Production, Costs, and Market Structures Overview

Explicit costs

Require an outlay of money.

Implicit costs

Do not require cash outlay.

Accounting profit

Total revenue minus total explicit costs.

Economic profit

Total revenue minus total cost.

Production function

Shows the relationship between the quantity of inputs used to produce a good and the quantity of output of that good.

Marginal product

The increase in output arising from an additional unit of that input, holding all other inputs constant.

Marginal product of labor (MPL)

Calculated as 𝚫Q/𝚫L.

Diminishing Marginal Product

The marginal product of an input declines as the quantity of the input increases, holding other things equal.

Fixed costs (FC)

Do not vary with the quantity of output produced.

Variable costs (VC)

Vary with the quantity produced.

Total cost (TC)

Calculated as FC + VC.

Average total cost (ATC)

Total cost divided by the quantity of output, ATC = TC/Q.

Marginal Cost (MC)

The increase in total cost from producing one more unit, MC = 𝚫T/𝚫Q.

Efficient scale

The quantity that minimizes ATC.

Minimum efficient scale (MES)

Where the marginal cost (MC) curve intersects the average total cost (ATC) curve.

Diseconomies of scale

Occurs when ATC rises as Q increases.

Economies of scale

Occurs when ATC falls as Q increases.

Constant returns to scale

Occurs when ATC stays the same as Q increases.

Short run

Some inputs are fixed; the costs of these inputs are FC.

Long run

All inputs are variable.

Marginal Revenue (MR)

Calculated as 𝚫TR/𝚫Q.

Profit maximization

Occurs where MR = MC.

Loss minimization

Occurs at the output level where MR equals MC, as long as the price is above the minimum average variable cost (AVC).

Short-run supply curve

The portion of its marginal cost (MC) curve that lies above its average variable cost (AVC) curve.

Long-run supply curve

The portion of the MC curve that lies above its average total cost (ATC) curve.

Long-run equilibrium

The process of entry or exit is complete - remaining firms earn zero economic profit.

Zero economic profit

Occurs when P=ATC.

Zero profit condition

P = MC = ATC.

Perfectly competitive market efficiency

Achieves both productive efficiency and allocative efficiency.

Monopoly

A firm that is the sole seller of a product without close substitutes.

Market power

The ability to influence the market price of the product it sells.

Barriers to Entry

Factors that prevent new firms from entering the market.

Natural monopoly

A single firm can produce the entire market Q at lower cost than could several firms.

Marginal Revenue (MR)

The additional revenue that will be generated by increasing product sales by one unit.

Price setter

A firm that has the ability to set the price of its product.

Deadweight Loss

The loss of economic efficiency that occurs when the equilibrium outcome is not achievable or not achieved.

Competitive equilibrium

Quantity = QC, P=MC, total surplus is maximized.

Monopoly equilibrium

Quantity = QM, P > MC, resulting in deadweight loss.

Price Discrimination

Selling the same good at different prices to different buyers based on willingness to pay.

Perfect Price Discrimination

When the monopolist produces the competitive quantity but charges each buyer his or her WTP.

Antitrust laws

Laws that promote competition and prevent monopolies.

Monopolistic Competition

A market structure where many firms sell similar but not identical products.

Excess Capacity

The monopolistic competitor operates on the downward sloping part of its ATC curve, producing less than cost-minimizing output.

Markup over marginal cost

Under monopolistic competition, P > MC; under perfect competition, P = MC.

Oligopoly

A market structure in which only a few sellers offer similar or identical products.

Cartel

A group of firms acting in unison that colludes to form a monopoly.

Nash Equilibrium

A situation in which economic participants interacting with one another each choose their best strategy given the strategies that all the others have chosen.

Prisoner's Dilemma

A game between two captured criminals that illustrates why cooperation is difficult even when it is mutually beneficial.

Dominant Strategy

A strategy that is best for a player in a game regardless of the strategies chosen by the other players.