Business and the Costs of Production Practice Flashcards

Comprehensive vocabulary flashcards covering economic costs, market structures (Pure Competition, Monopoly, Monopolistic Competition, Oligopoly), and production efficiencies based on the lecture notes.

Economic Cost

• The payment that must be made to obtain and retain the services of a resource

• the total true cost of a decision

• implict + explicit costs

• ex. starting a business vs. taking job offer

Explicit Costs

• the monetary payments it takes to purchase resources from others

• opportunity costs because any amount of money that the firm uses to purchase a particular resource X is money that could have been used to purchase alternative resources

Implicit Costs

The opportunity costs of using self-owned resources; these include a normal profit (rather than selling those resources to outsiders)

Accounting Profit

$$Accounting Profit = Revenue - Explicit Costs$$

Economic Profit

$Economic Profit = Accounting Profit - Implicit Costs$, or $Total Revenue - Economic Costs$.

Normal Profit

• The level of profit where economic profit equals $0$; it represents the payment necessary to cover the firm's next best alternative.

• minimum amount of profit needed to keep the business running

Short Run

A period of time where some inputs are variable but at least one factor of production is fixed

Long Run

A period of time where all inputs are variable and firms can adjust plant size or enter and exit an industry.

Marginal Product (MP)

$$MP = \frac{\text{Change in Total Product}}{\text{Change in Labor Input}}$$

Average Product (AP)

$$AP = \frac{\text{Total Product}}{\text{Units of Labor}}$$

Law of Diminishing Returns

• when you increase one factor of production (like hiring more workers or buying more machines) while keeping other factors constant (like workspace), each additional unit will eventually yield a progressively smaller increase in overall output

• ex. 1st Worker: Can bake 10 loaves of bread.

  • 2nd Worker: Helps prep dough, boosting production to 25 loaves.

  • 5th Worker: Now the oven is constantly full, and workers start bumping into each other waiting for space. Adding this worker only increases production by 2 loaves.

Fixed Costs (TFC)

Costs that do not vary with changes in output.

• ex. rent, salaries, equipment financing

Variable Costs (TVC)

Costs that change directly with output level.

ex. raw materials (flour, sugar), direct labor, shipping/packaging

Total Cost (TC)

$$TC = TFC + TVC$$

Average Fixed Cost (AFC)

$$AFC = \frac{TFC}{Q}$$

Average Variable Cost (AVC)

$$AVC = \frac{TVC}{Q}$$

Average Total Cost (ATC)

$$ATC = \frac{TC}{Q}$$

Marginal Cost (MC)

$$MC = \frac{\text{Change in TC}}{\text{Change in Q}}$$

Economies of Scale

Factors that cause a producer's average cost of production to fall as output increases.

Diseconomies of Scale

Factors that cause average costs of production to rise as output increases, often due to control and coordination problems.

Minimum Efficient Scale (MES)

The lowest level of output at which long-run average costs are minimized.

Natural Monopoly

An industry where long-run costs are minimized when only one firm produces the product.

Pure Competition

A market structure characterized by a very large number of sellers, standardized products, price takers, and free entry and exit.

Price Takers

Individual sellers in pure competition who have no control over the market price and must accept it as given.

Total Revenue (TR)

$$TR = P \times Q$$

Marginal Revenue (MR)

The extra revenue derived from selling one additional unit, calculated as $\frac{\text{Change in TR}}{\text{Change in Q}}$.

Profit Maximization Rule

The rule stating a firm should produce up to the point where $MR = MC$.

Break-even Point

An output level at which a firm makes a normal profit but zero economic profit.

Productive Efficiency

The condition where goods are produced at the lowest possible cost, occurring where $P = \text{minimum ATC}$.

Allocative Efficiency

The product mix of goods most highly valued by society, achieved where $P = MC$.

Creative Destruction

The process where innovation and the creation of new products or methods destroy old products and methods.

Pure Monopoly

A market structure where a single firm is the sole producer of a unique product with no close substitutes and entry is blocked.

Barriers to Entry

Factors such as economies of scale, legal barriers (patents/licenses), and resource ownership that prevent firms from entering an industry.

X-inefficiency

Occurs when a firm's actual cost of producing any output is greater than the lowest possible cost because competitive pressure is absent.

Rent-seeking Behavior

Activities designed to transfer income or wealth to a particular firm or resource supplier at someone else's or society's expense, such as seeking government-granted monopolies.

Socially Optimal Price

The price determined by the intersection of the demand curve and the marginal cost curve ($P = MC$), achieving allocative efficiency.

Fair Return Price

The price determined by the intersection of the demand curve and the average total cost curve ($P = ATC$), yielding a normal profit.

Price Discrimination

The practice of charging different buyers different prices for the same good when price differences are not justified by cost differences.

Monopolistic Competition

A market model involving a relatively large number of sellers, product differentiation, and easy entry and exit.

Product Differentiation

A strategy where firms provide products that are close substitutes but not perfect substitutes, creating non-price competition.

4-firm Concentration Ratio (CR)

The percentage of total sales in an industry accounted for by the four largest firms, where a ratio over $40\%$ often indicates an oligopoly.

Herfindahl Index (HI)

The sum of the squared market shares of all firms in an industry; a lower HI indicates more competition.

Excess Capacity

The amount by which actual output falls short of the output at which ATC is minimized, often seen in monopolistic competition.

Oligopoly

A market dominated by a few large producers of either standardized or differentiated products.

Mutual Interdependence

A situation where each firm's profit depends not only on its own price and sales but also on those of the other firms in the industry.

Game Theory

The study of how people or firms behave in strategic situations where they must consider the potential actions of rivals.

Cartel

A formal agreement among producers to set prices and individual output levels to increase industry profits; examples include OPEC.

Price Leadership

An oligopoly model where a dominant firm initiates price changes and other firms follow.

Limit Pricing

The practice of setting a price below the profit-maximizing level to block the entry of new firms.

Kinked-demand Curve

A model of non-collusive oligopoly where rivals match price decreases but ignore price increases, explaining price inflexibility.