Principles of Microeconomics - Production and Costs

Profit formula

Profit = Total revenue (TR) - Total cost (TC)

Total revenue formula

Total Revenue = Price (P) x Quantity (Q)

Total cost meaning

Total opportunity cost - the cost of the next best alternative that has to be given up in order to have something else

Implicit costs meaning

Input costs that do not require expenditure of money by the firm

Explicit costs meaning

Inputs that require expenditure of money by the firm

Why worry about opportunity costs?

Because resources can only be in their best use if they are covering the cost of the next best use

When is it worth starting a firm?

If starting the firm results in the firm bringing in an economic profit of £0 pa

What is the production function

The way inputs are combined to produce output

What are firm outputs?

Output (Q), Capital (K), Labour (L)

Production function

Q = 𝑓(L)

Average product of labour (APL) formula

APL = Q ÷ L

Marginal Product of Labour (MPL) meaning

The change in output caused by a change in labour output

MPL formula when change in L is discrete

MPL = Δ𝑄 ÷ Δ𝐿

MPL formula when change in L is continuous

dQ/dL

• Derived from the Production function

What is MPL graphically?

The slope of the production function

How can we use the quotient rule to show how APL changes with L?

𝑑𝐴𝑃/𝑑𝐿 = (𝐿 (𝑑𝑄/𝑑𝐿) − 𝑄) / 𝐿² = (𝑀𝑃𝐿 − 𝐴𝑃𝐿) / 𝐿

Interpret 𝑑𝐴𝑃/𝑑𝐿

• 𝑑𝐴𝑃/𝑑𝐿 > 0 (i.e. APL is rising) when MPL > APL

• 𝑑𝐴𝑃/𝑑𝐿 < 0 (i.e. APL is falling) MPL< APL

• 𝑑𝐴𝑃/𝑑𝐿 = 0 (i.e. APL is constant) MPL = APL

Fixed Costs (FC) meaning

Costs that do not vary with output

Variable Costs (VC) meaning

Costs that vary with output

Total costs (TC) meaning

The total costs of production

Total costs formula

TC = FC + VC

Average fixed cost (AFC)

AFC = FC/Q

Average variable cost (AVC)

AVC = VC/Q

Average total cost (ATC)

ATC = (FC + VC) / Q = AFC + AVC