Microeconomics: Producers in the Short Run

Chapter 7: Producers in the Short Run

7.1 What Are Firms?

  • Definition of Firms: Organizations that use resources to produce goods/services and can be structured in various forms.
    • Forms of Business Organizations:
    • Single proprietorship
    • Ordinary partnership
    • Limited partnerships (general and limited)
    • Corporations (private and public)
    • Crown corporations (state-owned enterprises)
    • Non-profit organizations
    • Multinational Enterprises (MNEs): Firms that operate in multiple countries; more common in larger corporations than in single proprietorships and ordinary partnerships.

7.2 Production, Costs, and Profits

  • Inputs for Production: Firms use various inputs for production:
    • Intermediate products (outputs from other firms)
    • Natural inputs
    • Labor services
    • Physical capital services
  • Production Function: Shows the maximum output produced via a combination of inputs.
    • Functional Notation: Q = f(L, K) (Q: output, L: labor, K: capital)
  • Explicit Costs: Direct expenditures for goods/services, including wages, rent, interest, and depreciation.
  • Accounting Profit: Calculated as Revenues - Explicit Costs.
  • Implicit Costs: Opportunity costs of resources not accounted for in explicit costs (e.g., owner’s time and capital).
  • Economic Profit: Revenues - (Explicit + Implicit Costs).
    • Negative economic profits are termed economic losses.

7.3 Production in the Short Run

  • Total Product (TP): Overall output in a given time period.
  • Average Product (AP): Total product divided by the amount of variable input used (AP = TP/L).
  • Marginal Product (MP): Change in TP from using an additional unit of the variable input (MP = ΔTP/ΔL).
  • Law of Diminishing Returns: With fixed input, adding more variable inputs yields progressively smaller increases in output.
    • Each successive unit of the variable factor has less of the fixed factor to work with.
    • Eventually, increases in input result in increasingly lower outputs.
  • Average-Marginal Relationship:
    • If MP is greater than AP, the AP increases; if MP is less than AP, the AP decreases.

7.4 Firms’ Costs in the Short Run

  • Total Cost (TC): Sum of total fixed (TFC) and total variable costs (TVC) (TC = TFC + TVC).
  • Average Total Cost (ATC): Average cost per unit of output (ATC = AFC + AVC).
  • Marginal Cost (MC): Increase in TC from increasing output by one unit (MC = ΔTC/ΔQ).
    • The MC curve intersects the ATC and AVC curves at their minimums.
  • U-Shaped Cost Curves:
    • The ATC curve initially declines, achieves a minimum, then rises as output increases.
    • The AVC curve also exhibits a U-shape due to diminishing returns, impacting average fixed costs.
  • Capacity: Level of output at which the firm's average total cost is minimized. Producing below capacity indicates excess capacity.
  • Shifts in Short-Run Cost Curves:
    • An increase in variable factor prices shifts both ATC and MC curves upward.
    • An increase in fixed factor prices affects ATC without changing MC.

Applying Economic Concepts

  • Profit Maximization: Firms are generally viewed as profit-maximizers under the assumption that they make consistent decisions as unified entities.
    • Ethics: Exploring whether profit maximization conflicts with broader social interests or motivates innovation and improved standards.
  • Digital Economy Considerations:
    • Many digital products have high fixed costs but lower marginal costs; leading to a scenario where the law of diminishing returns does not apply.
    • In this context, average variable cost equals marginal cost, allowing for declining average total costs as fixed costs are spread over increasing output.