Conditions for Perfect Competition - Texas A&M University

1

AGEC 603

Production and Cost Relationships

• Homogeneous products

– Products from different producers are perfect

substitutes

• No barriers to entry or exit

– Resources are free to move in and out of the sector

• Large number of buyers and sellers

– No market power – price takers

• Perfect information

– Including quantities, prices, quality, sources of

resources etc.

Conditions for Perfect

Competition

• Land - includes renewable (forests) and non-

renewable (minerals) resources

• Labor - all owner and hired labor services,

excluding management

• Capital - manufactured goods such as fuel,

chemicals, tractors and buildings

• Management - production decisions

designed to achieve specific economic goal

Classification of Inputs

2

• Mathematical relationship that characterizes

the physical relationship between the use of

inputs and the level of outputs

What Are Production Functions?

Output = f(capital | labor, land, and

management)

Start with

one variable

input

Assume all other inputs

fixed at their current

levels…

Data - Barlowe

Land Capital TPP APP MPP1 1 21 2 61 3 131 4 231 5 351 6 491 7 641 8 781 9 911 10 1021 11 1111 12 1181 13 1221 14 1231 15 121

TPP Curve

-5

10

25

40

55

70

85

100

115

0 5 10 15

Ou

tpu

t

Capital | Land unit

3

The change in the level

of output associated

with the change in the

use of an input.

Slope – small changes

Partial derivative

MPP =𝛿 𝑇𝑃𝑃

𝛿 input

Marginal Physical Product (MPP)

input

outputMPP

Land Capital TPP MPP1 1 2 (2-0)/(1-0) = 21 2 6 (6-2)/(2-1) = 41 3 13 71 4 23 101 5 35 121 6 49 141 7 64 151 8 78 141 9 91 131 10 102 111 11 111 91 12 118 71 13 122 41 14 123 11 15 121 -2

-5

0

5

10

15

20

0 5 10 15

MP

P

Capital | Land unit

MPP - Three Segments

Increasing

and positive

Decreasing but positive

Negative and

decreasing

“As successive units of a variable

input are added to a production

process with the other inputs held

constant, the marginal physical

product (MPP) eventually declines”

Law of Diminishing Marginal

Product

4

• Represents the

output per unit of

input

Average Physical Product (APP)

inputtotal

outputtotalAPP

Land Capital TPP APP1 1 2 2/1 = 2.0001 2 6 6/2 = 3.0001 3 13 13/3 = 4.3331 4 23 5.7501 5 35 7.0001 6 49 8.1671 7 64 9.1431 8 78 9.7501 9 91 10.1111 10 102 10.2001 11 111 10.0911 12 118 9.8331 13 122 9.3851 14 123 8.7861 15 121 8.067

0

5

10

15

20

0 5 10 15

AP

P

Capital | Land unit

APP Graphically

Increasing and positive Decreasing

but never goes negative

Data

Land Capital TPP APP MPP1 1 2 2.000 21 2 6 3.000 41 3 13 4.333 71 4 23 5.750 101 5 35 7.000 121 6 49 8.167 141 7 64 9.143 151 8 78 9.750 141 9 91 10.111 131 10 102 10.200 111 11 111 10.091 91 12 118 9.833 71 13 122 9.385 41 14 123 8.786 11 15 121 8.067 -2

5

Professor William Saupe of the University of Wisconsin has a trophy in his office certifying he won the Northwest Iowa Corn Contest. When he says “Look what I won for driving the marginal physical product of nitrogen to zero?” What does he mean?

Question

A) He added nitrogen such that he maximized his yields by causing MPP to be zero.

B) He should have added more nitrogen as the MPP was zero.

C) He should have added less nitrogen as the MPP was zero.

D) He does not understand the relationship between nitrogen and corn yields.

E) MPP is a separate curve from the TPP curve, therefore, any relationship is ambiguous.

Professor William Saupe of the University of Wisconsin has a trophy in his office certifying he won the Northwest Iowa Corn Contest. When he says “Look what I won for driving the marginal physical product of nitrogen to zero?” What does he mean?

Question

A) He added nitrogen such that he maximized his yields by causing MPP to be zero.

B) He should have added more nitrogen as the MPP was zero.

C) He should have added less nitrogen as the MPP was zero.

D) He does not understand the relationship between nitrogen and corn yields.

E) MPP is a separate curve from the TPP curve, therefore, any relationship is ambiguous.

-5

0

5

10

15

20

0 5 10 15

MP

P /

AP

P

Capital | Land unit

MPP

APP

Stages of Production

Stage I Stage II Stage III

• Stage I: MPP > APP

• Stage II: MPP = or < APP; MPP = 0

• Stage III: MPP < 0

6

-5

10

25

40

55

70

85

100

115

0 5 10 15

Ou

tpu

t

Capital | Land unit

TPP

APP

MPP

Relationships - Know

TPP

MPP

APP

Stage I

Stage II

Stage III

Assume a firm is producing where the MPP is negative. At this point of production, we know the APP and TPP curves are

Question

A) Both are negative.

B) One is negative and the other is positive but the relationship is unknown without further information.

C) Production is elastic at this point.

D) TPP is negative and APP is positive.

E) Both positive.

Assume a firm is producing where the MPP is negative. At this point of production, we know the APP and TPP curves are

Question

-15

-10

-5

0

5

10

15

20

25

30

35

0 2 4 6 8 10 12

Pickers per Day

Co

rn d

oze

n ~

0

20

40

60

80

100

120

140

160

0 2 4 6 8 10 12

Co

rn D

ozen

`

Stage IIIStage IIStage I

0

20

40

60

80

100

120

140

160

0 2 4 6 8 10 12

Positive

TPP

Positive

APP

A) Both are negative.

B) One is negative and the other is positive but the relationship is unknown without further information.

C) Production is elastic at this point.

D) TPP is negative and APP is positive.

E) Both positive. APP and TPP are always positive. KNOW WHY?

7

What is TPP at X= 11? What is MPP at input level of 14? What is APP at input level of 5? Why is input level 17 irrelevant to a rational economic decision maker?

Question

A) 200, 0, 10, and beyond max TPP

B) 150, 200, 50, and beyond max TPP

C) 150, 200, 10, and before max TPP

D) 100, 14, 10, and before max TPP

E) 150, 0, 10, and beyond max TPP

5 8 11 14 17 input

Output

200

150

100

50

What is TPP at X= 11? What is MPP at input level of 14? What is APP at input level of 5? Why is input level 17 irrelevant to a rational economic decision maker?

Question

A) 200, 0, 10, and beyond max TPP

B) 150, 200, 50, and beyond max TPP

C) 150, 200, 10, and before max TPP

D) 100, 14, 10, and before max TPP

E) 150, 0, 10, and beyond max TPP

5 8 11 14 17 input

Output

200

150

100

50

Max TPP slope =MPP is 0

APP = TPP/ input = 50/5= 10

Read TPP directly

off the graph

Beyond Max

TPP

Increasing input

decreases TPP

so why use?

• Value Product Analysis

• Assumptions

–Previous TPP

–Output price fixed at $1 / unit

–Capital price constant at $7 / unit

–Close to perfect competition

Profit Maximization

8

TVP

LandCapital TPP APP MPP TVP1 1 2 2.000 2 1*2 = 21 2 6 3.000 4 1*6 = 61 3 13 4.333 7 131 4 23 5.750 10 231 5 35 7.000 12 351 6 49 8.167 14 491 7 64 9.143 15 641 8 78 9.750 14 781 9 91 10.111 13 911 10 102 10.200 11 1021 11 111 10.091 9 1111 12 118 9.833 7 1181 13 122 9.385 4 1221 14 123 8.786 1 1231 15 121 8.067 -2 121

TVP = price * TPP

Note price = $1

Not generally the case

MVP

LandCapital TPP APP MPP TVP MVP1 1 2 2.000 2 2 1*2 = 21 2 6 3.000 4 6 1*4 = 41 3 13 4.333 7 13 71 4 23 5.750 10 23 101 5 35 7.000 12 35 121 6 49 8.167 14 49 141 7 64 9.143 15 64 151 8 78 9.750 14 78 141 9 91 10.111 13 91 131 10 102 10.200 11 102 111 11 111 10.091 9 111 91 12 118 9.833 7 118 71 13 122 9.385 4 122 41 14 123 8.786 1 123 11 15 121 8.067 -2 121 -2

MVP = price * MPP

or change in TVP / change

in input

Marginal return per unit of

input

Note price = $1

Not generally the case

AVP

Land Capital TPP APP MPP TVPMVP AVP1 1 2 2.000 2 2 2 1*2 = 21 2 6 3.000 4 6 4 1*3 = 31 3 13 4.333 7 13 7 4.3331 4 23 5.750 10 23 10 5.7501 5 35 7.000 12 35 12 7.0001 6 49 8.167 14 49 14 8.1671 7 64 9.143 15 64 15 9.1431 8 78 9.750 14 78 14 9.7501 9 9110.111 13 91 13 10.1111 10 10210.200 11 102 11 10.2001 11 11110.091 9 111 9 10.0911 12 118 9.833 7 118 7 9.8331 13 122 9.385 4 122 4 9.3851 14 123 8.786 1 123 1 8.7861 15 121 8.067 -2 121 -2 8.067

AVP = price * APP or

TVP / total input

Note price = $1

Not generally the

case

9

Total Variable Cost - TVC

Land Capital TPP APP MPP TVP MVP AVP TC1 1 2 2.000 2 2 2 1*2 = 2 7*1 = 71 2 6 3.000 4 6 4 1*3 = 3 7*2 = 141 3 13 4.333 7 13 7 4.333 211 4 23 5.750 10 23 10 5.750 281 5 35 7.000 12 35 12 7.000 351 6 49 8.167 14 49 14 8.167 421 7 64 9.143 15 64 15 9.143 491 8 78 9.750 14 78 14 9.750 561 9 91 10.111 13 91 13 10.111 631 10 102 10.200 11 102 11 10.200 701 11 111 10.091 9 111 9 10.091 771 12 118 9.833 7 118 7 9.833 841 13 122 9.385 4 122 4 9.385 911 14 123 8.786 1 123 1 8.786 981 15 121 8.067 -2 121 -2 8.067 105

TC

= p

rice o

f input * in

put le

vel

AFC and MFC

Land Capital TPP APP MPP TVP MVP AVP TC AFC MFC1 1 2 2.000 2 2 2 1*2 = 2 7 7/1 = 7 7/1 = 7

1 2 6 3.000 4 6 4 1*3 = 3 14 14/2 = 7(14-7)/ (2-1)=7

1 3 13 4.333 7 13 7 4.333 21 7 71 4 23 5.750 10 23 10 5.750 28 7 71 5 35 7.000 12 35 12 7.000 35 7 71 6 49 8.167 14 49 14 8.167 42 7 71 7 64 9.143 15 64 15 9.143 49 7 71 8 78 9.750 14 78 14 9.750 56 7 71 9 91 10.111 13 91 13 10.111 63 7 71 10 102 10.200 11 102 11 10.200 70 7 71 11 111 10.091 9 111 9 10.091 77 7 71 12 118 9.833 7 118 7 9.833 84 7 71 13 122 9.385 4 122 4 9.385 91 7 71 14 123 8.786 1 123 1 8.786 98 7 71 15 121 8.067 -2 121 -2 8.067 105 7 7

MFC = marginal factor cost = additional cost

associated with the application of each

successive variable input = ∆ in TC / ∆ input

AFC = average factor cost = cost per unit of input

= TC / input level

In this case the AFC = MFC = constant = $7

Why?

Net Returns or Profit

Land Capital TPP APP MPP TVP MVP AVP TC AFC MFCNet

Returns

1 1 2 2.000 2 2 2 2 7 7 7 2-7=-51 2 6 3.000 4 6 4 3 14 7 7 6-14=-81 3 13 4.333 7 13 7 4.333 21 7 7 -8.001 4 23 5.750 10 23 10 5.750 28 7 7 -5.001 5 35 7.000 12 35 12 7. 35 7 7 0.001 6 49 8.167 14 49 14 8.167 42 7 7 7.001 7 64 9.143 15 64 15 9.143 49 7 7 15.001 8 78 9.750 14 78 14 9.750 56 7 7 22.001 9 91 10.111 13 91 13 10.111 63 7 7 28.001 10 102 10.200 11 102 11 10.200 70 7 7 32.001 11 111 10.091 9 111 9 10.091 77 7 7 34.001 12 118 9.833 7 118 7 9.833 84 7 7 34.001 13 122 9.385 4 122 4 9.385 91 7 7 31.001 14 123 8.786 1 123 1 8.786 98 7 7 25.001 15 121 8.067 -2 121 -2 8.067 105 7 7 16.00

Net Returns = TVP – TC

10

Net Returns or Profit

Land Capital TPP APP MPP TVP MVP AVP TVC AFC MFCNet

Returns

1 1 2 2.000 2 2 2 2 7 7 7 2-7=-51 2 6 3.000 4 6 4 3 14 7 7 6-14=-81 3 13 4.333 7 13 7 4.333 21 7 7 -8.001 4 23 5.750 10 23 10 5.750 28 7 7 -5.001 5 35 7.000 12 35 12 7. 35 7 7 0.001 6 49 8.167 14 49 14 8.167 42 7 7 7.001 7 64 9.143 15 64 15 9.143 49 7 7 15.001 8 78 9.750 14 78 14 9.750 56 7 7 22.001 9 91 10.111 13 91 13 10.111 63 7 7 28.001 10 102 10.200 11 102 11 10.200 70 7 7 32.001 11 111 10.091 9 111 9 10.091 77 7 7 34.001 12 118 9.833 7 118 7 9.833 84 7 7 34.001 13 122 9.385 4 122 4 9.385 91 7 7 31.001 14 123 8.786 1 123 1 8.786 98 7 7 25.001 15 121 8.067 -2 121 -2 8.067 105 7 7 16.00

-20

0

20

40

60

80

100

120

140

0 2 4 6 8 10 12 14 16

Do

llars

Captial

TVP

TVC

Net Returns

MFC

MVP

Net Returns Maximization

Net returns

max at

greatest

distance

between

TVP and TC

Occurs at

input level in

which

MFC = MVP

-10

-5

0

5

10

15

20

25

30

35

0 2 4 6 8 10 12 14 16

Do

llars

Capital | Land unit

MFC

MVP

Net Returns

Net Returns Graph

Input level

that MFC =

MVP

maximizes

net returns

11

• Fixed costs – do not vary with the level

of input use

• Variable costs – vary with the level of

input use

• Similar to production can obtain curves

such as total, average, and marginal

costs

Short-Run Costs

• Fixed costs = 0 in Barlowe

• With only two inputs, land and capital the

profits we are generating are returns to

the fixed input – land

• Usually TC = TVC + FC but our case

–FC = 0, therefore TC = TVC

• OK

–returns to land

–fixed costs do not influence decision making

Note on Fixed Costs

Total Costs

• Recall capital costs = $7 / unit

Land Capital TPP FC TVC FC+TVC =TC1 1 2 0 1 * 7 = 7 0 + 7 = 71 2 6 0 2 * 7 = 14 0 + 14 = 141 3 13 0 3 * 7 = 21 211 4 23 0 28 281 5 35 0 35 351 6 49 0 42 421 7 64 0 49 491 8 78 0 56 561 9 91 0 63 631 10 102 0 70 701 11 111 0 77 771 12 118 0 84 841 13 122 0 91 911 14 123 0 98 981 15 121 0 105 105

Note,

Will ignore

Land and FC

in proceeding

slides!

12

Total Costs - Graphically

0

20

40

60

80

100

120

Do

llars

Output or TPP

After max TTP decreases

but costs still increase.

Produce in Stage III?

Cost increase at

increasing rate.

Cost increase at

decreasing rate.

Average / Marginal Costs• Average cost = total cost / output

• Marginal cost = change in total costs / change in output

Capital TPP TC ATC MC1 2 7 7/2 = 3.50 (7-0)/(2-0) = 3.502 6 14 14/6 = 2.33 (14-7)/(6-2) = 1.753 13 21 21/13 = 1.62 (21-14)/(13-6) = 1.004 23 28 1.22 0.705 35 35 1.00 0.586 49 42 0.86 0.507 64 49 0.77 0.478 78 56 0.72 0.509 91 63 0.69 0.54

10 102 70 0.69 0.6411 111 77 0.69 0.7812 118 84 0.71 1.0013 122 91 0.75 1.7514 123 98 0.80 7.0015 121 105 0.87 -3.50

Why MC is

not relevant

in stage III!

Marginal / Average Costs

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

Do

llars

Output or TPP

MC

AC

13

• MC

– Decreasing MC is associated with increasing MPP

– Increasing MC is associated with diminishing

marginal returns – decreasing MPP

• AC

– Decreasing AC is associated with increasing APP

– Increasing AC is associated with decreasing APP

• MC = AC at minimum AC

Cost / Production Relationships

What is the shape of your MC curve between input levels of 125 and 150 pounds of fertilizer to your spinach field? Why?

A) Upward sloping, MPP is increasing is stage 2.

B) Upward sloping, MPP is decreasing in stage 2.

C) Downward sloping, MPP is increasing in stage 2.

D) Downward sloping, MPP is

decreasing in stage 2.

E) Upward sloping, the stage

of production is irrelevant.

Question

Stage 1

Stage 2

Stage 3

What is the shape of your MC curve between input levels of 125 and 150 pounds of fertilizer to your spinach field? Why?

A) Upward sloping, MPP is increasing is stage 2.

B) Upward sloping, MPP is decreasing in stage 2.

C) Downward sloping, MPP is increasing in stage 2.

D) Downward sloping, MPP is

decreasing in stage 2.

E) Upward sloping, the stage

of production is irrelevant.

Question

Stage 1

Stage 2

Stage 3

14

Net Returns = TVP - TC

0

20

40

60

80

100

120

140

Do

llars

Output or TPP

TC

TVP

Net returns

max at

greatest

distance

between

TVP and TC

Similar to what we have been doing

• Total Revenue (TVP) = price x quantity – WHY?

• Average Revenue – revenue per unit of output

• Marginal Revenue – change in total revenue as

output changes

• Objective maximize net returns given fixed land

unit

Short-Run Decisions

output

revenueMR

outputtotal

revenuetotalAR

Average / Marginal Revenues

• Recall price of $1

TPP TPP * price = TR AR MR2.00 2 * 1 = 2.00 2/2 = 1.00 (2-0)/(2-0) = 16.00 6* 1 = 6.00 6/6 = 1.00 (6-2)/(6-2) = 1

13.00 13.00 1.00 123.00 23.00 1.00 135.00 35.00 1.00 149.00 49.00 1.00 164.00 64.00 1.00 178.00 78.00 1.00 191.00 91.00 1.00 1

102.00 102.00 1.00 1111.00 111.00 1.00 1118.00 118.00 1.00 1122.00 122.00 1.00 1123.00 123.00 1.00 1121.00 121.00 1.00 1

𝐴𝑅 = 𝑇𝑅/𝑇𝑃𝑃 M𝑅 = Δ𝑇𝑅/𝛥𝑇𝑃𝑃

15

• Perfect competition in the short run produce at the point

MC = MR

Level of Output MC = MR

Net revenue

maximizing

point MC = MR

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

Do

llars

Output or TPP

MC

AC

MR

• Why? Examine MR and MC curves

Level of Output MC = MR

MC

MR

MCb

MCA

MC < MR

Produce more – Why?

MC > MR

Produce less – Why?

MC = MR

Correct output level – Why?

TR and TC Areas

Note change in y-axis for clarity

16

Total Returns

Gray area =

TR = P * Q

Total Cost

Red area TC

= AC x Q

Net Returns

Green area

net returns

TR - TC

17

• Breakeven price - price that just covers total costs

• TR = TC implies economic profits are zero

Breakeven Price

Price = $0.69

= min AC



Breakeven Price

Gray area TR

Price = $0.69

= min AC



Breakeven Price

Price = $0.69

= min AC

Red area TC

Notice

profits = 0

18

At a price of $2.50, how

much of total costs are

being covered?

Question

A) None

B) Can not tell, because you need to know quantity

C) Some but not all

D) Curves are average curves and you can not obtain

totals from averages

E) All

Quantity

5.00

2.50

MCAC

Dollars

Quantity

5.00

2.50

MC

Dollars



being covered?

Question

A) None


C) Some but not all



E) All

Total costs

Total Revenue

Quantity

5.00

2.50

MCAC

Dollars

Quantity

5.00

2.50

MC

Dollars



being covered?

Question

A) None


C) Some but not all



E) All

Quantity

5.00

2.50

MCAC

Dollars

Quantity

5.00

2.50

MC

Dollars

19



being covered?

Question

Quantity

5.00

2.50

MCATC

AVC

Dollars

Quantity

5.00

2.50

MCATC

AVC

Dollars

A) None


C) Some but not all



E) All

Total costs

Total Revenue

At which point would a

profit maximizing firm

produce if price =$5?

Why?

Question

A) A

B) B

C) C

D) D

E) E

Quantity

5.00

MC

AC

Dollars

Quantity

5.00

MC

Dollars

A B C D E

At which point would a

profit maximizing firm

produce if price =$5?

Why?

Question

A) A MR = MC but MC decreasing -- not in stage 2

B) B MR does not = MC

C) C MR does not = MC

D) D MR does not = MC

E) E MR= MC and MC increasing -- stage 2

Quantity

5.00

MC

AC

Dollars

Quantity

5.00

MC

Dollars

A B C D E

20

What area gives the

total costs? Price = $5

Question

Quantity

5

G

F

MC

AC

Dollars

Quantity

MC

Dollars

0 E

A

B

C

A) AE05

B) BE0G

C) CE0F

D) ABG5

E) BCFG

What area gives the

total costs? Price = $5

Question

Quantity

5

G

F

MC

AC

Dollars

Quantity

MC

Dollars

0 E

A

B

C

A) AE05

B) BE0G

C) CE0F

D) ABG5

E) BCFG

What area gives the

total revenue?

Price = $5

Question

Quantity

5

G

F

MC

AC

Dollars

Quantity

MC

Dollars

0 E

A

B

C

A) AE05

B) BE0G

C) CE0F

D) ABG5

E) BCFG

21

What area gives the

total revenue?

Price = $5

Question

A) AE05

B) BE0G

C) CE0F

D) ABG5

E) BCFG

Quantity

5

G

F

MC

AVC

Dollars

Quantity

MC

AVC

Dollars

0 E

A

B

C

What area gives profits?

Price = $5

Question

Quantity

5

G

F

MC

AC

Dollars

Quantity

MC

Dollars

0 E

A

B

C

A) AE05

B) BE0G

C) CE0F

D) ABG5

E) BCFG

A) AE05

B) BE0G

C) CE0F

D) ACF5

E) BCFG

What area gives profits?

Question

Quantity

5

G

F

MC

AC

Dollars

Quantity

MC

Dollars

0 E

A

B

C

22

• Land the fixed factor

– Short Run - land usually assumed fixed

– Long Run - land is variable

• Define economic land use

• Intensity

– Refers to the relative amount of capital and labor

combined with units of land in the production process -

relative amounts of capital and labor

• high ratio implies intensive use

• downtown vs. ranch

• Two Concepts

– Intensive margin

– Extensive margin

Intensity of Land Use

• Concept applies to all uses of land

• Intensive Margin

– Input level associated with maximizing net returns

• MFC = MVP or

• MC = MR

Intensive Margin of Land

We will concentrate on cost curves

Give same point

MR

5

10

15

20

25

30

5 10 15 20 25 30 35 40 450

MC

AC

Pri

ce

Output

Intensive Margin – Good

Area of insufficient input use Area of too much input use

Intensive margin

Green box = net returnsProduce at MR = MC

Assume occurs at 15 units of capital

23

MR

5

10

15

20

25

30

5 10 15 20 25 30 35 40 450

AC

PR

ICE

Output

Intensive Margin - Average

Area of

insufficient

input use Area of too much input use

Intensive margin

MC


MR

5

10

15

20

25

30

5 10 15 20 25 30 35 40 450

AC

PR

ICE

Output

Intensive Margin - Marginal

Area of

insuffici

ent input

use

Area of too much input use

Intensive margin

MC


Net returns = 0

• Extensive margin

– large land area (low capital and labor)

– break even tract

– lowest grade of land

– least accessible site

• Occurs when operator is applying intensive level of

inputs (MR=MC) for a given land use and finds

they are using the lowest grade of land they can

afford to operate

Extensive Margin of Land Use

24

Extensive Margin

AC

MR

Pri

ce

Output

MC

AC

MR

Pri

ce

Output

MC AC

MR

Pri

ce

Output

MC

Good Average Marginal

Intensive margins Extensive margin

Decreasing Land Capacity

Eco

no

mic

Cap

acit

y o

f La

nd

Continuum

15

10

5


Intensive margins

Extensive margin


Eco

no

mic

Cap

acit

y o

f La

nd

Continuum

15

10

5


Intensive margins for

Best land

Sub average land

25


Eco

no

mic

Cap

acit

y o

f La

nd 15

10

5


Marginal land – taken out of productionExtensive margin shifts to left

Price Decrease / Cost Increase

Good land – uses less inputs

Average land – uses less inputs

Price Decrease

AC

MR before

Pri

ce

Output

MCAC

MR before

Pri

ce

Output

MC

Good Marginal

Intensive margin beforeIntensive margin before

MR after

Intensive margin after

MR after

Would not produce after

Price Increase / Cost Decrease


Eco

no

mic

Cap

acit

y o

f La

nd 15

10

5


Sub marginal land –put into productionExtensive margin shifts to right

Good land – uses more inputs

Average land – uses more inputs

Marginal land – uses more inputs

26

Price Increase

AC

MR beforePri

ce

Output

MC

ACMR before

Pri

ce

Output

MC

Good Sub marginal

Intensive margin afterIntensive margin after

MR after

Intensive margin before

MR after

Intensive margin before

Not producing

• Type of use

– Commercial vs. residential vs. farming

– Technology

• For a given use– Characteristics of the land

– Changing economic conditions

– Owners expectations and attitudes

– Technology

Factors Influencing Intensity

• Equi-marginal principle

• If a resources is limited, maximum net returns

occur when MVP is at least equal to the next

best alternative (opportunity cost)

• MVP will be equal

• Example

• Assumptions• Three tracts of land - not homogenous

• 30 units of the input available

• TVP and MVP varying between the tracts – next table

• Input costs = $3 / unit = MFC

Equi-marginal Principle

27

Different Land

# of

Variable

Inputs

First Tract Second Tract Third Tract

TVP MVP TVP MVP TVP MVP

1 $10 $10 9 9 8 8

6 $47 11 45 10 42 9

7 59 12 56 11 49 7

8 72 13 65 9 54 5

9 84 12 73 8 57 3

10 95 11 80 7 59 2

11 104 9 86 6 60 1

12 112 8 90 4 60 0

13 119 7 93 3

14 124 5 95 2

15 128 4 95 0

16 131 3

17 133 2

No Constraints MFC = MVP

# of

Variable

Inputs



1 $10 $10 9 9 8 8

6 47 11 45 10 42 9

7 59 12 56 11 49 7

8 72 13 65 9 54 5

9 84 12 73 8 57 3

10 95 11 80 7 59 2

11 104 9 86 6 60 1

12 112 8 90 4 60 0

13 119 7 93 3

14 124 5 95 2

15 128 4 95 0

16 131 3

17 133 2

No constraints

Tract Units TVP MVP

1 16 131 3

2 13 93 3

3 9 57 3

Total 38 281

Constrained to 30 units

Use to intensive margin on best

land first

Tract Units TVP MVP

1 16 131 3

2 13 93 3

3 1 8 8

Total 30 232


Use 10 units / grade

Tract Units TVP MVP

1 10 95 11

2 10 80 7

3 10 59 2

Total 30 234


Equi-marginal principle

Tract Units TVP MVP

1 13 119 7

2 10 80 7

3 7 49 7

Total 30 248

net returns = 281 – 3*38 = $167 net returns = 232 – 3*30 = $142

net returns = 234 – 3*30 = $144 net returns = 248 – 3*30 = $158

28

Equi-marginal Principle

# of

Variable

Inputs



1 $10 $10 9 9 8 8

6 $47 11 45 10 42 9

7 59 12 56 11 49 7

8 72 13 65 9 54 5

9 84 12 73 8 57 3

10 95 11 80 7 59 2

11 104 9 86 6 60 1

12 112 8 90 4 60 0

13 119 7 93 3

14 124 5 95 2

15 128 4 95 0

16 131 3

17 133 2

The long run average cost (LAC) curve reflects points

of tangency with a series of short run average total cost

(SAC) curves. The point on the LAC where the following

holds is the long run equilibrium position (QLR) of the

firm:

SAC = LAC = SMC = PLR

where PLR represents the long run price and SMC short

run marginal costs.

Long Run Average Cost Curve

Developing the LAC

29

• Increasing returns to size – increase in output is

more than proportional increase in input use

– LAC is decreasing when firm is expanded

• Decreasing returns to size - increase in output is

less than proportional increase in input use

– LAC is increasing when firm is expanded

• Constant returns to size - increase in output is

equal to the proportional increase in input use

– LAC is horizontal when firm is expanded

Economies of Size

Returns to Size

DecreasingIncreasing

Constant

What can we say about the four

firms in this graph?

30

Q3

WHY?

Size 1 would lose

money at price P

Q3

Firm size 2, 3 and 4

would earn a profit

at price P….

WHY?

Q3

Firm #2’s profit would

be the area shown

below…

31

Q3


be the area shown

below…

Q3


be the area shown

below…

If price were to fall to

PLR, only size 3 would

not lose money; it would

break-even. Size 4 would

have to down size its

operations! Size 1 and 2

would have to increase

operations.

Documents

Conditions for Perfect Competition - Texas A&M University