs of equipment such as tractors or other
machinery.
Opportunity Costs: The cost borne by the producer when a resource that is
currently being used for one activity is used in its next most valuable
(profitable) activity. An opportunity cost is another type of implicit cost.
Represents the true costs of production.
Giving up more sorghum beans to produce more green beans due
to profit increase in green beans.
Bookkeeping Profit: Revenues minus expenses. (only explicit)
Economic (pure) Profit: Revenues minus explicit and implicit (opportunity)
costs.
Economic profit is the amount by which net earnings exceed
payment required to attract it to (or keep it in) its present use.
Variable Costs: Costs that increase or decrease as output changes.
Fixed Costs: Costs incurred for resources that do not change as output is
changed.
Length of Run: A planning concept that defines the level of flexibility in how
resources (inputs) can be changed in the production process.
Immediate Short Run: a span of time so short that no resources (input)
changes can be made in the production process. (farmer planting a seed for
the next year, can’t change the seed until after this year)
Ultimate Long Run: a span of time long enough that all resources (inputs) are
considered variable. No inputs can be considered fixed.
Length of Run
In many cases, farmers face management decisions between the
long run and short run where some inputs are fixes and others are
variable. Example: farmer plants a crop (short run) but varies the
use of pesticides, fertilizers, ect. (long run)
Total Variable Cost: (TVC) total spending for the variable input. (things you
can change in the time period you are working with.)
Total Fixed Cost: (TFC) The total costs of all other inputs that do not change
as output changes. (where land or machinery is fixed, you can’t sell it in one
day or week)
Total Cost: (TC) Sum of TVC and TFC.
Total Revenue: (TR) Synonym of TVP in chp 5; calculated as price per unit of
output multiplied by total output level.
Pure Profits: Total Revenue (TR) minus total costs (TC).
Average Variable Costs: amount spent on the variable input per unit of
output. AVC=TVC/Y y represents the level of output for all slides in chp 6.
Average Fixed Costs: the cost of fixed resources (inputs) per unit of output.
AFC=TFC/Y
Average Total Costs: total costs of all the resources (inputs) per unit of
output produced.
Marginal Cost: the change in total cost when output is changed by one unit.
MC=deltaTC/deltaY or deltaTVC/deltaY
Marginal Revenue: (MR) the amount added to total revenue when an
additional unit of output is produced and sold. MR=deltaTR/deltaY=Py
Py is the price of the output Y
Relationship Between Production and Variable Costs
If we remember the TPP curve from chp 4 where output changes
with incremental
Curve has 3 regions
During the convex proportion of the TPP curve, the input is more
productive in producing output.
As a result, the marginal cost of producing an additional unit of
output declines
Marginal costs continue to decline until one reaches the of the
convex portion of the TPP curve, which is the inflection point.
During the concave portion of the TPP curve, the productivity of
inputs being converted to outputs declines
Hence, the marginal costs of producing an additional unito of output
in this area of the production function increases.
These costs continue to increase until the TPP is maximized
(MPP=0). At that point, the MC curve becomes vertical.
Inflexion point, where the graph goes from convex to concave, is
where MPP is maximized and MC are minimized.
Maximizing profit is where Marginal Revenue=Marginal Cost
The more you produce, the lower and lower AFC will get because
you are dispersing it over more products.
AVC is minimized where it crosses MC.
ATC is minimized where it crosses MC.
Profit Maximizing Output
The profit maximizing level of output (the optimum output level) is
found where marginal revenue is equal to marginal cost or MR=MC.
The total cost curve has equal but opposite relationships to the TPP
curve.
o At low levels of input – TPP curve is convex
o At low levels of output – TC curve is concave
o At high levels of input – TPP curve is concave
o At high levels of output – TC curve is convex
Profit= TR-TC
Short Run Supply Curve of Firm
The profit maximizing point is based on the relationships between
the level of the output price, the ATC, and the AVC.
If the output price Py is greater than the minimum cost point on the
ATC curve at the point where MR=MC, then the firm is generating
economic profit.
o Economic Profit: occurs where the revenue made from selling
the product exceeds both the explicit costs of the variable
inputs used to produce the product and the implicit costs of
the fixed inputs used to produce the product.
If the output price (Py) is less than the minimum cost point on the
ATC curve but greater than minimum point on the AVC curve at the
point where MR=MC, then the firm is incurring an economic loss
o At this price of the output, the firm can pay the variable costs
of production but cannot cover the fixed costs of production.
The firm will continue to produce until the value of the fixed
input (resource) is completely depreciated
If the output price (Py) is less than minimum point on the AVC curve
but where MR=MC, then the firm cannot pay for the variable costs
of production
o At this price of the output, the firm is better off shutting down
and simply incurring the costs associated with the sunk fixed
costs rather than continuing to lose more money as more of
the output is produced.
o The point where output price is equal to the AVC is known as
the shutdown point.
The economic profit occurs in the shaded area which is simply the
difference between the cost per unit of the output where MR=MC
and the cost per unit of the output = ATC.
Economic profits in the short run become a “signal” for other
potential producers.
o As more producers enter the market, two impacts occur…
The price of the output declines as more output floods
the market from additional producers and drives down
price
The price of the variable and fixed inputs increase as
more producers “bid up” the price of inputs
The effect of the downward pressure on the output price shifts the
MR curve downward
The effect of the upward pressure on input prices results in an
upward shift of the AVC, AFC, ATC, and MC curves.
The result of both shifts reduces the economic profits and can even
eliminate the
Supply Curve: (for the individual firm) The amount of a good or services
producers are willing to offer for sale at different prices, ceteris paribus.
Graphically, occurs where the marginal cost curve equals different
prices of the output, (Py) (i.e. different marginal revenue curves)
The individual firm’s supply curve starts at the minimum of the AVC
curve (shutdown point)
Market Supply Curve: The horizontal summation of all individual firms’ supply
curves for a product or commodity.
Graphically, it is the horizontal summation of all individual firms’
marginal costs curves above their minimum AVC.
Changes in Market Supply
There are two types of changes in market supply: Change in
quantity supplied and change in supply.
Change in quantity supplied
o Movement along a supply curve that shows the changing
levels of the product or commodity supplied given changes in
the price of the product or commodity
o Analogous to movement along a demand curve when one has
a change in quantity demanded to a change in the price of the
good consumed
Change in Supply
o A shift in the entire supply curve (supply schedule)
o Factors shifting the supply curve include good/bad growing
conditions (ample rain/drought), improvement in production
technology, reduction/increase in input prices,
reduction/increase in relative prices of other products or
commodities, changes in institutional constraints such as
changes in acreage allotments under a farm program.
Price Elasticity of Supply: A measure of the percentage change in quantity
supplied in response to a percent change in price, ceteris paribus.
Calculating Price Elasticity of Supply
Es=[(Q1-Q2)/(Q1+Q2)]/[P1-P2)/(P1+P2)]
Price elasticities are highest in ag commodities where production
adjustments are easiest and lower where they are not.
Price Determination
the point where the demand curve and the supply curve intersect
determines the equilibrium quantity of the product sold in the
marketplace and the equilibrium price of the quantity sold
Market Equilibrium
In market equilibrium, the quantity demanded by consumers equals
the quantity supplied by producers
No shortages or surpluses occur at this market equilibrium price
No tendency to move away from equilibrium as long as there are no
changes in demand or supply (supply and demand shifters)
o When a market is at equilibrium, there is equality between
production and consumption at a specific price.
Market Disequilibrium
Market disequilibrium occurs when prices are not allowed to change
to market forces of supply and demand
Results in market shortages or surpluses
Price ceilings (keeps price low) create shortages while price floors create a
surplus (keeps price high).
Quiz 1
1. minimizing the resource cost of producing a particular commodity is
referred to as the least cost combination.
2. The line which shows the amounts of two resources that can be bought for
a given amount of money is referred to as the isocost line.
3. The line representing all possible combinations of two products sold that
will bring the same TR is referred to as the isorevenue line.
4. The line showing the revenue and profit maximizing proportions of two
products as the firm expands or contracts output is the expansion path.
5. The full range of feasible allocations for a firm is referred to as its
production possibilities.
6.The line showing all combinations of inputs that result in the same quantity
of an output is referred to as the isoquant.
7. The slope of the production possibilities curve is the marginal rate of
product substitution.
8. The slope of an isoquant is the marginal rate of substitution.
CALCULATE MARGINAL RATE OF PRODUCT SUBSTITUTION= delta Y2/delta Y1
TOTAL REVENUE= (P1xY1)+(P2xY2)
PROFIT MAXIMIZING POINT IS Py1/Py2 AND FIND MARGINAL RATE OF
PRODUCT SUBSTITUTION THAT COORESPONDS WITH IT.
Quiz 2
TABLE WITH TVC; TFC; TC; AVC; AFC; ATC; MC
TC=TVC+TFC (figure out total cost first)
AVC=TVC/output
AFC=TFC/output (as output goes up, AFC continuously declines)
ATC=TC/output
MC=deltaTC/delta output
Setting MC to MR(price) [answer choice will be the output]
Quiz 3
1-4 Identify the curves [from top to bottom, its MC, ATC, AVC, AFC]
Adding average fixed cost to average variable cost will give you average
total cost. Marginal Revenue curve would be a line straight across the graph.
6. The shutdown point is where marginal cost intersects average
variable cost.
7. The lowest point on the firm level supply curve is the shut-down point.
8-9 Calculating price elasticity [(Q1-Q2)/(Q1+Q2)]/[(P1-P2)/(P1+P2)]
10. A Supply Elasticity that is equal to 1.0 is referred to as Unitary Elastic.
11. A Supply Elasticity that is greater than 1.0 is referred to as Elastic.
12. A Supply Elasticity that is less than 1.0 is referred to as Inelastic.
13. The government fixing the price of a commodity at some level below the
equilibrium price will result in a shortage.
14. The government fixing the price of a commodity at some level above the
equilibrium price will result in a surplus.
15. If the supply curve for rice shifts to the left due to weather conditions,
the equilibrium price will increase.
BONUS WILL BE RELATED TO MATERIAL.
Exam 3 1/22/10 9:42 AM
Chapter 7
Function of Price
In a free enterprise economy, the market is decentralized.
No centralized forces such as government determining allocation
decisions (how much to produce or what inputs to use)
Prices determine allocation of resources in a market-oriented
economy.
When a good becomes more scarce relative to the demand for it,
the price of the good increases.
This relative price increase is a market signal
o Higher prices signal consumers to purchase less of the good
and purchase more of available substitutes.
o Higher prices signal producers to increase production to take
advantage of increase revenue opportunities.
o Helps to find equilibrium.
Price allows the market to be an efficient allocation of resources.
Classification of Markets
Two extreme classifications
o Pure (perfect) Competition
o Pure Monopoly
Pure Competition
Properties of a market with pure competition
o Many firms in an industry
Output of firm is such a small percentage of the overall
output of entire industry that firm has no influence on
price.
o Homogeneous product
The product sold has either uniformity in all physical
characteristics or the market has a common standard or
grading procedure to make similar products
homogeneous in classification.
The market cannot discriminate through the pricing
mechanism to prefer one firm’s homogeneous product
over the other.
Examples might include corn, eggs, USDA Choice beef.
o Freedom of entry and exit
An individual firm or farmer can enter or leave the
market based on what the costs and returns might
dedicate without restrictions or encouragement.
Government regulations such as acreage allotments for
specific commodities can be a barrier to entry or exit for
farmers.
Price Taker: A firm must take the market price of a commodity thus having
no influence on the price per unit that the firm sells. Firms in a perfectly
competitive market are price takers. An individual that is a price taker faces
the perfectly elastic demand curve (horizontal MR curve).
Pure Monopolist
Properties of a market with pure monopolist
o An individual firm is the only firm producing the product—
therefore the individual’s supply curve is the market supply
curve. The product is often considered a fully differentiated
product having no effective substitutes. (only firm producing
in that market;
o The pure monopolist faces a perfectly inelastic demand curve.
(by choosing the level of supply the firm will sell to the
market, the individual firm can determine the market price of
the product)
o There are measurable barriers of entry and exit
Monopolist firm owns or controls inputs to produce
product.
High initial fixed costs in capital
Pure Monopoly
# of firms-one
Product differentiation-total
Freedom of entry and exit-none
Pure Competition
# of firms-many
Product differentiation-none
Freedom of entry and exit-complete
Normal profits: Profits that occur to the firm because each resource in the
firm is earning a return that is neither greater nor less than its next-best
employment possibility (its opportunity cost). Sometimes referred to as
market equilibrium.
No firm is encouraged to enter or leave the industry because
earnings are neither better nor worse than they would be elsewhere
in the system. Producing at no profit, but basically getting a return
to the resources used.
Where MR, MC, ATC intersects. Zero profit, equilibrium.
Economic rent: surplus earnings made by the firm. Economic rent and
economic profits are synonyms. (firms come in to the market driving the
price down) MR (P) curve will decrease.
-Profit margin is the difference between the price being sold at and what the
total cost is (point where MC and P intersect and corresponding point on ATC
curve)
Negative economic rent: when the firm incurs losses. Negative economic
rent and economic loss are synonyms. (firms will leave the market driving
the price up) MR (P) curve will increase.
-profit margin is the difference between the point on ATC curve and MC
curve.
Efficiency of Pure Production
Normal profits for the firm occur when firm receives a price that
covers all variable and fixed costs of production but does not
generate economic profits. Normal Profits occur where MR=MC at
the minimum of the ATC curve. This point is also the long-term
equilibrium price for the product.
Effects of Disequilibrium on the Market
Two forms of disequilibrium cause the market to make structural
changes –when a firm generates positive economic rents and
negative economic rents.
Positive Economic Rents
When a firm receives positive economic rents, other firms enter the
market producing the product and lowering the market price, all
firms “bid up” the input price resulting in upward shifts of the MC
and ATC curves, and a new long term equilibrium occurs where
P=MC at the minimum of the ATC curve.
Negative Economic Rents
When a firm receives negative economic rents, other firms leave
the market reducing the product on the market and raising the
market price, fewer firms purchasing input to produce the output
resulting in lower input prices and downward shifts of MC and ATC
curves, and a new long term equilibrium occurs where P=MC at the
minimum of the ATC curve.
Disequilibrium Conclusion
When either positive or negative economic rents occur, the market
eliminates the rent by adding or removing firms and increasing or
decreasing input prices. The end result is a long-term market
equilibrium whether the remaining firms receive normal profits.
Length of Run and Market Supply
Previously stated, in the short run, all variables affecting the output
are fixed and in the long run, all variables affecting the output are
variable.
Hence, in the short run, all individual firm’s supply curves are
inelastic; meaning that no increase in the output price will result in
increased output supplied to the market. (no matter what price you
put on the output (high or low), the same amount of output will be
produced) But in the long run, the firm can adjust all inputs to
increase output resulting in a perfectly elastic market supply.
(change in price will result in a change in output; vice versus)
Chapter 8
Comparing Marginal Revenue between Competition and Monopoly
Perfect Competition: because there are so many firms in the
industry, an individual firm cannot affect price, so they must take
the market price (MR) as the output price. Therefore, the horizontal
MR curve is the demand curve for the individual firm.
Pure Monopolist: the firm’s individual demand curve is the same as
the market demand curve. Therefore, the only way for the
monopolist to increase its demand is to decrease its output price.
Hence, the marginal revenue and demand curve are two separate
curves for the monopolist.
Monopolist Terms
Total Revenue: price of good times the number of good sold.
Marginal Revenue: Change in total revenue divided by the change in
output/sales. MR= deltaTR/deltaQ
Profit Maximizing for Monopolist
The profit maximizing output level is where MC=MR.
But the MR curve is downward sloping below the demand curve.
The profit per unit of output is the point on the ATC curve that
corresponds with the point where MC=MR subtracted from the point
on the demand curve that corresponds with the point MC=MR.
HENCE the profit is driven by the demand curve.
Final 1/22/10 9:42 AM
Chapter 15
When you have excess supply, you will export your product
When you have a higher demand than the amount of product you’re
supplying, you will import that profit from other countries.
