ARE 201 · Fall 2026

Exam 2 Review

Units 6, 7, 8a and 8b · elasticity, consumer choice, costs, perfect competition

Before we begin

Exam 2 · Friday, October 23

Fri, Oct 23

In class, on paper

1:55–2:45 PM

50 minutes. Arrive on time; late arrival does not add testing time.

Units 6–8b

Multiple choice. Units 6, 7, 8a and 8b.

Bring to the exam

One 4×6 index card

Handwritten, front and back. Formulas, decision rules, one worked table.

A basic calculator

No scientific or graphing calculators. No phones, watches or printed notes.

Today: 19 skills. For each one, a REVIEW page recaps the idea from our lectures, then a PRACTICE page works the matching question from your Exam 2 checklist. Try it on paper before we reveal.
Exam 2 · what it covers

Nineteen skills: review the idea, then practice

Unit 6 · Elasticity

  • A1Midpoint price elasticity
  • A2Elasticity and total revenue
  • A3What makes demand elastic
  • A4Price elasticity of supply
  • A5Who pays a tax

Unit 7 · Consumer choice

  • B1Total and marginal utility
  • B2Buying by MU per dollar
  • B3The utility-maximizing rule
  • B4Income and substitution effects
  • —From utility to the demand curve (review only)

Unit 8a · Costs

  • C1One table, every cost
  • C2Fixed or variable?
  • C3Diminishing returns → rising MC
  • C4Which cost curves move

Unit 8b · Perfect competition

  • D1Price taker: P = MR
  • D2The most profit, from a table
  • D3Break-even vs. shutdown
  • D4Accounting vs. economic profit
  • D5Entry, exit and the long run

A1–D5 are the practice questions in your Exam 2 checklist, in the same order.

Unit 6

Elasticity

REVIEW
Review · Unit 6 · LO 6.1–6.2

Price elasticity of demand: how much, not which way

Ed = % change in quantity demanded% change in price
%ΔQ = Q2 − Q1(Q1 + Q2) ÷ 2
%ΔP = P2 − P1(P1 + P2) ÷ 2
|Ed|NameWhat it means
> 1ElasticQuantity responds more than proportionally
< 1InelasticQuantity responds less than proportionally
= 1Unit elasticSame percentage change
= 0Perfectly inelasticQuantity does not change; vertical curve
→ ∞Perfectly elasticAny price rise drives Q to zero; horizontal

Why the midpoint method?

A percentage has to ask: compared to what? $10 → $20 is +100%, but $20 → $10 is −50%. Averages as the bases give the same answer in both directions.

Say it in a sentence

Report the absolute value, then translate: |Ed| = 1.17 means “a 10% price increase would cut quantity demanded by about 11.7%.”

Lecture example. Strawberries: $12 → $16, 700 → 500 flats. Averages 600 and $14. %ΔQ = 200 ÷ 600 = 33.3%; %ΔP = $4 ÷ $14 = 28.6%; |Ed| = 1.17, elastic.
Trap: “Inelastic” does not mean quantity does not change. Only perfectly inelastic means no change.
PRACTICE A1
Unit 6 · checklist practice A1

A1 · Midpoint price elasticity

A campus craft booth raises the price of its handmade earrings from $25 to $35 a pair. Monthly sales fall from 20 pairs to 14. Demand did not shift.

a. Use the midpoint method to find the price elasticity of demand.

Average Q = (20 + 14) ÷ 2 = 17 pairs; average P = $30. %ΔQ = −6 ÷ 17 = −35.3%; %ΔP = 10 ÷ 30 = +33.3%. Ed = −35.3% ÷ 33.3% ≈ −1.06, so |Ed| ≈ 1.06.

b. Classify demand and say what the number means in one sentence.

Elastic, just barely (1.06 > 1): a 10% price increase would cut the quantity of earrings sold by about 10.6%.

c. Check your answer using total revenue.

TR before = $25 × 20 = $500; after = $35 × 14 = $490. Price rose and revenue fell: the elastic pattern.
Watch out: starting values as bases give (−6 ÷ 20) ÷ (10 ÷ 25) = −0.75, which would wrongly say “inelastic.”
REVIEW
Review · Unit 6 · LO 6.4

Total revenue: price effect vs. quantity effect

TR = P × Q

Price effect ↑

Every unit you still sell now earns more.

Quantity effect ↓

By the law of demand you sell fewer units.

DemandRaise the priceLower the price
Elastic |E| > 1TR falls ↓TR rises ↑
Inelastic |E| < 1TR rises ↑TR falls ↓
Unit elastic |E| = 1TR unchangedTR unchanged

Read it backwards too: price and TR move the same way → inelastic; opposite ways → elastic.

Lecture example. The same $4 increase, $10 → $14. Inelastic: Q 100 → 92, TR $1,000 → $1,288 (rises). Elastic: Q 100 → 60, TR $1,000 → $840 (falls).

Along a straight-line demand curve

The slope is the same everywhere, but elasticity is not: elastic above the midpoint, unit elastic at the midpoint, inelastic below it.

So TR is highest where demand is unit elastic: cut the price above the midpoint, raise it below.

Why the elasticity changes

Up top the price is big and the customer base small, so a price cut wins many customers in percentage terms. Down low it is the reverse.

PRACTICE A2
Unit 6 · checklist practice A2

A2 · Elasticity and total revenue

For each move, classify demand as elastic or inelastic, and say whether revenue rose or fell.

a. Parking permits. A university raises the price of a parking permit by 10%; permits sold fall by 4%.

|Ed| = 4% ÷ 10% = 0.4 → inelastic. Price up, revenue rises: 1.10 × 0.96 = 1.056, about +5.6%.

b. Matinee tickets. A movie theater cuts matinee prices by 20%; matinee attendance rises by 35%.

|Ed| = 35% ÷ 20% = 1.75 → elastic. Price cut, revenue rises: 0.80 × 1.35 = 1.08, about +8%.

c. Both moves raised revenue, one with a price increase and one with a price cut. What is the general lesson?

Raise the price where demand is inelastic; cut it where demand is elastic. A seller who knows both elasticities can raise revenue in both markets at once.
Watch out: “A price increase always raises revenue” is false. It depends on whether |Ed| is above or below 1.
REVIEW
Review · Unit 6 · LO 6.3

What makes demand elastic: four escape routes

1 · Substitutes

What else would do the job just as well?

More substitutes → more elastic

Hubble telescope vs. a cheeseburger. A narrowly defined good (one brand) has more substitutes than a broad category.

2 · Necessity

Can the purchase simply be skipped?

Luxuries elastic, necessities inelastic

Insulin vs. a Caribbean cruise. The test is whether “no” is an option, not the price tag.

3 · Budget share

Is it worth shopping around over?

Bigger share of income → more elastic

Table salt vs. a new car.

4 · Time

How long does the buyer have to adjust?

Longer horizon → more elastic

Gasoline this month vs. over ten years.

All four ask one question: how easily can this buyer say no? Every escape route (another product, a later date, a smaller bill) makes demand more elastic.

On the exam

You are given a good, not a number. Name the determinant doing the work and say which way it pushes.

When determinants conflict

Housing: a big budget share says elastic; a necessity says inelastic. Measured |Ed| ≈ 0.12. Say that they conflict; data settle which one wins.

PRACTICE A3
Unit 6 · checklist practice A3

A3 · What makes demand elastic

Which statement is correct? Choose an answer, then explain why.

Answer: C. C. One brand has many close substitutes (every other brand of sparkling water); drinks in general have almost none, so the narrowly defined good is more elastic. A is backwards (time: ten years gives more ways to adjust). B is backwards (a smoke alarm is a cheap necessity; a Persian rug is an expensive luxury). So D is false.

REVIEW
Review · Unit 6 · LO 6.5

Supply elasticity: how fast can output expand?

Es = % change in quantity supplied% change in price

Always positive: along a supply curve price and quantity move the same way. Same midpoint method; same thresholds (above 1 elastic, below 1 inelastic).

Lecture example. Rent $650 → $700; units supplied 10,000 → 13,000. %ΔQ = 3,000 ÷ 11,500 = 26.1%; %ΔP = $50 ÷ $675 = 7.4%; Es ≈ 3.5, elastic.

Why it matters

The same demand increase lands mostly on price when supply is inelastic, and mostly on quantity when supply is elastic. Prices move more in the short run; quantities move more in the long run.

Supply is more elastic with…

More time
This season the crop is in the ground → next year farms switch acreage → over a decade, new orchards and new land.
Spare capacity
Idle equipment or an extra shift: elastic. At capacity, more output means a new plant: inelastic.
Storable goods
Chocolate stores well, so Valentine's Day lands on quantity; roses cannot be stored, so it lands on price.
Available inputs
Bread, pencils, books: ordinary inputs, easy to expand.
Fixed resources
Beachfront land, the Mona Lisa: no price makes more. Nearly perfectly inelastic.
PRACTICE A4
Unit 6 · checklist practice A4

A4 · Price elasticity of supply

a. The price of blueberries falls 12%, and quantity supplied falls 6%. Find Es and classify it.

Es = (−6%) ÷ (−12%) = +0.5 → inelastic. A 10% price change moves quantity supplied by only about 5%.

b. A newly planted pecan orchard takes 6 to 10 years to bear nuts. Demand for pecans jumps this fall. Is pecan supply elastic or inelastic this season? In ten years?

Inelastic this season: growers can harvest only trees already bearing. Much more elastic in ten years: they can plant and harvest new orchards.

c. Population growth raises demand by the same amount for beachfront homes and for new cars. In which market does price rise more?

Beachfront homes. No one can make more beachfront (very inelastic supply), so the demand increase shows up mostly as a higher price; car makers can build more cars.
Watch out: do not take the absolute value or add a minus sign to Es: both changes are negative, so the ratio is already positive.
REVIEW
Review · Unit 6 · LO 6.7

Who bears a tax: measure from the price before the tax

Gallons (millions)$DS3.803.002.80buyers paybefore the taxsellers keep$1 tax7590

The lecture's $1.00 gasoline tax (illustrative numbers).

Who writes the check does not matter

Tax the seller or tax the buyer: buyers still pay $3.80, sellers still keep $2.80, 75 million gallons. The law sets statutory incidence; the market sets economic incidence.

1 · The wedge
Price buyers pay − price sellers keep = the tax. Quantity falls.
2 · Each burden
Measure from the price before the tax. Buyers: $3.80 − $3.00 = $0.80 (80%). Sellers: $3.00 − $2.80 = $0.20 (20%).
3 · The rule
The more inelastic side bears more: it has the fewest escape routes.
4 · Special cases
Equally elastic → the tax is split equally. Perfectly inelastic buyers → buyers bear all of it.
5 · On a graph
At the shared starting point, the steeper curve is the less elastic side.
PRACTICE A5
Unit 6 · checklist practice A5

A5 · Who pays a tax, on a graph

0QuantityPrice ($)DSS + tax5.506.004.001372537.5

A $2 tax per unit is collected from sellers. The dashed line is supply plus the tax.

c. Quick fire. Who bears more of a tax? (i) Es = 0.5, Ed = −0.5   (ii) demand is perfectly inelastic   (iii) Es = 0.2, Ed = −2

(i) Equally elastic: split equally. (ii) Buyers bear all of it. (iii) 0.2 < 2: sellers bear most.

a. Read the graph: how much more do buyers pay? How much less do sellers keep? What share of the tax does each side bear?

Before the tax: $5.50 at Q = 37.5. After: buyers pay $6.00, sellers keep $4.00 at Q = 25. Buyers bear $0.50 (25%); sellers bear $1.50 (75%).

b. Which curve is less elastic at the starting point? Does that match your answer to (a)?

Supply (steeper there) is less elastic. Yes: the less elastic side, sellers, bears more.
Watch out: the tax was collected from sellers, but that does not decide who bears it. Measure burdens from the old price ($5.50), not from each other.
Unit 7

Consumer choice

REVIEW
Review · Unit 7 · LO 7.1, 7.4

Total utility vs. marginal utility

Utility

The satisfaction a person gets from consuming, counted in utils. It is personal: rank your own options, but never compare utils across people.

MU = change in total utilitychange in quantity
and TU = the sum of the MUs

Law of diminishing marginal utility

Each additional unit tends to add less satisfaction than the one before: the first unit goes to its most important use.

Slice123456
MU24181260−6
TU244254606054
MU > 0
TU rises (more slowly as MU shrinks).
MU = 0
TU is at its peak: the 5th slice adds nothing.
MU < 0
TU falls, 60 − 6 = 54, but TU is still positive.
Why it matters. What you will pay follows marginal utility, not total utility: your 30th Labubu adds little, so you pay little for it.
PRACTICE B1
Unit 7 · checklist practice B1

B1 · Total and marginal utility

Priya drinks coffee during an all-day study session. Her total utility is:

Cups12345
Total utility1424303027
Marginal utility141060−3

a. Fill in the MU row. What is the marginal utility of the 3rd cup?

MU row: 14, 10, 6, 0, −3. The 3rd cup: 30 − 24 = 6 utils; the shrinking MUs are diminishing marginal utility.

b. How many cups give Priya the most total utility?

3 or 4 cups (TU = 30). TU stops rising when MU = 0: the 4th cup adds nothing.

c. What is the MU of the 5th cup? Is her total utility now negative?

MU = 27 − 30 = −3. TU falls to 27 but is still positive: a negative MU lowers TU; it does not make TU negative.
Watch out: MU and TU are different numbers. “The 5th cup has negative utility” is about MU, not TU.
REVIEW
Review · Unit 7 · LO 7.3, 7.5

Compare utility per dollar, not utility

MU per dollar = marginal utilityprice

The budget line

Every bundle on the line spends the whole budget; inside leaves money over; outside is unaffordable. Intercept = income ÷ price.

José: $56, T-shirts $14, movies $7: 14T + 7M = 56.

Lecture example. José's 1st T-shirt: 22 ÷ $14 = 1.57 utils per $. 1st movie: 16 ÷ $7 = 2.29. Buy the movie first, even though the T-shirt has more MU. His best bundle: 1 T-shirt + 6 movies, 103 utils, the highest TU on his budget line.

The procedure

1
Build MU from TU: MU = change in TU.
2
Divide each MU by the good's price.
3
Buy the unit with the highest MU per dollar that you can afford. A tie you can afford: buy both.
4
Stop when the budget is spent.
5
Read total utility from the TU table, and check it against other affordable bundles.
Trap: picking the good with the highest MU. Divide by price first.
PRACTICE B2
Unit 7 · checklist practice B2

B2 · Buying by marginal utility per dollar

Marco has $20 for lunches this week. Sandwiches cost $4; smoothies cost $2.

Units123456
TU, sandwiches32567280––
TU, smoothies203648566062
MU ÷ P, sandwiches8642
MU ÷ P, smoothies1086421

a. Which item does Marco buy first? Why?

A smoothie: 20 ÷ $2 = 10 utils per dollar beats a sandwich's 32 ÷ $4 = 8.

b. Spend all $20 by MU per dollar. What bundle does he end up with, and what is his total utility?

3 sandwiches + 4 smoothies: $12 + $8 = $20; the last dollar on each buys 4 utils. TU = 72 + 56 = 128.

c. Check: is 4 sandwiches and 2 smoothies, which also costs $20, any better?

No: 80 + 36 = 116 < 128. The 4th sandwich gives only 2 utils per dollar.
REVIEW
Review · Unit 7 · LO 7.5

The utility-maximizing rule: equal MU per dollar

MUXPX = MUYPY and the whole budget is spent

Why it holds

Rice gives 4 utils per dollar, fruit 2, and the budget is spent. Move a little money from fruit to rice: more rice → rice's MU falls; less fruit → fruit's MU rises. Stop when the two ratios are equal: no small shift can raise utility.

Trap: the rule equalizes MU per dollar, not MU. MUs are equal only when prices are equal. With whole items, compare affordable bundles; exact equality need not occur.

Use 1 · Fix a choice

Compare the ratios; move spending toward the higher one.

Coffee $4, MU 20 → 5 per $. Tea $2, MU 6 → 3 per $. Move spending from tea to coffee.

Use 2 · Find a price

At the best bundle the ratios are equal; solve for the one unknown.

Concert: 90 ÷ $30 = 3 per $. A movie gives 36 utils, so 36 ÷ P = 3 → P = $12.

PRACTICE B3
Unit 7 · checklist practice B3

B3 · The utility-maximizing rule

a. Fix a choice. Kayla has spent her whole budget. Her last dollar on yoga classes adds 6 utils; her last dollar on concert tickets adds 9. What should she change?

Move dollars from yoga to concerts (each dollar moved: −6 + 9 utils). As she does, concerts' MU falls and yoga's rises, until the two ratios are equal.

b. Find a price. Sam is at his best bundle of apples and granola bars. The last apple adds 16 utils and costs $0.80; the last granola bar adds 30 utils. What does a granola bar cost?

Apples: 16 ÷ $0.80 = 20 utils per dollar. At the best bundle 30 ÷ P = 20, so P = $1.50.

c. True or false? At the utility-maximizing bundle, the last unit of each good adds the same marginal utility.

False. The rule equalizes MU per dollar. Sam's last apple (16) and granola bar (30) are a counterexample.
REVIEW
Review · Unit 7 · LO 7.2

One price change, two effects

Substitution effect

The change in consumption caused by a change in relative prices, holding purchasing power constant. Always toward the good that became relatively cheaper.

Income effect

The change in consumption caused by the price change altering the purchasing power of the same money income. More buying power: normal goods ↑, inferior goods ↓.

A price fallsGood that got cheaperThe other good
Substitution effect+ more− less
Income effect, normal good+ more+ more
Income effect, inferior good− less− less

If a price rises, flip every sign. The observed change combines both effects.

Reading the other good

For a normal good, the two effects push the other good in opposite directions. The direction you observe tells you which effect was bigger.

Lecture example. Coffee gets more expensive; you buy less coffee and less tea. For tea, the income effect won. Pizza gets cheaper; you buy fewer tacos. For tacos, the substitution effect won.
PRACTICE B4
Unit 7 · checklist practice B4

B4 · Income and substitution effects

a. Electricity gets more expensive. Dana uses less electricity, and she also buys fewer paperback books. For books, which effect was larger?

The income effect. Substitution pushes toward more books (now relatively cheaper); her smaller purchasing power pushes toward fewer. Books fell, so the income effect won.

b. Bus fares fall. Leo rides the bus more and takes fewer rideshare trips. Rideshares are a normal good for Leo. For rideshares, which effect was larger?

The substitution effect. Cheaper buses pull him away from rideshares; his extra buying power pushes toward more. Rideshares fell, so substitution won.
Watch out: for the other good, the two effects point opposite ways (for a normal good). The observed direction tells you which won; it does not mean the goods are inferior.
REVIEW
Review · Unit 7 · LO 7.6

From utility to the demand curve

Every point is a best bundle

Change only the good's own price, re-solve the consumer's choice, and record the quantity.

Movie priceJosé's best bundle (T, M)Movies
$8(1, 5)5
$7(1, 6)6
$6(1, 7)7

Held fixed: income ($56), the T-shirt price, tastes.

Why demand slopes down

Diminishing MU
Each extra unit is worth less, so only a lower price gets you to buy more.
Substitution
A higher price makes the good relatively pricier: you shift toward others.
Income
A higher price shrinks what your budget can buy: less of a normal good.
What changes?On the graph
The good's own priceA movement along the demand curve
Income, the price of another good, or tastes (the MU of every unit)The whole demand curve shifts (right if the buyer now wants more at every price)
Unit 8a

Production and costs

REVIEW
Review · Unit 8a · LO 8a.3–8a.4

One cost table, six numbers

Fixed cost
FC = TC at Q = 0
Variable cost
VC = TC − FC
Marginal cost
MC = ΔTCΔQ
Average fixed cost
AFC = FCQ
Average variable cost
AVC = VCQ
Average total cost
ATC = TCQ = AFC + AVC

When a table adds one unit at a time, ΔQ = 1 and MC is just the difference in TC.

Marginal pulls the average

Quiz average 85: a 90 on the next quiz pulls it up to 86; a 70 pulls it down to 82.

MC < ATC
ATC falls
MC = ATC
ATC is at its lowest
MC > ATC
ATC rises

The same holds for AVC.

Lecture example. Pine Hollow. At 180 bushels ATC = $7.67. The next 20 bushels have MC = $6 < ATC, so ATC falls to $7.50. The next 10 have MC = $12 > ATC, so ATC rises to $7.71.
Trap: “MC is rising, so ATC must be rising.” MC can rise while ATC still falls, as long as MC is below ATC. Compare levels, not directions.
PRACTICE C1
Unit 8a · checklist practice C1

C1 · One table, every cost

A cider mill's daily total cost:

Barrels per day0123456
Total cost ($)120150170195230280345
MC ($)—302025355065
ATC ($)—150856557.55657.5
a. What is the fixed cost?FC = TC at Q = 0 = $120.
b. What is the variable cost at 3 barrels?VC = TC − FC = $195 − $120 = $75.
c. What is the marginal cost of the 4th barrel?MC = $230 − $195 = $35.
d. What is the average variable cost at 2 barrels?VC = $170 − $120 = $50; AVC = $50 ÷ 2 = $25.
e. At what output is ATC lowest? Use MC to explain why.5 barrels (ATC = $56). The 5th barrel's MC ($50) is below ATC ($57.50), so it pulls ATC down; the 6th's MC ($65) is above $56, so ATC rises.
REVIEW
Review · Unit 8a · LO 8a.3

Fixed and variable costs, short run and long run

Fixed cost (FC)

The cost of the fixed inputs. The same however much the firm produces in the short run, and paid even if nothing is produced.

Variable cost (VC)

The cost of the variable inputs. It rises when the firm produces more and is zero when nothing is produced.

One test for any cost: does it change if the firm produces one more unit? Yes → variable. No → fixed.
Lecture example. Pine Hollow, this harvest. Fixed: land rent $400 + digger lease $350 + insurance $150 = FC $900 a day, even if nobody digs. Variable: $120 per worker, diesel, boxes. TC = FC + VC, so FC = TC at Q = 0.

Short run vs. long run

Short run: at least one input is fixed. Long run: every input is variable. Over five years Pine Hollow can lease a second digger, rent more land, or sell the farm. “Fixed” depends on the time span.

PRACTICE C2
Unit 8a · checklist practice C2

C2 · Fixed or variable?

A pick-your-own strawberry farm, over one season. Is each cost fixed or variable? Why?

CostFixed or variable, and why
1. Wages of seasonal pickersVariable: more berries picked, more pickers
2. Annual property tax on the farmFixed: same bill at 0 pints or 10,000
3. Pint basketsVariable: one per pint sold
4. Monthly loan payment on the tractorFixed: owed whatever the harvest
5. Fuel for the irrigation pumpVariable: more watering for a bigger crop
6. Yearly website and booking-app feeFixed: a flat fee, not per visitor
Watch out: “fixed” depends on the time span. Over five years the farm could sell the tractor or the land, so every cost is variable in the long run.
REVIEW
Review · Unit 8a · LO 8a.1–8a.2

Diminishing marginal returns make MC rise

MP = ΔTPΔL
TP = total product, L = workers
MC = wageMP
cost of one more unit

Diminishing marginal returns

With technology and other inputs held constant, successive units of one input eventually add smaller amounts to total output.

Worker123456
MP (bu)406050302010
MC per bu$3.00$2.00$2.40$4.00$6.00$12.00

Pine Hollow: one digger, $120 a day per worker.

Where it begins
At the first MP smaller than the one before: worker 3 (60 → 50). On a graph, where TP starts to flatten.
Why
A fixed input: every worker shares one digger. Not lazier workers.
TP vs. MP
TP keeps rising while MP shrinks; only a negative MP makes TP fall.
MC mirrors MP
One more worker costs the wage and adds MP units, so each unit costs wage ÷ MP. As MP falls, MC rises.
Short vs. long run
More output with a fixed input raises MC. Economies of scale (all inputs growing together) are a long-run idea.
PRACTICE C3
Unit 8a · checklist practice C3

C3 · From production to cost

A bakery with one oven pays each worker $120 a day.

Worker1234
Extra loaves (MP)40302010
MC per loaf$3$4$6$12

a. Fill in the cost of each extra loaf (MC = wage ÷ MP).

$120 ÷ 40 = $3; $120 ÷ 30 = $4; $120 ÷ 20 = $6; $120 ÷ 10 = $12.

b. Why does MC rise, even though the wage never changes?

MP falls from the 2nd worker on: diminishing marginal returns to the fixed input, the one oven every worker shares. Each extra loaf takes more paid labor time.

c. Holiday orders double and the owner adds workers this week. What happens to MC?

MC rises: this week the oven is fixed, so more output means crowding it further.
Watch out: “more output lowers MC through economies of scale” is a long-run idea. In the short run, with the oven fixed, MC rises.
REVIEW
Review · Unit 8a · LO 8a.3, 8a.5

What moves the cost curves, and what stays put

One question sorts every case: does this cost change when the firm produces one more unit? If not, MC and AVC stay put.
What changesMCAVCAFCATC
A variable input costs more
wages, diesel, fertilizer, cocoa		↑↑—↑
A fixed input costs more
rent, a lease, insurance, equipment		——↑↑

Productivity changes

A drought or storm means each worker adds less (MP ↓), so the cost of each extra unit, MC = wage ÷ MP, rises, and AVC and ATC rise with it. Better equipment does the opposite.

Why it matters next

Higher input prices or lower MP push MC up, so supply shifts left (Unit 4). A fixed-cost change leaves MC alone, so it does not change how much a price taker produces (Unit 8b).

PRACTICE C4
Unit 8a · checklist practice C4

C4 · What moves, what stays put

For each change, mark ↑, ↓ or — (no change) for each cost curve, and explain.

ChangeMCAVCAFCATCWhy
a. The county doubles the farm's property tax——↑↑Fixed cost: only AFC and ATC rise.
b. Diesel for the tractors gets cheaper↓↓—↓Variable cost: MC, AVC and ATC fall.
c. The hourly wage of seasonal pickers rises↑↑—↑Variable cost: MC, AVC and ATC rise.
Watch out: a rise in fixed cost does not change the profit-maximizing quantity in the short run, because MC is unchanged (see D2, part d).
Unit 8b

Perfect competition

REVIEW
Review · Unit 8b · LO 8b.1–8b.2

Four ingredients make every seller a price taker

Many buyers and many sellers

No one is big enough to move the price (CR4 close to 0%).

Identical products

Also called standardized: buyers don't care whose it is.

Perfect information

Every buyer and seller knows the going price.

Free entry and exit

Anyone can start or stop; it matters most in the long run.

One market, two demand curves

Market demand slopes down. One firm's demand is horizontal at the going price: perfectly elastic. Ask more and you sell nothing.

MR = ΔTRΔQ = P for every unit
Lecture example. The sardine coast: going price $5. 10 sardines bring $50, 20 bring $100; every extra sardine adds $5. Ask $6 and buyers walk to the next boat.
Trap: “In perfect competition, demand is perfectly elastic.” Only the firm's demand. The market demand curve still slopes down.
PRACTICE D1
Unit 8b · checklist practice D1

D1 · Price taker: P = MR

a. Jo sells soybeans at the going price of $11 a bushel. What is her marginal revenue from the 500th bushel?

$11. Jo is too small to move the price, so every bushel, including the 500th, sells for $11: MR = ΔTR ÷ ΔQ = $11 = P.

b. Jo posts a price of $11.50. How many bushels does she sell?

Zero. Buyers can get identical soybeans from other farms at $11 and know the going price.

c. True or false? Market demand for soybeans is inelastic, so each soybean farmer also faces inelastic demand.

False. The market demand curve slopes down (and may be inelastic); the demand curve facing one farmer is horizontal at $11: perfectly elastic.
REVIEW
Review · Unit 8b · LO 8b.2–8b.4

The most profit: produce while MR ≥ MC

Profit = TR − TC   ·   one more unit changes profit by MR − MC

MR > MC

The next unit adds more than it costs: profit is still rising. Produce more.

MR = MC

The next unit adds nothing: the top of the hill. Stay here.

MR < MC

The last unit cost more than it brought in. Produce less.

Price taker: MR = P, so produce where P = MC. In a table: the largest Q whose MC ≤ P.
Lecture example. Sardines at $5. Hauls 1–3 add $36 + $16 + $6 to profit; haul 4's sardines cost $6 each, so it would cut profit by $4. Stop at 26 sardines.

Three reminders

MR = MC
does not mean zero profit: every earlier unit added profit.
TC
already includes fixed cost; do not subtract it again.
Fixed cost
changes profit, not MC, so it does not change the best Q.
PRACTICE D2
Unit 8b · checklist practice D2

D2 · The most profit, from a table

A honey producer in a competitive market:

Jars01234567
TR ($)012243648607284
TC ($)1016212837506583
MC ($)—6579131518
Profit ($)−10−438111071
a. What is the market price?TR rises by $12 with every jar, so MR = $12; for a price taker P = MR = $12.
b. What output maximizes profit?4 jars. Make every jar with MC ≤ $12: the 4th costs $9. The 5th costs $13 > $12, so it would cut profit by $1.
c. What is the maximum profit?TR − TC = $48 − $37 = $11, the largest number in the profit row.
d. Fixed cost rises to $20. Does the best output change?No. TC rises by $10 at every output but every MC is unchanged: still 4 jars, and profit falls to $1.
REVIEW
Review · Unit 8b · LO 8b.3, 8b.5

Profit, loss, and when to shut down

Profit = (P − ATC) × Q
P > min ATCEconomic profit
P = min ATCBreak even: the break-even price
min AVC < P < min ATCLoss, but keep producing
P < min AVCShut down in the short run; min AVC = the shutdown price

Short-run supply = the rising part of MC above min AVC.

Why stay open at a loss?

Fixed cost is owed either way. Open only if sales cover variable cost: TR ≥ VC ⇔ P ≥ AVC.

Lecture example. Taco truck, rainy August, $2,000 rent already paid. At $3.00 a taco: closed −$2,000, open −$800 → open. At $1.50: open −$2,300 → close and lose only the rent.
Trap: shutting down is a short-run decision (fixed costs are still owed); exiting is a long-run decision. The break-even price is not “today's price.”
PRACTICE D3
Unit 8b · checklist practice D3

D3 · Break-even vs. shutdown

A dairy farm in a competitive market has minimum AVC = $14 per hundredweight and minimum ATC = $19. What should it do this month at each price: P = $22, P = $17, P = $12? Then name the break-even price and the shutdown price.
P = $22

Produce at a profit: $22 > $19 (min ATC). Produce where P = MC.

P = $17

Keep producing at a loss: below $19, but above $14, so sales cover all variable cost and part of the fixed cost.

P = $12

Shut down in the short run: $12 < $14, so sales cannot cover variable cost; the loss is then limited to the fixed cost.

Break-even price = min ATC = $19. Shutdown price = min AVC = $14.
REVIEW
Review · Unit 8b · LO 8b.6

Two ways to count cost

Explicit costs

Money paid out: rent, ingredients, wages. The accountant counts these.

Implicit costs

What you give up without paying: the value of your next-best alternative. The economist counts these too.

Accounting profit = TR − explicit costs
Economic profit = TR − (explicit + implicit costs) = accounting profit − implicit costs
Lecture example. Taco truck or a $10,000 internship? TR $24,000; explicit costs $16,000. Accounting profit = +$8,000. Economic profit = $8,000 − $10,000 = −$2,000: the internship paid more.

Reading economic profit

> 0
You beat your next-best option; others will want in.
= 0
A normal profit: you earn exactly what your next-best option pays. Not failure.
< 0
Your next-best option pays more; in time, you leave.

Implicit costs are never negative, so economic profit ≤ accounting profit.

PRACTICE D4
Unit 8b · checklist practice D4

D4 · Accounting vs. economic profit

Rosa runs a food cart. Revenue this year: $90,000. Ingredients, permits and cart rental: $55,000. To run the cart she turned down a job paying $42,000.

a. What is her accounting profit?

TR − explicit costs = $90,000 − $55,000 = $35,000.

b. What is her economic profit?

Accounting profit − implicit cost = $35,000 − $42,000 = −$7,000. The job would have paid her more.

c. True or false? A firm's economic profit can be larger than its accounting profit.

False. Economic profit = accounting profit − implicit costs, and implicit costs are never negative.

d. What does zero economic profit mean?

A normal profit: the owner earns exactly what the next-best use of her time and money would pay. Accounting profit is still positive.
REVIEW
Review · Unit 8b · LO 8b.6

The long run: entry and exit

Short runLong run
What can changeAt least one input is fixedAll inputs adjust; leases expire
DecisionProduce, or temporarily shut down (P vs. AVC)Stay, enter or exit (P vs. ATC)
Economic profit (P > ATC)→Firms enter→Market supply shifts right→Price falls→Profit shrinks to 0
Economic loss (P < ATC)→Firms exit→Market supply shifts left→Price rises→Loss shrinks to 0

Long-run equilibrium

P = MR = MC = minimum ATC: zero economic profit (a normal profit), and no reason to enter or leave. Lecture: entry takes the price $17 → $14.50 → $12 = min ATC.

What makes it work

Free entry and exit. A barrier to entry (a license cap, a costly plant) keeps new firms out, so economic profit can last.

Trap: profit does not lead one price taker to raise its price. Profit changes the number of firms.
PRACTICE D5
Unit 8b · checklist practice D5

D5 · Entry, exit and the long run

Microgreens catch on with restaurants. Growers in this competitive market earn positive economic profit.

a. What happens over time? Trace the steps.

1New growers enter (free entry)
2Market supply shifts right
3The price falls
4Profit shrinks until P = min ATC: zero economic profit

b. A county rule caps the number of growers' licenses. Can economic profit last in the long run now? Why?

Yes. The cap is a barrier to entry: new growers cannot enter, so nothing pushes the price down to min ATC.

c. Suppose instead growers were losing money. What happens in the long run?

Some growers exit when their commitments expire; supply shifts left; the price rises until the remaining growers earn zero economic profit.
Before Friday

What belongs on your 4×6 card

Unit 6

  • Ed = %ΔQ ÷ %ΔP, midpoint bases
  • Elastic: P and TR opposite; inelastic: same direction
  • Es > 0; the less elastic side bears more tax

Unit 7

  • MU = ΔTU
  • Best bundle: MUX/PX = MUY/PY, budget spent
  • Price ↑: substitution (away from it) + income (less of normal goods)

Unit 8a

  • FC = TC at Q = 0; VC = TC − FC
  • MC = ΔTC; ATC = TC ÷ Q; AVC = VC ÷ Q
  • Fixed cost moves AFC, ATC only

Unit 8b

  • Price taker: P = MR; produce while MC ≤ P
  • P vs. min ATC: profit? P vs. min AVC: operate?
  • Economic profit = accounting profit − implicit costs; long run: P = min ATC
Write one worked table on the back: a TC table with FC, VC, MC and ATC, and the stopping rule MC ≤ P.
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