Microeconomics- Chapter 10

What is the fundamental goal of a firm?

A: To maximize economic profit (total revenue – total cost, including opportunity cost).

Difference between accounting profit and economic profit?

A:

• Accounting profit = Total revenue – explicit (accounting) costs.

• Economic profit = Total revenue – (explicit + implicit opportunity costs).

Why do economists include opportunity costs in total cost?

A: Because they reflect the value of the next-best use of the firm’s resources.

What are the three types of opportunity costs in production?

A:

1. Resources bought in the market.

2. Resources owned by the firm.

3. Resources supplied by the owner.

Example of an opportunity cost for owned resources?

A: Forgone interest on capital or economic depreciation on machines.

What is normal profit?

A: The return to entrepreneurship that covers opportunity cost; it’s part of total cost.

Formula for economic profit?

A: Economic Profit = Total Revenue – Total Opportunity Cost.

What are the 5 key decisions firms make to maximize profit?

A:

1. What to produce and how much.

2. How to produce.

3. How to organize and compensate workers/managers.

4. How to market and price.

5. What to produce vs. what to buy.

Difference between short run and long run?

A:

• Short run: At least one factor is fixed (usually capital).

• Long run: All factors are variable; firms can change plant size.

What are sunk costs?

A: Past costs that cannot be recovered; irrelevant to current decisions.

Define total product (TP).

A: Total quantity of output produced with a given amount of labor.

Define marginal product (MP).

A: The additional output from employing one more unit of labor.
Formula: MP = ΔTP / ΔL

Define average product (AP).

A: Output per unit of labor.
Formula: AP = TP / L

What does the law of diminishing returns state?

A: As more of a variable factor is added to a fixed factor, MP eventually decreases.

What is the relationship between MP and AP?

A:

• When MP > AP, AP rises.

• When MP < AP, AP falls.

• MP = AP when AP is at its maximum.

What are the three short-run cost measures?

A: Total cost (TC), marginal cost (MC), and average cost (AC).

Define total cost (TC).

A: Sum of total fixed cost (TFC) and total variable cost (TVC).
Formula: TC = TFC + TVC

Define total fixed cost (TFC).

A: Cost of fixed factors; constant regardless of output.

Define total variable cost (TVC).

A: Cost of variable factors; changes with output.

Define marginal cost (MC).

A: The increase in total cost from producing one more unit of output.
Formula: MC = ΔTC / ΔQ

Define average fixed cost (AFC).

A: Fixed cost per unit of output.
Formula: AFC = TFC / Q

Define average variable cost (AVC).

A: Variable cost per unit of output.
Formula: AVC = TVC / Q

Define average total cost (ATC).

A: Total cost per unit of output.
Formula: ATC = TC / Q = AFC + AVC

Why is the MC curve U-shaped?

A:

• Falls initially due to specialization.

• Rises later due to diminishing returns.

Why is the ATC curve U-shaped?

A:

• Downward slope from spreading fixed cost.

• Upward slope from rising AVC due to diminishing returns.

Relationship between MC and ATC/AVC?

A:

• MC < ATC → ATC decreases.

• MC > ATC → ATC increases.

• MC = ATC → ATC at minimum.

How are product curves related to cost curves?

A:

• When MP rises → MC falls.

• When MP falls → MC rises.

• When AP rises → AVC falls.

• When AP falls → AVC rises.

What happens when technology improves?

A:

• Product curves shift upward.

• Cost curves shift downward.

What happens when input prices change?

A:

• ↑ Fixed input price → shifts TFC, AFC, TC upward.

• ↑ Variable input price → shifts TVC, AVC, MC upward.

What can vary in the long run?

A: Both capital and labor; all costs are variable.

What is the production function?

A: Relationship between maximum output and input quantities (labor and capital).

What is diminishing marginal product of capital?

A: As capital increases, extra output from each additional machine decreases (holding labor constant).

What does the LRAC curve show?

A: The lowest possible average cost of producing each output when the firm can vary all inputs.

How is LRAC derived?

A: From the lowest points of short-run ATC curves for different plant sizes.

Why is the LRAC curve typically U-shaped?

A: Due to economies and diseconomies of scale.

What are economies of scale?

A: When average cost decreases as output increases (due to specialization and efficiency).

What are diseconomies of scale?

A: When average cost increases as output increases (due to management complexity).

What are constant returns to scale?

A: When average cost remains constant as output increases.

What is the minimum efficient scale (MES)?

A: The smallest output level at which long-run average cost is minimized.

Why does MES matter for market structure?

A:

• Small MES → many firms → competitive market.

• Large MES → few firms → oligopoly/monopoly.