Part 6

• Types of Costs:

  • Explicit Costs: Out-of-pocket expenses (e.g., wages, lease payments, materials)

  • Implicit Costs: Opportunity costs, such as owners' forgone salaries

Page 6

• Profit Types:

  • Accounting Profit:

    • Calculated as Total Revenue - Total Explicit Costs

  • Economic Profit:

    • Calculated as Total Revenue - Total Opportunity Costs

    • Total Opportunity Cost = Explicit Costs + Implicit Costs

• Short run production theory

• Cost Theory is the Relationship between output and costs varies depending on time frame

  • Short Run: A period of time where at least one input is fixed

  • Long Run: Sufficient period of time to vary all inputs

• Types of Inputs:

  • Fixed Input: Quantity does not change during the period of time under consideration

  • Variable Input: Quantity can change during the period of time under consideration

• Production Function:

  • Defines the maximum output a firm can produce at given input levels

• Marginal Product:

  • Change in total output produced by adding one unit of a variable input, keeping all other inputs constant

  • Law of diminishing returns explains the shape of the marginal product curve

• Law of Diminishing Returns:

  • Principle stating that marginal product decreases as more units of a variable input are added to a fixed input

  • Overall productivity declines after a certain input threshold

• Short-Run Cost Concepts:

  • Total Fixed Cost: Does not vary with output, must be paid even if output is zero

  • Total Variable Cost: Varies with output

  • Total Cost: Sum of total fixed and total variable costs at each output level

  • Average Fixed Cost: Total fixed cost per unit produced

  • Average Variable Cost: Total variable cost per unit produced

  • Average Total Cost: Total cost per unit produced

  • Marginal Cost: Change in total cost from producing one additional unit

• Marginal Cost Concept:

  • Focus on the cost associated with producing additional output units

  • Defined as the change in total cost from producing one more unit

  • mc = change in tc/change in q = change in tvc/change in q

• Marginal Cost Relationships:

  • When Marginal Cost (MC) < Average Cost (AC): AC decreases

  • When MC > AC: AC increases

  • When MC = AC: AC at minimum point

• Inverse Relationship:

  • Marginal Cost and Marginal Product are inversely related

• Long-Run Equilibrium in Perfect Competition

  Dynamics:

  Economic Profit: Attracts new firms to enter the market and increases supply, pushing

  prices down, as observed in the technology sector.

  Economic Loss: Firms exit, reducing the supply and increasing prices; for instance, when a

  smartphone model fails to attract significant user interest.

  Long-Run Supply Curves

  Types:

  Constant-Cost Industry: No change in costs as industry output changes, like

  basic agricultural goods.

  Increasing-Cost Industry: Costs rise as industry output increases, often due to

  limited resources; example, mineral extraction.

  Decreasing-Cost Industry: Costs fall as industry expands, potentially due to

  gains in efficiencies, such as technological improvements in manufacturing.

• Returns to Scale:

  • Economies of scale: Long Run Average Cost LRAC declines with output increase

  • Constant returns to scale: LRAC remains unchanged with output increase

  • Diseconomies of scale: LRAC rises as output increases

• Reasons for Economies and Diseconomies of Scale:

  • Economies: Improved division of labor, specialization, efficient capital use

  • Diseconomies: Bureaucracy, communication barriers, management challenges like lack of coordination