AU26 Economics 2001.01 Chapter 6: Sellers and Incentives

firm

an active business in a market

characteristics of perfect comp

• free entry and exit in and out the market (low barriers)

• all firms earn 0 economic profit in the long run (identical costs with all firms)

seller/firm’s problem

choosing a quantity that will maximize the firm’s profits

3 elements:

1.) making the goods (inputs → outputs)

2.) the cost of doing business (production costs)

3.) the rewards of doing business (revenue)

profit

revenue-costs (net benefit equation)

• what firms are trying to maximize

production

process of transforming inputs to outputs

physical capital

any man-made resources

ex.) machines and buildings

short run

at least one fixed factor of production

long run

all inputs are variable factors

fixed factor of production

an input that cannot change, regardless of production levels

variable factor of production

firm can adjust all inputs depending on the level of production

marginal product (MP)

change in total output employing an additional input unit

• generally positive

• eventually exhibits diminishing returns (capacity constraints)

• can exhibit increasing returns through specialization

change in TP/change in labor

MPi = ∆q/∆i >0 i ∈ {K,L,T}

q = output

i = input

specialization

MP can exhibit increasing returns

• the practice where individuals, businesses, or nations focus their labor and resources on producing a limited range of goods or services to maximize efficiency and productivity

law of diminishing marginal returns

adding more of one resource (like workers or fertilizer) while keeping other things constant (like factory size or land) will eventually lead to smaller and smaller increases in output

cost of production

Term	Abbreviation	Meaning
Total cost	TC	All production costs combined
Fixed cost	FC	Costs that don't change with output
Variable cost	VC	Costs that change with output
Average total cost	ATC	Cost per unit, including fixed and variable costs
Marginal cost	MC	Cost of producing one additional unit

total cost (TC)

VC+FC

variable cost (VC)

costs of variable factors of production (things that can change overtime)

fixed cost (FC)

costs of fixed factors of production (rent for building)

• stays the SAME of the table

What happens with TC and VC in the long run?

TC=VC

average total cost (ATC)

AFC+AVC

TC/q

average variable cost (AVC)

VC/q

average fixed cost (AFC)

FC/q

marginal cost (MC)

the additional cost of producing one more unit

MC=ATC?

ATC is at minimum value

MC=AVC

at AVC minimum

MC<ATC

ATC is decreasing (negatice slope)

MC <AVC

AVC is decreasing (negative slope)

MC >ATC

ATC is increasing (positive slope)

MC >AVC

then AVC is increasing (positive slope)

AFC apporaches zero…

as q approaches ∞

revenue

price x quantity

• benefit firms recieve from selling their good/service

marginal revenue (MR)

additional revenue they get for selling one more unit of output

• constant

MR = change in revenue/change in quantity

D = MR = P

accounting profits

Explicit expenses, such as rent and wages

economic profits

Explicit expenses and what you give up by running the business

price elasticity of supply

how much the quantity supplied changes when the price changes

shutdown

• Short-run action

• A firm stops producing temporarily (the business still stays in operation)

sunk costs

a cost that has already been committed and cannot be recovered

producer surplus

the benefit a seller receives from selling a product for more than the minimum price they would have accepted

economies of scale

cost advantages that a business achieves by increasing its production output, which lowers the average cost per unit

constant returns to scale

happen when a business increases its production inputs, like labor and capital, and output increases by the exact same proportion

diseconomies of scale

when a business grows so large that its average cost per unit starts to rise as production increases

exit

• long run action
  - fully leaving the market for good

free entry

one of the characteristics of perfect competition markets

subsidy

financial support given by the government to producers or consumers to lower costs and increase the production or use of a good or service