M5: The Cost of Production

Law of Supply

firms are willing to produce and sell a greater quantity of a good when the price of the good is higher. This response leads to a supply curve that slopes upward.

Industrial Organizations

the study of how firms’ decisions about prices and quantities depend on the market conditions they face

How much output to supply, how to produce that output, How much of each input to demand

The behaviors of Profit-Maximizing Firms (3)

total revenue

the amount a firm receives for the sale of its output

PxQ

Total Revenue formula

total cost

the market value of the inputs a firm uses in production

profit

total revenue minus total cost

Total Revenue –Total Costs

Economic Profit Formula

economic profit

total revenue minus total cost, including both explicit and implicit costs

accounting profit

total revenue minus total explicit cost

Rate of return

is the annual flow of net income generated by an investment expressed as a percentage of the total investment.

normal rate of return

A __ is the rate that is just sufficient to keep owners and investors satisfied. If the rate of return were to fall below normal, it would be difficult or impossible for managers to raise resources needed to purchase new capital.

positive level of profit

When a firm earns a positive level of profit____, it is earning more than is sufficient to retain the interest of investors.

negative level of profit

When a firm suffers a ____—that is, when it incurs a loss—it is earning at a rate below that required to keep investors happy.

market price of output, techniques of production that are available, prices of inputs

In the language of economics, a firm needs to know three things (2):

optimal method of production

The production method that minimizes cost

short run

The period of time for which two conditions hold: The firm is operating under a fixed scale (fixed factor) of production, and firms can neither enter nor exit an industry

long run

That period of time for which there are no fixed factors of production: Firms can increase or decrease the scale of operation, and new firms can enter and existing firms can exit the industry

production technology

The quantitative relationship between inputs and outputs.

Labor intensive technology

Technology that relies heavily on human labor instead of capital.

Capital-intensive technology

Technology that relies heavily on capital instead of human labor.

production function

the relationship between the quantity of inputs used to make a good and the quantity of output of that good

marginal product

the increase in output that arises from an additional unit of input

diminishing marginal product

the property whereby the marginal product of an input declines as the quantity of the input increases

Fixed costs

are expenses that must be paid even if the firm produces zero output.

Variable costs

costs that do vary as output changes. Examples include materials required to produce output (such as steel to produce automobiles), production workers to staff the assembly lines, power to operate factories, and so on.

Marginal cost (MC)

denotes the extra or additional cost of producing 1 extra unit of output.

TC/Q

ATC formula

FC/Q

AFC formula

VC/Q

AVC Fomula

change in TC/change in Q

MC formula

rising MC, U-shaped ATC, relationship between MC and ATC

3 conclusions

Economies of scale

ATC in short run with small factory, left u

constant return to scale

ATC in short run with medium factory, middle u

diseconomies of scale

ATC in short run with large factory, right u