Unit 3: Production Costs, Profit, and Perfect Competition

Fixed Input

input whose quantity is fixed for a period of time

ex. 10 acres of land

Variable Input

input whose quantity the firm can vary at any time

ex. workers

Short Run

time period in which at least one input is fixed

Long Run

time period in which all inputs can be varied, no fixed resources

Total Production

total output or quantity produced

Total Product Curve

quantity of output depends on quantity of variable input, for a given quantity of fixed input

Marginal Product

additional quantity of output that is produced using one or more unit of input

when 0 = total product at maximum

when negative = total product is declining

How to find marginal product

percent change in quantity of output / percent change in quantity of labor

Average Product

measures the productivity with a particular number of workers

How to find average product

total product / quantity of workers

Law of Diminishing Marginal Returns

an increase in a specific input leads to a decline in the marginal product of that input

only true in the short run

3 Stages of Return (based on marginal product)

Increasing, diminishing, negative

Fixed Cost

cost that does not depend on the quantity of output produce

ex. rent, insurance

Variable Cost

cost that depends on the quantity of output produced

ex. wages, raw materials

Total Costs

fixed costs + variable costs

Marginal Cost

cost of producing 1 or more unit of output

change in total cost / change in output

Average Total Cost

total cost / quantity of output

sum of FC and VC

Average Fixed Cost

Fixed cost / quantity

Average Variable Cost

Variable cost / quantity of output

Minimum Cost Output

quantity of output at which the average total cost is lowest

bottom of the U-shaped ATC

Long Run Average Total Cost

shows relationship between output and average total cost when fixed cost is chosen to minimize average total cost for each level of output

Economies of Scale

when long-run average total cost declines as output increases

first half of LRATC curve

Increasing Returns to Scale

when output increases more than in proportion to an increase in all inputs

ex. doubling inputs more than doubles the output

Minimum Efficient Scale

smallest quantity at which a firm’s long-run average total cost is minimized

Diseconomies of Scale

when long-run average total cost increases as output increases

second half of LRATC curve

Decreasing Returns to Scale

when output increases less than in proportion to an increase in all inputs

Constant Returns to Scale

when output increases directly in proportion to an increase in all inputs

Explicit Costs

cost that involves out of pocket expenses

fixed + variable costs

Total Revenue

Price x Quantity

Total Accounting Profit

Total Revenue - Explicit costs

Implicit Cost

opportunity cost, benefits that are forgone

Economic Profit

Total Revenue - (explicit costs + implicit costs)

positive = best use of resources

negative = there is a better alternative

Normal Profit

economic profit equal to 0; economic profit just high enough to keep a firm engaged in its current activity

Profit/Loss

Total Revenue - Total Cost

Marginal Revenue

change in total revenue generated by an additional unit of output

change in total revenue / change in quantity

Profit Maximizing Rule

profit is maximized by producing the quantity of output at which the MR of the last unit produced is equal to is MC 

MR = MC or last unit where MR > MC

Market Structure

a classification that describes the nature and degree of competition among firms in the same industry 

Price Takers

a firm whose actions have no effect on the market price of the good/service

Market Share

a single firm or a group of firms cannot account for the majority of sales in the market

Perfect Competition Characteristics

many firms, identical products, price takers, low barriers to entry

Shutdown Point

where MC meets minimum AVC

Break Even Point

where MC meets minimum ATC

Shut down rule in the short run

TR < VC < TC

Profit/breaking even in the short run

TR > TC or TR = TC

Stay open but operate at a loss in the short run

VC < TR < TC

Productive Efficiency

production of a good in a least costly way (minimum amount of resources used)

Price = Minimum ATC

Allocative Efficiency

producers are allocating resources to make the products most wanted by society

Price = Marginal Cost