Studied by 14 people
Production
The process by which a producer takes inputs (factors of production) and creates an output
Fixed Costs
The costs that aren’t affected by the quantity produced
Examples:
Rent
Variable Costs
The costs that are affected by the quantity produced
Examples:
Tomatoes to make pizza sauce
Total Revenue
Total amount of money a firm brings in
TR = P * Q
Accounting Profit
The amount of money a business makes
Just explicit costs
Economic Profit
Profit, including the opportunity cost
Explicit and implicit costs
Total Product (TP)
How much a firm outputs in total
Example: 2 workers produce 50 units, total is 50
Average Product (AP)
Divides total product by number of inputs
Example: 2 workers produce 50 units, average is 25
Marginal Product (MP)
Additional output from adding one more input
Helps us determine when we should stop adding more inputs - zero or negative, we stop
Example: 2 workers produce 50 units, 3 workers produce 60 units - the 3rd worker’s MP was 10 units
Law of Diminishing Marginal Product
As we add more inputs, the additional product produced we get from each input will eventually diminish
Returns to Scale
Proportional increase in output from an increase in inputs
Production doubles when input doubles
Increasing Returns to Scale
Production more than doubles with doubled input
Decreasing Returns to Scale
Production less than doubles with doubled input
Short-Run
Period of time where at least one input is fixed and cannot change
Long-Run
Period of time where no variables are fixed
Accounting Costs
Explicit costs paid by firms to use resources during the production process
Economic Costs
Sum of both the implicit costs (opportunity costs) and explicit costs of production
Total Cost
Total cost of producing some quantity of output
Sum of the variable and fixed costs
TC = VC + FC
Cost Curves Graph
Profit
Difference of revenue and costs
Profit = TR - TC
Average Total Cost (ATC) Equation
TC / Q
AFC + AVC
Average Variable Cost (AVC) Equation
VC / Q
ATC - AFC
Average Fixed Cost (AFC) Equation
FC / Q
ATC - AVC
Marginal Cost
Additional cost of producing one more unit
Total Cost, Variable Cost, Fixed Cost curves
MC, ATC, AVC, AFC curves
In the long run, all resources are…
flexible
Long Run ATC (LRATC) Curve
Short Run Total Cost Curves will shift in the Long Run as more is produced
How do we find Long Run ATC (LRATC)?
Take the lowest average total cost curve at each level of output (short run cost curves)
LR ATC Car Scenario (to help understand)
In the beginning of production, a factory does not use it’s full plant capacity and mass production is difficult, so there is a high cost producing less quantity
As the firm continues production, it expands in capacity and can mass produce, lowering ATC
As the firm expands, its output becomes larger than its plant capacity and is too big to manage, so costs rise again
Economies of Scale
Refers to the reduction in total cost-per-unit as a firm increases its production
In this phase, the firm can reduce the total cost-per-unit by boosting its plant capacity and output
Diseconomies of Scale
Refers to the rise in total cost-per-unit as the firm increases its production
In this phase, the firm would be better off reducing its plant capacity and output to lower per-unit costs
Constant Returns to Scale
Between Economies of Scale and Diseconomies of Scale
In this phase, when the firm increases production, costs stay the same
ATC is at its lowest
Economies/Diseconomies of Scale
Blue is Economies of Scale
Green is Diseconomies of Scale
Yellow is Constant Returns to Scale
What does each color represent in the graph:
Blue
Yellow
Green
Blue = Economies of Scale
Yellow = Constant Returns to Scale
Green = Diseconomies of Scale
Normal Profit
When economic profit is zero - breaking even
Our accounting profit is positive
Economic losses
When revenue is less than costs
Supernormal profit
When a firm experiences economic profits in the long run
Theory of the Firm
The primary goal of any firm, regardless of market structure, is to maximize profits
Profit Maximizing Rule
MR=MC
Perfectly Competitive Market
Many, small firms in the industry
Firms are price takers, and have no control over the price of the goods they sell in the market
Market is impacted when firms enter or exit
Low barriers to entry
Firms break even in the long run
Products sold are identical
No non-price competition
All products are identical, so no need for advertising
Firms are perfectly efficient in the long-run
Perfect Competition Side by Side Graphs
Perfect Competition Short Run Profit
ATC and AVC curves are below MR=MC
Perfect Competition Short Run Loss
ATC curve is above MR=MC, and AVC curve is below MR=MC
Perfect Competition Short Run Shut Down
ATC and AVC curves are above MR=MC
Perfect Competition Long Run Equilibrium
ATC Curve is tangent to MR=DARP where MR=MC
It is allocatively and productively efficient - perfectly efficient
Perfectly Competitive Market
Short Run Shut Down Rule
The firm should continue to operate as long as the price is equal to or above AVC
Perfectly Competitive Market
When firms are earning economic loss in the short run, in the long run firms will…
leave the industry due to the lack of profit available
Perfectly Competitive Market
When firms are earning economic profit in the short run, in the long run firms will…
enter the industry due to the potential profit available
What is MR DARP?
MR = D = AR = P
Market equilibrium is equal to marginal revenue
Perfectly Competitive Market
When a firm enters the market, what will happen?
Supply will shift right
This will decrease price, driving MR DARP down
Perfectly Competitive Market
When a firm leaves the market, what will happen?
Supply will shift left
This will increase price, raising MR DARP up
Perfectly Competitive Market
In the long run, the market will shift towards…
equilibrium, or normal profits
Note 
Flashcard (29)