Short Run Production Costs Terminology

Define the law of diminishing marginal returns

As more units of variable inputs are combined with fixed inputs, there is a point beyond which the additional input from additional units of the variable factor will eventually diminish. 

Total Fixed Costs (TFC)

Costs that do not vary with output

Total Variable Costs (TVC)

Costs that vary directly with level of output

• if output rises, TVC rises proportionately 

• If output is 0, TVC=0

Total Cost (TC)

Sum of total fixed & variable costs

TFC + TVC

Average Fixed Cost (AFC)

Fixed cost per unit output; TFC/Quanity

Average Variable Cost (AVC)

Variable cost per unit output (TVC/Quanity)

Average Cost (AC or ATC) 

Cost per unit of output (AC = AFC + AVC) 

Marginal Cost (MC)

The additional cost of producing one more unit of output.

MC = ΔTC/ΔQ; where ΔTC is TFC + TVC

Explicit Costs

Out of pocket expenditure

Implicit Costs

Costs that do not involve any direct payment of money to a third party but involves a sacrifice made by the firm. E.g. opportunity costs

Total Revenue (TR)

The amount of money received by a firm from the sale of a given level of output. 

TR = Price (P) x Quantity (Q)

Average Revenue (AR)

Amount of money a firm received per unit of output sold over a given time period. If price of output is constant, then the average revenue is the same price as the good.

AR = TR/Quantity = Price (P)

Marginal Revenue (MR)

The additional revenue gained by selling one more unit of output per unit period of time

MR = ΔTR/ΔQ

Total profit 

Total revenue - total cost

Accounting Profit

Total revenue - explicit costs only)

Total Costs

Explicit + Implicit costs

Economic Profit

Total revenue - (implicit + explicit costs)

Normal Profits

Zero economic profit (TR = TC)

Supernormal Profits

Positive economic profit (TR - TC > 0)

Profit in excess of normal profit

Subnormal profits

Negative economic profit (TR - TC < 0)

A loss is made

Marginalist Principle 

MR = MC is the output where the firm will maximise their profits.

MR — The extra revenue a firm earns from selling one additional unit of output. Should continue production to ensure the most of the revenue earned (profit yet to be maximised; could be more)

MC — The additional cost of producing one more unit of output. Should decrease output to deter further losses.