7.1 The Production Function

Allocative efficiency: when marginal cost = marginal value

• Also known as efficiency in output

• Marginal cost: cost of producing one more unit

• Marginal value: value of one more unit

Technical efficiency: reached when economy’s factors of supply are used to maximize production

• Also known as efficiency in production

Marginal product: additional output produced per period when one more unit of an input is added

Law of diminishing marginal returns: as one amount of an input increases, marginal returns will eventually decrease

Average product:

Total product curve: shows relationship between total amount of output produced vs. number of units of an input used

• Fixed costs: do not change when more output is produced

• Variable costs: do change when more output is produced

• Total Costs = Total Fixed Costs + Total Variable Costs

  • TC = TFC + TVC

7.2 Short- and Long-Run Production Costs

Short run: time frame where at least one factor of production is constant

• Firms cannot enter/exist market

• Long-run: all factors of production are variable, no fixed costs

Economies of scale: exist over range of output where long-run average cost curve slopes down

• Cost per unit decreases

7.3 Types of Profit

• Profit: value remaining after paying all costs and financial obligations of a company

  • Profit = TR - TC

• Gross profit: total sales - total cost of goods/services

• Operating profit: gross profit - operating expenses

• Net profit: amount left after deducting all other expenses

  • Ex) After taxes, loan interests

7.4 Profit Maximization

• Profit: total revenue - total cost

• Break-even points: points on graph where total revenue = total cost

• Profit maximization: loss minimization

7.5 Perfect Competition

When is there perfect competition?

• Many sellers

• Products are standardized

• Firms accept market price → “price takers”

• Firms can enter/exit market freely

Economic profits: total revenue - total cost