Unit 3 - Production, Cost, and the Perfect Competition Model Guide (copy)

Production function

Relation between the quantity of inputs a firm uses and the quantity of output it produces.

Fixed input

An input whose quantity doesn’t change.

Variable input

An input whose quantity can change.

Long run

Time period in which all inputs can be variable.

Short run

Time period in which at least one input is fixed.

Marginal product

Change in overall output when input changes.

Marginal product of labor (MPL)

∆Q/∆L.

Diminishing marginal returns

As input increases, the output of each input will be less than the previous input.

Output

Quantity produced.

Rental rate

Price of capital.

Capital

Goods that are used to produce goods/services.

Fixed cost

Cost that doesn’t change with the amount of output produced.

Variable cost

Cost that changes with the amount of output produced.

Total cost

Fixed cost + Variable cost.

Marginal cost

Cost difference of one additional unit of output (∆TC/∆Q).

Average fixed cost (AFC)

FC/Q.

Average variable cost (AVC)

VC/Q.

Average total cost (ATC)

TC/Q.

Long run average total cost (LRATC)

Same as short run ATC, but larger.

Economies of scale

LRATC declines as output increases.

Diseconomies of scale

LRATC increases as output increases.

Constant returns to scale

Output increases directly in proportion to an increase in all inputs.

Economic profit

Revenue - explicit cost - implicit cost.

Accounting profit

Revenue - explicit cost.

Implicit cost

Not an actual cost, a cost that you could’ve been earning.

Marginal Revenue

Additional revenue gained by producing one more unit.

Profit Maximising point

Where MR = MC for a firm to maximize profits.

Shutdown rule

As long as P > AVC, continue to produce; if AVC > P, shutdown.

Exit rule

If P < ATC, exit the market.

Perfect competition

Market structure with many identical firms competing at a constant market price.