Markets in the Short and Long Run

Output

The product that the firm creates

Factors of Production

Inputs used in producing goods and services

Production Function

the relationship between inputs the firm uses and the output it creates

Marginal Product

The change in output associated with one additional unit of an input

Diminishing Marginal Product

Occurs when successive increases in inputs are associated with a slower rise in output

Total Costs

Composed of explicit costs and implicit costs

Explicit Costs

costs that require an outlay of money by the firm

Implicit Costs

Costs that do not require an outlay of money by the firm

Fixed Costs

Costs that do not vary with the quantity of output produced (in the short run)

Variable Costs

Costs that vary with the quantity or output produced

Average Fixed Cost

= (Fixed Cost) / Quantity

Average Variable Cost

= (Variable Cost) / Quantity

Average Total Cost

= (Total Cost) / Quantity

= AFC + AVC

Economies of Scale

long-run average total costs decline as output expands

production is more productive

ex. car manufacturers- building one car vs building several cars

Diseconomies of Scale

long-run average total costs rise as output expands

production is less productive

ex. Hospitals- more patients can mean running out of space

Constant Returns to Scale

Long-run average total costs remain constant as output expands

ex. Chain restaurants- similar costs of labor and materials everywhere

Total Revenue

= Price * Quantity

Average Revenue

= (Total Revenue) / Quantity

Marginal Revenue

= (Change in Revenue) / (Change in Quantity)

Profit

=Total Revenue - Total Cost

= (Price-Average Total Cost) * Quantity

Change in Profit

= Marginal Revenue - Marginal Cost

Profit Maximizing Rule

Stop producing when Marginal Revenue = Marginal Cost

if (P-ATC) > 0

Profit > 0

If (P-ATC)<0

Profit < 0

Sunk Costs

unrecoverable costs that have been incurred as a result of a bad decision

Must stay open ad operate at a cost

Short run- P > ATC

Firm should stay open because they are making a positive profit

When ATC > P > AVC

all variable costs and part of the fixed costs are covered

Short run- when AVC > P

Firm should shut down

Long run- If P > ATC

Firm should stay open

Long run- if AVC > P

firm should shut down