Chapter 7 - Production, Costs, and Industry Structure

Key questions a firm must consider regarding production

• What product(s) to produce

• how to produce them

• how much output to produce

• what price to charge

• how much labor to employ

Formula for accounting profit?

Total revenue minus explicit costs.

Formula for economic profit?

Total revenue minus total costs (explicit costs plus implicit costs).

Explicit costs

Out-of-pocket costs, including wages, rents, and payments for supplies.

Implicit costs

Opportunity costs of resources already owned by the firm that could be used for another productive purpose.

Factors of production in a business like Whataburger

• Natural resources - (land, beef,potatoes)

• Labor - (cooks, cashiers)

• Capital - (grills,deepfryers)

• Technology - (how hot and how long to cook fries)

• Entrepreneurship - (decisions that the franchise makes on how to run the business)

Difference between short run and long run production?

In the short run, at least some factors of production are fixed; in the long run, all factors are variable.

Diminishing marginal product

The principle that as a firm increases the number of one type of input, the additional output produced eventually declines.

Fixed costs

Costs of _____ inputs that do not change in the short run.

Variable costs?

Costs of _______ inputs that can change in the short run.

Average total cost measures the cost per unit of output.

What does average total cost (ATC) measure?

MC intersects ATC at its minimum point.

What is the relationship between marginal cost (MC) and average total cost (ATC)?

AFC are sunk costs that should be ignored when making decisions.

What is the importance of average fixed costs (AFC)?

The long run average cost of production decreases as total output increases.

What are economies of scale?

The long run average cost of producing output increases as total output increases.

What are diseconomies of scale?

The long run average cost of production does not change as total output increases.

What are constant returns to scale?

How does the LRAC curve determine the number of firms in an industry?

It indicates how many firms can operate efficiently at a given output level.

10 pizza restaurants (1,000/100).

If the market for pizzas has an equilibrium quantity of 1,000 pizzas per day and LRAC is minimized at 100 pizzas per day, how many pizza restaurants will there be?

There will be 1 pizza restaurant in Brownsville.

What happens when the LRAC is minimized at 1,000 pizzas per day in a monopoly situation?

The additional output produced by one more unit of labor.

What is the marginal product (MP) of labor?

Initially increases efficiency but eventually leads to diminishing marginal productivity.

What is the impact of adding more workers in the short run?

It determines the most efficient methods for production and operational processes.

What is the role of technology in production?

AVC represents the variable costs per unit of output and can be reduced in the short run.

What is the significance of the average variable cost (AVC)?

AVC is always below ATC, and the distance between them represents average fixed costs.

What is the relationship between AVC and ATC?

It indicates that the firm is experiencing economies of scale before reaching the minimum ATC.

What is the implication of MC increasing while ATC is still decreasing?

f[NR,L,K,T,E]

f[L,K]

The Production Function Equation and the Shorthand Equation

additional output from one more unit of an input

change in Total Product

change in Labor

Marginal Products Definition and Forumla

Total Costs

Total Product

Average Costs Formula

change in Total Costs

change in Total Product

Marginal Costs Formula

Profit

Loss

If Price > ATC, the firm is making a ______

If Price < ATC, the firm is making a _______

PROFITABLE

NOT PROFITABLE

If MR>MC, it is ____________ to produce an additional unit

If MR<MC, it is ____________ to produce an additional unit