Econ ch 7 - theory of the firm

firm

An economic institution that transforms resources (factors of production) into outputs

sole proprietorship

A type of business structure where a single owner supervises and manages the business and is subject to unlimited liability

partnership

Similar to a sole proprietorship but involves more than one owner who shares the management of the business. Partnerships are also subject to unlimited liability

corporation

A business structure that has most of the legal rights of individuals and, in addition, can issue stock to raise capital. The owners’ (shareholders’) liability is limited to what they have invested in the company

profit

The difference between total revenue and total cost

total cost

The sum of all costs to run a business. To an economist, this includes both out-of-pocket expenses and opportunity costs

economic costs

The sum of explicit (out-of-pocket) and implicit (opportunity) costs

explicit costs

Those expenses paid directly to another economic entity, including wages, lease payments, taxes, and utilities

implicit costs

The opportunity cost of a firm’s resources used in the business. These costs are not directly paid to another entity.

accounting profit

The difference between total revenue and explicit costs. This profit is taxed by the government

economic profit

Profit in excess of a normal profit. This profit subtracts both explicit and implicit costs from total revenue

normal profits

The rate of return necessary to keep investors satisfied in the business over the long run. It is equal to zero economic profit

production

The process of converting resources (factors of production)—land, labor, capital, and entrepreneurial ability—into goods and services

marginal product

The change in output that results from a change in labor

average product

Output per worker, found by dividing total output by the number of workers employed to produce that output

increasing marginal returns

A new worker hired adds more to total output than the previous worker hired, so that both average product and marginal product are rising

diminishing marginal returns

An additional worker adds to total output, but at a diminishing rate.

fixed costs

Costs that do not change as a firm’s output expands or contracts, often called overhead

variable costs

Costs that vary with output fluctuations, including expenses such as labor and material costs.

marginal cost

The change in total cost arising from the production of one additional unit of output

average fixed cost (AFC)

Total fixed cost divided by output

average variable cost (AVC)

Total variable cost divided by output

average total cost

Total cost divided by output (TC ÷ Q). Average total cost is also equal to AFC + AVC

long run average total cost (LRATC)

In the long run, a firm can adjust its plant size. The __ curve shows the lowest unit cost at which any particular output can be produced in the long run.

economies of scale

As a firm’s output increases, its long-run average total cost decreases

constant returns to scale

As a firm’s output increases, its long-run average total cost is constant

diseconomies of scale

As a firm’s output increases, its long-run average total cost increases