Microeconomics3e-Ch07

Chapter 7: Production, Costs, and Industry Structure

7.1: Explicit and Implicit Costs, and Accounting and Economic Profit

• Profit Formula: Profit = Total Revenue – Total Cost

  • Revenue: Income generated from selling products; Total Revenue = Price × Quantity Sold

  • Explicit Costs: Out-of-pocket expenses; includes wages, rent, etc.

  • Implicit Costs: Opportunity costs of using resources owned by the firm; includes depreciation of goods and equipment.

7.2: Production in the Short Run

• Definition of Production: Combining inputs to produce outputs with higher value than the inputs.

• Example: Pizza production with inputs such as ingredients and labor.

Production Inputs

• Factors of Production:

  • Natural Resources (Land and Raw Materials)

  • Labor

  • Capital

  • Technology

  • Entrepreneurship

• Production Function: Q = f [Natural Resources, Labor, Capital, Technology, Entrepreneurship]

Short Run vs Long Run

• Short Run: At least one input is fixed; time period in which certain factors cannot be changed.

• Long Run: All inputs are variable; efficient production methods can be implemented.

Example: Lumberjack Productivity

• Short Run Production Function: Q = TP = f [L, K] (Total Product based on Labor and Fixed Capital)

• As more labor (lumberjacks) is utilized, output increases up to a point (Law of Diminishing Marginal Productivity).

7.3: Costs in the Short Run

• Definition of Costs:

  • Fixed Costs: Costs that do not change with the level of production (e.g., rent).

  • Variable Costs: Costs that change with production level (e.g., labor costs).

• Total Cost Calculation: Total Cost = Fixed Costs + Variable Costs

• Average Total Cost (ATC): ATC = Total Cost / Quantity of Output

• Marginal Cost (MC): Additional cost of producing one more unit of output.

7.4: Production in the Long Run

• Long Run Production Function: All factors (including capital) are variable; exhibits most efficient production.

7.5: Costs in the Long Run

• Long Run Cost Dynamics: All costs are considered variable; production technologies can be adjusted.

• Economies of Scale: Cost per unit decreases as output increases due to larger production scale.

Shapes of Cost Curves

• Long-Run Average Cost (LRAC) Curve: Represents the lowest average cost achievable when varying all inputs.

• Short-Run Average Cost (SRAC) Curves: Show total average costs short-term, including varying fixed costs.

Implications of Cost Curves

• Constant Returns to Scale: Expansion of all inputs at the same rate does not affect average production costs.

• Diseconomies of Scale: Increased output leads to higher unit costs due to management inefficiencies.

Industry Competition Dynamics

• The structure of the cost curves influences the number and size of firms in an industry:

  • Low-Cost Firms: Operate efficiently at certain output levels, allowing competition at various scales.

  • Challenges for Smaller or Larger Firms: Firms outside optimal output range face higher average costs.