Economics: Costs of Production and Firm Profit Maximization

Goal of a Firm

The main goal of a firm is to maximize profit.

Profit

Profit = Total Revenue (TR) − Total Cost (TC)

Total Revenue

Money earned from selling output.

Total Cost

Value of everything given up to produce that output.

Explicit Cost

Requires money payment (e.g., wages, rent, utilities).

Implicit Cost

No money payment; it's opportunity cost (e.g., owner's time, income they gave up).

Accounting Profit

TR - Explicit Costs.

Economic Profit

TR - (Explicit + Implicit Costs); usually smaller than accounting profit.

Production Function

Shows how input affects output.

Marginal Product (MP)

Change in output from one more unit of input.

Stages of Marginal Product

Describes the effect on output as more workers are added.

Increasing Marginal Returns

Extra workers help → efficient; output rises faster.

Diminishing Marginal Returns

Too many workers share tools/space; output still rises but slower.

Negative Marginal Returns

Workers get in each other's way; output falls.

Fixed Cost (FC)

Does NOT change with output (e.g., rent).

Variable Cost (VC)

Changes with output (e.g., supplies, labor).

Total Cost (TC)

TC = FC + VC.

Average Fixed Cost (AFC)

AFC = TFC / Q.

Average Variable Cost (AVC)

AVC = TVC / Q.

Average Total Cost (ATC)

ATC = TC / Q = AFC + AVC.

Marginal Cost (MC)

MC = ΔTC / ΔQ.

Important Relationship

When MC < ATC → ATC is falling; when MC > ATC → ATC is rising.

Shapes of Cost Curves

MC curve rises (because of diminishing returns); ATC is U-shaped.

Short Run vs Long Run

Short Run: Some inputs are fixed; Long Run: All inputs are variable.

Economies of Scale

ATC falls as output increases (bigger = cheaper per unit).

Constant Returns to Scale

ATC does not change with output.

Diseconomies of Scale

ATC rises as output increases (too large to manage efficiently).