Businesses and the Costs of Production (Economics Notes)

Flashcards focus on core vocabulary and definitions from the lecture notes on costs of production, short-run vs long-run concepts, production functions, and cost curves.

Economic costs

The payments required to obtain and retain the services of resources; includes explicit costs and implicit costs.

Explicit costs

Monetary payments for resources owned by others (non-owners’ resources).

Implicit costs

The value of the next best alternative use of self-owned resources; includes the opportunity cost of entrepreneurial effort (normal profit).

Normal profit

The opportunity cost of using entrepreneurial abilities in production; part of implicit costs.

Total Revenue

The total receipts a firm earns from selling its output.

Accounting profit

Total Revenue minus Explicit Costs.

Economic profit

Total Revenue minus Economic Costs (Explicit plus Implicit Costs); equals Total Revenue minus all opportunity costs.

Economic costs

Sum of Explicit and Implicit costs used to assess true profitability.

Short Run

A period with some fixed inputs (fixed plant) and some variable inputs.

Long Run

A period in which all inputs are variable; firms can change plant size and enter or exit the market.

Fixed plant

Capital inputs that cannot be easily changed in the short run.

Variable inputs

Inputs whose quantities can be changed in the short run (e.g., labor, materials).

Total Product (TP)

Total output produced with a given set of inputs.

Marginal Product (MP)

The change in Total Product when an additional unit of a variable input (e.g., labor) is used.

Average Product (AP)

Total Product divided by the units of the variable input (TP/L).

Law of Diminishing Returns

With fixed inputs, adding more of a variable input eventually yields smaller MP.

Total Cost (TC)

The sum of Total Fixed Cost and Total Variable Cost (TC = TFC + TVC).

Fixed Costs (TFC)

Costs that do not vary with output in the short run.

Variable Costs (TVC)

Costs that vary with the level of output.

Average Fixed Cost (AFC)

TFC divided by quantity (AFC = TFC/Q).

Average Variable Cost (AVC)

TVC divided by quantity (AVC = TVC/Q).

Average Total Cost (ATC)

TC divided by quantity (ATC = TC/Q).

Marginal Cost (MC)

The change in Total Cost from producing one more unit (MC = ΔTC/ΔQ).

Long-Run Average Cost Curve (LRATC)

The envelope of short-run ATC curves; shows costs when all inputs are variable.

Economies of Scale

Cost advantages from increasing all inputs; lower average costs as output grows.

Diseconomies of Scale

Higher average costs as a firm becomes too large due to coordination/communication problems.

Constant returns to scale

A situation where increasing inputs leads to proportional increases in output, with no change in average costs.

Minimum Efficient Scale (MES)

The smallest output level at which long-run average costs are minimized; helps determine industry structure.

Sunk costs

Costs that have already been incurred and cannot be recovered; should be ignored in current decisions.

Long-run ATC vs short-run ATCs

LRATC is the envelope of all SRATCs; in the long run, inputs are variable and firms can adjust plant size.