AP Microeconomics Unit 3

economic cost

The measure of any resource used tk produce a good is the value or worth the resource would have in its best alternative use

explicit costs

monetary payments it makes to those who supply labor, services, materials, fuel, transportation etc.

implicit costs

the opportunity costs of using its self-owned, self-employed resources

the money payments that self-employed resources could have earned in their best alternative use

accounting profit

total revenue-explicit costs

economic profit

total revenue-economic cost

economic cost

explicit-implicit

short run (fixes plant)

a period too brief to alter its plant capacity, but enough to permit a change in the degree the fixed plant is used

change amounts of resources used, add or cut labor force

long run (variable plant)

a period long enough to adjust all resources, including plant capacity

also can mean enough time for riffs to enter or leave the industry

Law of Diminishing (Marginal) Returns

as successive units of a variable resource (such as labor) are added to a fixed resource (such as capital or land), beyond some point the extra (marginal) product that can be attributed to each unit of the variable resource will decline

total product (TP)

the total quantity of a good produced

marginal product (MP)

the extra product associated with adding a unit of resource (labor)

=change in total product/change in input

average product (AP)

labor productivity, output per unit of input

=total product/units of labor

fixed costs

costs that do not vary with changes in output

Ex. rental payments, interest on debt, depreciation, insurance

variable costs

costs that change with the level of output

Ex. materials, fuel, power, transportation, labor

total cost

the sum of fixed costs and variable costs

TC=TFC+TVC

average fixed cost

total fixed costs divided by quantity of output

AFC=TFC/Q

average variable cost

total variable cost divided by quantity of output

AVC=TVC/Q

average total cost

total cost divided by quantity of output

ATC=TC/Q=AFC+AVC

marginal cost

the additional cost of producing 1 more unit of output

the change in total cost divided by the change in quantity of output

MC= change in TC/change in Q

Long-Run Production Costs

in the long-run, firms can adjust all resources

all costs are variable in the long run, no fixed costs

Long-Run cost curve (Planning Curve)

found by combining the successive short-run ATC curves for the firm at various capacities

found by joining lowest points of each of the infinite number of shirt-run curves

economies of scale

Assumptions:

No law of diminishing returns in the long run- all resources are available--resource prices remain constant

As plant size increases, there will be lower average costs of production

labor specialization

workers can be more productive in specialized tasks

managerial specialization

make better use of manager, more employees under each manager, can specialize in one area of expertise

efficient capital

only large-scale producers can buy the best equip magnet and use it to its greatest efficiency

other factors

start-up costs decline as units of output is increased

other factors like advertising decline with increased output

expertise and efficiency increase with output-learning by doing

diseconomies of scale

lead to higher average costs

factors of diseconomies

Difficulty of Efficient Management: more bureaucracy, slower and removed decision making

Increased Worker Alienation: in a big firm, more opportunity to shirk, not care, etc.

Constant Returns to Scale

an increase in input causes an equal increase in output

Pure Competition

very large numbers, standardized product(perfect substitutes), "price takers", free entry/exit, perfectly elastic demand

"price takers"

the individual seller is at the mercy of the market

must take the price given at market

revenue

average revenue=price

total revenue=price x quantity

marginal revenue=change in total from selling one more unit

P=AR=MR

in perfect competition

profit maximization

where marginal revenue = marginal cost

Shutdown Rule

firms should only produce when P>AVC

below AVC, it would be better to cover fixed costs and not produce any product

3 steps to determine best (optimal) output

1. Should the fir produce?If P is greater than or equal to AVC at any output, then yes.

2. If the firm continues to produce, find where MR=MC. Find the highest output possible before MC>MR

3. Find profits or losses

Profits P>ATC, Q(P-ATC)

Losses P

perfect competition in the long run

no economic profit- the firm earns a normal profit-explicit and implicit cost are covered

there is no incentive to use resources elsewhere

price (=MR) is tangent to ATC at its lowest point

provides productive efficiency (P=ATC) and allocative efficiency (P=MC)