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goal of firms
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maximize profits
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explicit costs
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direct payments made for factors of production/inputs (ex. wages, cost of capital, land rents)
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implicit costs
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opportunity costs of factors of production (ex. interest on a bank account that you won't have bc you opened a business, your old salary)
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accounting profit
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total revenue - explicit costs
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economic profit
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total revenue - explicit costs - implicit costs
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total revenue (TR)
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price x quantity
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accounting vs. economic profit
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accounting profit is always greater than or equal to economic profit, never less than
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production function
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a mathematical equation that shows the relationship between inputs and ouputs (ex. y=10KL)
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production function assumptions
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firm only uses 2 inputs labor (L) and capital (K) and the amount of capital is fixed so firms can only choose the amount of labor
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law of diminishing returns
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as additional workers are hired, while holding capital fixed, output will increase but at a decreasing rate
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marginal product of labor (MPL)
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the additional output that is produced when an additional worker is hired (L increases)
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short run
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a period of time in which at least one input is fixed (ex. capital/K)
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average fixed cost
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TFC/Q, will decrease as output increases
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total variable cost (TVC)
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costs that vary with the level of production- as Q increases, TVC increases
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average variable cost (AVC)
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TVC/Q
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TC
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TFC + TVC or ATC x Q
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average total cost (ATC)
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TC/Q or AFC + AVC
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marginal cost (MC)
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the increase in total cost that occurs when one more unit is produced
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MC curve below AVC curve
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AVC curve will fall
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MC curve above the AVC curve
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AVC curve will rise
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as output increases,
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AFC gets smaller and the differences between ATC and AVC decreases
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the MC curve must intersect the AVC curve....
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at its minimum point
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"u-shaped"
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AVC and ATC curves
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"j-shaped"
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MC curve
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long-run
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the period of time in which there are no fixed factors of production
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increasing returns to scale (economies of scale)
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if a firm increases both capital and labor by x% and output increases by more than x%, a firm will experience lower ATC as production rises
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constant returns to scale
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if both capital and labor increase by x% and output increases exactly by x%, a firm will experience no change in ATC as output increases
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decreasing returns to scale (diseconomies of scale)
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if both capital and labor increase by x% and output increases by less than x%, a firm will experience ATC increase as Q increases
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long-run average cost curve
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they have increasing returns to scale
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a firm should expand if...
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they have constant returns to scale
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a firm should stay the same if...
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they have decreasing returns to scale
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a firm should contract if...
answer
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