Chapter 9 Businesses and The Costs of Production

What’re fixed costs? What’re variable costs?

Fixed Costs: Costs that don’t vary with output (costs that stay the same- i.e, rent)

Variable Costs: Costs that do vary with output (costs that change- i.e, gas, electric, etc.)

What’re explicit costs?

Out of pocket costs for a firm

• Payment of salaries, wages, utilities, rent, etc.

What’re implicit costs?

An opportunity cost: the cosy of resources already owned by the firm that could have been put to some other use. (Includes a normal profit)

• I.e: An entrepreneur who owns a business could use her labor to earn income at a job

What’s the formula for accounting profit?

Revenue - Explicit Costs

What’s the formula for Economic Profit?

Revenue - Explicit Costs - Implicit Costs (economic costs)

What’s true about economic profit in relation to accounting profit?

It’s always smaller than accounting profit

Whats Normal Profit?

Returns to an entrepreneur, the amount of money required for a entrepreneur to stay in a specific market.

What’s the “short run”? What’re it’s characteristics?

A period of time that’s too shirt for a firm to alter its plant capacity. But the firm can alter output by adjusting their inputs

• Some variable inputs

• Fixed plant

What’s the “long run”? What’re it’s characteristics?

A period of time that’s long enough for the firm to adjust its plant size or enter/ exit the industry

• All inputs are variable

• Firms can adjust plant size and enter / exit the industry

• All costs are variable

What’re the short term production relationships and what’re the formulas?

• Total Product (TP): Total Quantity Produced

• Marginal Product (MP): change In total product / change in labor input

• Average Product (AP): Total product / units of labor

Law of Diminishing Returns

As increments of a variable resource are added to a fixed resource, the marginal product of the variable resource will decrease. (The more you add decreases efficiency because of over crowding)

• Resources are of equal quantity

• Technology is fixed

• Variable resources are added to fixed resources

• Marginal product will eventually fall

What’re the short run production costs:

• Fixed Costs (TFC): Costs that don’t vary with output

• Variable Costs (TVC): Costs that do vary with output

• Total Costs (TC): Sum of TFC and TVC

What’re the per unit or average costs? What’re the formulas?

1. Average Fixed Cost (AFC)(fixed costs per unit produced): TFC/Q

2. Average Variable Cost (AVC)(variable cost per unit produced): TVC/Q

3. Average Total Cost (ATC): TC/Q (can also be found by adding the AFC + AVC)

4. Marginal Cost (MC)(additional costs associated with producing one more unit of output): Change in total cost / Change in quantity

What’re economies of scale? What’re its characteristics

Large plants leading to lower unit costs

(A reduction in the per unit cost of production as the volume of production increases)

(an increase in inputs leads to a proportional increase in output)

1. Labor specialization

2. Managerial specialization

3. Efficient Capital

4. Other factors

What’re diseconomies of scale?

When the incremental per unit cost of production rises from an increase in production volume. Diseconomies of scale happen when a firm becomes too large. (Expansion leads to higher average total costs. Increases in inputs don’t match increases in outputs)

1. Control and coordination problems

2. Communication problems

3. Worker alienation

4. Shirking (work avoidance)

What’s the Minimum Efficent Scale (MES)

• Lowest level of output at which long run average costs are minimized

• Can determine the structure of the industry (determines if there will be more of new producers and if they will be large, small, or different sizes

What’s a Natural monopoly?

Long run costs are minimized when only one firm produces the product