Economic Theory Unit 5/8

Cost

The amount of money that is spent on the production or creation of a good or service.

Opportunity Costs

The lost benefits that the business entity could have enjoyed by selecting the best alternative over others.

Fixed Costs

Indirect costs that do not alter with the changing output and they remain unchanged in the form of rent, salaries, property tax and so on.

Total Costs

The sum of total fixed costs and the total variable costs (TC = Fixed + variable costs).

Variable Costs

Costs that change with changes in the quantity of output.

Implicit Costs

Costs which take place and are not seen, and are not directly linked to expenditure like repair and servicing of machines, etc.

Explicit Costs

Costs incurred by an organisation in terms of inputs like employee wages, utility bills, rent and so on.

Average Cost

Total cost divided by the total quantity.

Average Fixed Cost (AFC)

Total fixed costs divided by quantity; per unit fixed cost that declines continuously as production increases.

Average Variable Cost (AVC)

Total variable costs divided by the quantity. The average variable cost curve is in the form of a U-shape and lies below the average cost curve.

Marginal Cost

The change in cost for quantity produced changes by an extra unit; cost of producing one extra unit of the product.

Social Costs

Private costs and other external costs incurred by people in society.

External Costs

Costs that are incurred by third parties.

Replacement Costs

Costs spent by a business entity to replace essential assets like real estate property, machinery and so on.

Short-run Costs

Costs that are incurred for a short term in the process of production used over a short quantity of output, including fixed costs (capital, plant, equipment) and variable costs (employee wages, raw materials).

Total Fixed Cost (TFC)

Costs that remain constant and fixed and do not change with change in the output level. When the output is zero, the total fixed cost remains constant.

Total Variable Cost (TVC)

Costs that are directly proportionate to the output of an organisation. Hence when the output increases, the total variable costs also increase and a decrease in the output level leads to a decrease in the total variable costs.

Short-Run Average Cost (SRAC)

Per unit cost of output at different levels of production.

Long run costs

The costs in the long run are the time period for a business entity where all the different factors of production can be changed. There are no fixed inputs in the long run and it consists of only variable inputs.

Long-run Total Cost (LTC)

The minimum cost that is required for producing a given level of output; shows the least cost of different quantities of output.

Production

The process involved in manufacturing goods from raw materials or various inputs that are required for creating a finished product through manufacturing. It transforms inputs into outputs that eventually provide value to the customer.

Production Function

States the functional relationship between the factors for production and the number of products. It describes the link between the factors of production and the final output obtained.

Total Production (TP)

Refers to the total units of output produced per unit of time by all factor inputs.

Average Production (AP)

The total production per unit of a given variable factor. It is calculated by dividing the total product by the number of variable factors (AP = TP/QVF).

Marginal Production (MP)

Refers to the additional units produced with the usage of the last variable factor. It is the change in total production that takes place due to the addition of a variable factor.

Short-Run Production Function

Explains the relationship between the input and output where there is one variable factor, and the quantities of all other factors are fixed.

Long-Run Production Function

Refers to the time where all the input factors are variable in the same proportion. The organization can make changes and adjustments in all the factors of production and quantity produced according to the situation.

Law of Variable Proportions

Determines the short-run relationship between the alterations in the output and inputs, where some factors are fixed and some are variable.

Law of Returns to Scale

Refers to the change in output due to the change in the scale of factors in the form of inputs in the same proportion in the long run.

Increasing Returns to Scale

The situation when the factors of production are increased and with this the output of the firm too increases at a higher rate.

Constant Returns to Scale

Refers to a situation where all inputs are increased by a certain percentage and an increase, in the same percentage is experienced in the output.

Diminishing Returns to Scale

Refers to a situation of production where all the factors of production are increased in a specified proportion but the output increases in a smaller proportion only.

Isoquant

A locus of points that represent the different technically efficient ways of combining the factors of production for producing a fixed level of output. Also known as the 'equal product curve'.

Marginal Rate of Technical Substitution (MRTS)

The rate at which one factor of input should decrease for maintaining the same level of output when another factor is increased. MRTS = MPL/MPK

Revenue

The income obtained by a firm through its various business operations involving the selling of goods and services at different prices.

Total Revenue (TR)

The total income that a seller or producer earns after selling the output. TR = AR × Q

Average Revenue (AR)

Refers to the revenue received by the seller after selling the per unit commodity. It is calculated by dividing the total revenue by total output. AR = TR/Q

Marginal Revenue (MR)

The net revenue obtained by selling an extra unit of the concerned commodity. MR = /ΔTR/ΔQ

Market

The place which facilitates the gathering of various buyers and sellers in the area or region for the exchange and transaction of goods and services.

Virtual markets

Markets where buyers purchase goods and services through the Internet.

Auction markets

Markets where the seller sells his goods to one who bids the highest.

Black markets

Setups where illegal goods such as drugs and weapons are sold.

Knowledge markets

Places that deal in the exchange of information- and knowledge-based products.

Perfect competition markets

Market systems characterized by several buyers and sellers with no single entity influencing the market price.

Monopoly markets

Markets characterized by an individual seller who sells unique products and faces no competition.

Monopolistic competition markets

Market systems that combine elements of monopoly and perfect competition, where many firms offer similar but not perfect substitutes.

Market Structure

The relationship between sellers and other sellers, and sellers to buyers within a market.

General Market Transaction

Markets dominated by demand-supply dynamics, where every transaction involves the exchange of commodities.

Imperfect Competition

Occurs when there is a major competitive situation among various sellers, even when selling heterogeneous or dissimilar products.

Price Determination

The process by which the forces of demand and supply interact to establish the market price for goods and services, influencing resource allocation in an economy.

Perfect Competition

A hypothetical market structure characterized by numerous buyers and sellers, homogeneous products, and free entry and exit, where prices are determined by market demand and supply.

Equilibrium of the Firm (Perfect Competition)

Occurs when a firm produces at the output level where marginal cost (MC) equals marginal revenue (MR), maximizing profit or minimizing losses; firms are price takers in perfect competition.

Short Run Equilibrium (Perfect Competition)

A firm may experience profits or losses in the short run, but production occurs where MC = MR. Losses may lead to shutting down if operating losses exceed fixed costs.

Long Run Equilibrium (Perfect Competition)

Firms earn only normal profits due to free entry and exit. Prices adjust to OP, ensuring no supernormal profits or losses, as new firms enter or exit the industry.

Equilibrium of the Industry

The industry is in equilibrium when total output equals total demand at the prevailing price, which is the equilibrium price. It requires the group of firms to manufacture homogeneous products in a market.

Monopoly Market

A market structure with a single seller of a product with no close substitutes, where new firms cannot enter, and the monopolist aims to maximize profit. They act as a price maker not taker.

Demand Curve (Monopoly)

The demand curve for a monopolist is the industry demand curve, sloping downwards from left to right, showing that more is sold at a lower price.

Supply Curve (Monopoly)

The supply curve of a monopolist is based on the average cost curve. Relationship between average cost and marginal cost depends on laws of returns.

Equilibrium Condition (Monopoly)

Essential condition is equality between marginal revenue (MR) and marginal cost (MC) at the point where monopolist profits are maximized.

Price Discrimination

Charging different prices to different consumers for the same product by a monopolist to gain pricing power and market advantage.

First-Degree Price Discrimination

Perfect price discrimination where a firm charges a different price for every unit sold, capturing all consumer surplus.

Second-Degree Price Discrimination

Charging different prices for different quantities, such as quantity discounts for bulk purchases.

Third-Degree Price Discrimination

Charging different prices to different consumer groups, such as peak and off-peak seasons.

Monopolistic Competition

A market structure with differentiated products, a large number of sellers, and freedom of entry and exit; competition is not based solely on price.

Equilibrium in Monopolistic Competition

Firms are in equilibrium where marginal revenue (MR) equals marginal cost (MC). In the long run, firms earn only normal profits due to new firms entering the market.