Chapter 8: The Costs of Production

Opportunity cost

Value of resource in best alternative use

Explicit costs

Monetary payments for use of resources owned by others

Normal profit

Cost of doing business

Economic profit

Total revenue - economic costs

Short run

Period too brief for firm to alter plant capacity, but long enough to change resources like hourly labor, raw materials, etc.

Long run

Period long enough to change quantities of all resources it employs, including plant capacity

Total product (TP)

Total output of good/service produced

Marginal product (MP)

Extra output of product with adding unit of variable resource

Average product (AP)

Output per unit of labor input

Law of diminishing returns

Successive units of variable resource added to fixed resource → Marginal product for each additional unit of variable resource will decline

Fixed costs

Aren’t affected by changes in output

Variable costs

Costs that change w/ level of output

Total cost

Total fixed costs + total variable costs

Average fixed cost (AFC)

Total fixed cost / output

Average variable cost (AVC)

Total variable cost / output

Average total cost (ATC)

Total cost / output

Marginal cost

Extra cost of producing one more unit of output

Economies of scale

Down-sloping part of long run ATC curve; as plant size increases, a number of factors will for a time lead to lower average costs of production

Diseconomies of scale

Difficulty of efficiently controlling and coordinating a firm’s operations as it becomes a large-scale producer

Constant returns to scale

Long run average cost doesn’t change

Minimum efficient scale (MES)

Lowest level of output at which a firm can minimize long-run average costs

Natural monopoly

Average total cost is minimized when only one firm produces the particular good or service