unit 3: production, costs, & perfect competition models

Economic Cost

A payment that must be made to obtain and retain the services of a resource; the income a firm must provide to a resource supplier to attract the resource away from an alternative use; equal to the quantity of other products that cannot be produced when resources are instead used to make a particular product

Explicit Cost

The monetary payment a firm must make to an outsider to obtain a resource.

Implicit Cost

The monetary income a firm sacrifices when it uses a resource it owns rather than supplying the resource in the market; equal to what the resource could have earned in the best-paying alternative employment; includes a normal profit

Short Run Time

(1) In microeconomics, a period of time in which producers are able to change the quantities of some but not all of the resources they employ; a period in which some resources (usually plant) are fixed and some are variable

Long Run Time

In microeconomics, a period of time long enough to enable producers of a product to change the quantities of all the resources they employ; period in which all resources and costs are variable and no resources or costs are fixed

Law of Diminishing Returns

The principle that as successive increments of a variable resource are added to a fixed resource, the marginal product of the variable resource will eventually decrease

Total Product

The total output of a particular good or service produced by a firm (or a group of firms or the entire economy).

Marginal Product

The additional output produced when 1 additional unit of a resource is employed (the quantity of all other resources employed remaining constant); equal to the change in total product divided by the change in the quantity of a resource employed

Average Product

The total output produced per unit of a resource employed (total product divided by the quantity of that employed resource)

Average Variable Cost

A firm’s total variable cost divided by output (the quantity of product produced)

Average Total Cost

A firm’s total cost divided by output (the quantity of product produced); equal to average fixed cost plus average variable cost

Marginal Cost

The extra (additional) cost of producing 1 more unit of output; equal to the change in total cost divided by the change in output (and, in the short run, to the change in total variable cost divided by the change in output)

Fixed Cost

Any cost that in total does not change when the firm changes its output; the cost of fixed resources

Variable Cost

A cost that in total increases when the firm increases its output and decreases when the firm reduces its output

Total Cost

The sum of fixed cost and variable cost

Profit Maximizing

the process where a firm determines the output level and price to yield the highest possible profit, achieved by setting marginal revenue (MR) equal to marginal cost (MC)

Break Even Point

The level of output at which the costs of production equal revenue

Loss-Minimizing

microeconomic firms adjusting output to make losses as small as possible when price is below average total cost but above average variable cost

Herfindahl Index

A measure of the concentration and competitiveness of an industry; calculated as the sum of the squared percentage market shares of the individual firms in the industry

Economies of Scale

Reductions in the average total cost of producing a product as the firm expands the size of plant (its output) in the long run; the economies of mass production

Diseconomies of Scale

Increase in the average total cost of producing a product as the firm expands the size of its plant (its output) in the long run

Constant returns to Scale

if all inputs are increased by a certain proportion, the total output increases by the exact same proportion

Increasing-cost Industry

An industry in which expansion through the entry of new firms raises the prices firms in the industry must pay for resources and therefore increases their production costs

Decreasing-cost industry

An industry in which expansion through the entry of firms lowers the prices that firms in the industry must pay for resources and therefore decreases their production costs

Constant-cost Industry

An industry in which expansion by the entry of new firms has no effect on the prices firms in the industry must pay for resources and thus no effect on production costs

Short-run Supply Curve

A supply curve that shows the quantity of a product a firm in a purely competitive industry will offer to sell at various prices in the short run; the portion of the firm’s short-run marginal cost curve that lies above its average variable cost curve

Long-run Supply Curve

A schedule or curve showing the prices at which a purely competitive industry will make various quantities of the product available in the long run

Normal Profit

The payment made by a firm to obtain and retain entrepreneurial ability; the minimum income entrepreneurial ability must receive to induce it to perform entrepreneurial functions for a firm

Accounting Profit

A company’s total revenue minus its explicit costs (direct expenses)

Economic Profit

The total revenue of a firm less its economic costs (which include both explicit costs and implicit costs); also called “purse profit” and “above-normal profit”

Marginal Revenue

The change in total revenue that results from the sale of 1 additional unit of the firm’s product; equal to the change in total revenue divided by the change in the quantity of the product sold.

Average Revenue

Total revenue from the sale of a product divided by the quantity of the product sold (demanded); equal to the price at which the product is sold when all units of the product are sold at the same price

Pure (Perfect) Competition

A market structure in which a very large number of firms sells a standardized product, into which entry is very easy, in which the individual seller has no control over the product price, and in which there is no nonprice competition; a market characterized by a very large number of buyers and sellers

Price Taker

A seller (or buyer) of a product or resource that is able to affect the product or resource price by changing the amount it sells (or buys)

MR (P) = MC Rule

The principle that a firm will maximize its profit (or minimize its losses) by producing the output at which marginal revenue and marginal cost are equal, provided product price is equal to or greater than average variable cost.

Shut Down

The circumstance in which a firm would experience a loss greater than its total fixed cost if it were to produce any output greater than zero; alternatively, a situation in which a firm would cease to operate when the price at which it can sell its products is less than its average variable cost