RAT 3 Topics

Implicit costs

The opportunity costs associated with a firm’s use of resources that it owns. These costs do not involve a direct money payment. Examples include wage income and interest forgone by the owner of a firm who also provides labor services and equity capital to the firm.

Explicit cost

Payments by a firm to purchase the services of productive resources.

Opportunity cost of equity capital

The rate of return that must be earned by investors to induce them to supply financial capital to the firm.

Economic profit

The difference between the firm’s total revenues and its total costs, including both the explicit and implicit cost components.

Accounting profit

The sales revenues minus the expenses of a firm over a designated time period, usually one year. Typically make allowances for changes in the firm’s inventories and depreciation of its assets. No allowance is made, however, for the opportunity cost of the equity capital of the firm’s owners, or other implicit costs.

Normal profit rate

Zero economic profit, providing just the competitive rate of return on the capital (and labor) of owners. An above-normal profit will draw more entry into the market, whereas a below-normal profit will lead to an exit of investors and capital.

Long run in production

A time period long enough to allow the firm to vary all of its factors of production.

Short run in production

A time period so short that a firm is unable to vary some of its factors of production. The firm’s plant size typically cannot be altered in the short run.

Total cost

The costs, both explicit and implicit, of all the resources used by the firm. Includes a normal rate of return for the firm’s equity capital.

Total fixed cost

The sum of the costs that do not vary with output. They will be incurred as long as a firm continues in business and the assets have alternative uses.

Total variable cost

The sum of those costs that rise as output increases. Examples are wages paid to workers and payments for raw materials.

Average fixed cost

Total fixed cost divided by the number of units produced. It always declines as output increases.

Average variable cost

The total variable cost divided by the number of units produced.

Average total cost

Total cost divided by the number of units produced.

It is sometimes called per-unit cost.

Marginal cost

The change in total cost required to produce an additional unit of output.

Law of diminishing returns

The postulate that as more and more units of a variable resource are combined with a fixed amount of other resources, using additional units of the variable resource will eventually increase output only at a decreasing rate. Once diminishing returns are reached, it will take successively larger amounts of the variable factor to expand output by one unit.

Average product

The total product (output) divided by the number of units of the variable input required to produce that output level.

Marginal product

The increase in the total product resulting from a unit increase in the employment of a variable input. Mathematically, it is the ratio of the change in total product to the change in the quantity of the variable input.

Total product

The total output of a good that is associated with each alternative utilization rate of a variable input.