Theory of the Business Firm Cost Curves Micro (2)

Theory of the Business Firm

• Introduction to cost curves, critical for understanding microeconomics.

• Emphasis on graphs, particularly cost curves, to aid in comprehension.

• Focus on thoughtful math over computational math—aim for numeracy understanding.

Key Concepts in Microeconomics

• Theory of the Business Firm: Understanding profit incentives driving firm decisions in a market economy.

  • Business Firm Organization: How companies are structured.

  • Industry Organization: Interaction of firms within their markets.

  • Macroeconomic Impacts: How broader economic conditions affect firm decisions.

  • Application of previously covered economic concepts to real business scenarios.

• Some economists advocate that all economics can be viewed through the micro lens.

Profit Definitions

• Accounting Profit:

  • Formula: Total Revenues (PxQ) - Total Explicit Costs (TCxQ)

• Economic Profit:

  • Formula: Total Revenues (PxQ) - Total Explicit + Implicit Costs (TCxQ)

• Comparison:

  • Accounting profit is always greater than economic profit due to consideration of opportunity costs in economic profit.

Case Study: Anna's Pizzeria

• Background: Anna leaves her accounting job ($100,000 salary) to follow her dream of running a pizzeria.

• First-Year Financials:

  • Expenses: $150,000

  • Revenues: $200,000

• Profit Analysis Needed:

  • Calculate accounting profit.

  • Calculate economic profit considering her previous earnings and opportunity costs.

Diminishing Marginal Returns

• Law of Diminishing Marginal Returns:

  • Returns decrease with the addition of variable resources (like labor) to a fixed resource (like capital).

  • While total output may increase, it does so at a decreasing rate.

  • Marginal product (additional output from using one more unit of input) declines.

• Short-term vs. Long-term:

  • Short term: At least one input is fixed.

  • Long term: All inputs can adjust (e.g., acquiring technology, resizing facilities).

• Average Product vs. Marginal Product:

  • Average product equals the average of marginal products of resource inputs.

Production Function

• Production Metrics:

  • Total product (TP), average product (AP), and marginal product (MP) in relation to resource quantity.

Graph Analysis of Production Function

• Key Questions to Examine:

  • What changes occur in TP as output increases?

  • What happens to MP and AP as output increases?

  • Understand the significance of the law of diminishing marginal returns and the relationships between MP and TP and MP and AP.

Cost Curves Overview

• Marginal Cost (MC) and Marginal Product (MP) curves exhibit inverse relations.

Marginal Cost Relationships (Formula Summary)

• Total Cost (TC) Breakdown:

  • TC = Total Fixed Costs (TFC) + Total Variable Costs (TVC)

• Average Total Cost (ATC) Calculation:

  • ATC = TC/Q = (TFC/Q) + (TVC/Q) = AFC + AVC

• Characteristics:

  • AFC decreases with output.

  • AVC and ATC increase with output.

  • Marginal cost is the cost of producing an additional unit.

  • Average costs curves are generally U-shaped due to the behavior of marginal costs.

Fixed Costs Graphs

• Analyzing total and average fixed costs:

  • Fixed costs do not change with output.

  • Average fixed costs (AFC) decrease as output increases (AFC = FC/Q).

Average Cost Graphing Tasks

• Draw average costs, ensuring understanding of U-shaped cost curves.

• Distinguish between AVC (Average Variable Cost) and ATC (Average Total Cost) in graphs.

Relationships Among Cost Curves

• ATC is always higher than AVC due to the inclusion of AFC.

• The vertical distance between AVC and ATC reflects the AFC.

Takeaways from Cost Curve Graphing

• Essential to graph ATC, AVC, AFC, and MC accurately.

• Recognize U-shape characteristic of cost curves.

• MC intersects AVC and ATC at their lowest points.

• Understand why ATC is always the highest curve in cost analysis.