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producers try to maximize:
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profit
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opportunity cost
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- to hire a resource a firm must pay this, that is at, at least what the resource could earn in its best alternative
- all resources have this no matter what
- all resources have this no matter what
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explicit cost
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- opportunity cost of resources employed by a firm that takes the form of cash payments
- actual cash payments for resources
- wages, rent, interest, insurance, taxes
- recorded on accounting statement
- actual cash payments for resources
- wages, rent, interest, insurance, taxes
- recorded on accounting statement
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implicit costs
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- opportunity costs of using resources owned by the firm or provided by the firm's owners
- the use of a company owned car, the use of company funds, the use of the time of the firm's owners
- requires no cash payment and no entry into the firm's accounting statement (records revenues, explicit costs, and accounting profit)
- the use of a company owned car, the use of company funds, the use of the time of the firm's owners
- requires no cash payment and no entry into the firm's accounting statement (records revenues, explicit costs, and accounting profit)
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accounting profit
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- total revenue minus explicit costs
- accountants use this profit to determine a firm's taxable income
- accountants use this profit to determine a firm's taxable income
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economic profit
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- total revenue minus all opportunity costs, explicit and implicit
- takes into account the opportunity cost of all resources used in production
- what Wanda Wheeler earns as an entrepreneur -- an amount over and above what all her resources could earn in their best alternative
- any accounting profit in excess of a normal profit is economic profit
- takes into account the opportunity cost of all resources used in production
- what Wanda Wheeler earns as an entrepreneur -- an amount over and above what all her resources could earn in their best alternative
- any accounting profit in excess of a normal profit is economic profit
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normal profit
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- the accounting profit just sufficient to ensure that all resources used by the firm earn their opportunity cost
- you earn this when the accounting profit = implicit costs
- you earn this when the accounting profit = implicit costs
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variable resource
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- any resource that can be varied in the short run (quickly) to increase or decrease production/output rate
- Ex: labor
- Ex: labor
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fixed resource
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- any resource that cannot be varied in the short run/cannot be altered as easily
- Ex: the size of a building
- Ex: the size of a building
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when considering the time required to change the quantity of resources employed, economists distinguish between the:
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short run & long run
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short run
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- at least one resource is fixed
- output can be changed by adjusting variable resources
- the size or scale of the firm is fixed
- increasing and diminishing marginal returns from a variable resource
- output can be changed by adjusting variable resources
- the size or scale of the firm is fixed
- increasing and diminishing marginal returns from a variable resource
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long run
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- no resources are fixed/all resources can be varied
- the length of this differs from industry to industry because the nature of production differs
- all inputs under the firm's control can be varied, so there is no fixed cost
- best thought of as a planning horizon
- the choice of input combinations is flexible
- economies and diseconomies of scale
- the length of this differs from industry to industry because the nature of production differs
- all inputs under the firm's control can be varied, so there is no fixed cost
- best thought of as a planning horizon
- the choice of input combinations is flexible
- economies and diseconomies of scale
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Law of Diminishing Marginal Returns
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- states that as more of a variable resource is combined with a given amount of other resources, marginal product eventually declines and could become negative
- the most important feature of production in the short run
- marginal product decrease
- the most important feature of production in the short run
- marginal product decrease
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total product
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a firm's total output
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production function
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the relationship between the amount of resources employed and total product is called the firm's production function
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marginal product
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the change in total product resulting from an additional unit of labor, assuming other resources remained unchanged
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increasing marginal returns
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the marginal product of a variable resources increases as each additional unit of that resource is employed --> marginal product increases
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- as long as marginal product is positive, total product: - once marginal product turns negative, total product starts to:
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increases; decrease
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there are two kinds of costs in the short run:
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fixed and variable
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fixed cost
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- pays for fixed resources
- a firm incurs this in the short run even if no output is produced --> any production cost that is independent of the firm's output rate
- a firm incurs this in the short run even if no output is produced --> any production cost that is independent of the firm's output rate
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variable cost
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- pays for variable resources (labor)
- when no labor is employed, output is zero, and so is this cost
- as workers are hired, output increases, and so does this cost
- depends on the amount of labor employed and on the wage
- when no labor is employed, output is zero, and so is this cost
- as workers are hired, output increases, and so does this cost
- depends on the amount of labor employed and on the wage
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total cost
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- sum of the fixed cost and variable cost
- includes a normal profit
- TC = FC + VC
- includes a normal profit
- TC = FC + VC
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marginal cost
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- how total cost changes as output changes
- MC = change in TC/change in q
- at low rates of output, marginal cost declines as output expands because of increasing marginal returns from labor
- at higher rates of output, marginal cost increases because of diminishing marginal returns from labor
- has a positive relationship with average cost --> when MC is less than AC, AC declines; when MC is above AC, AC increases
- MC = change in TC/change in q
- at low rates of output, marginal cost declines as output expands because of increasing marginal returns from labor
- at higher rates of output, marginal cost increases because of diminishing marginal returns from labor
- has a positive relationship with average cost --> when MC is less than AC, AC declines; when MC is above AC, AC increases
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when the firm experiences increasing marginal returns, the marginal cost of output _____. when the firm experiences diminishing marginal returns, the marginal cost of output _________.
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falls, increases
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average fixed cost
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- fixed cost/quantity
- continues to fall as output expands
- continues to fall as output expands
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average variable cost
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- variable cost/quantity
- first declines, then increases as output expands
- first declines, then increases as output expands
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average total cost
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- total cost/quantity
- or AFC + AVC
- first declines, then increases as output expands
- or AFC + AVC
- first declines, then increases as output expands
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the distance between the average variable cost curve and the average total cost curve is:
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average fixed cost --> which gets smaller as the rate of output increases
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when the marginal product of labor increases
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marginal cost of output falls
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firms plan for the _____ ____, but they produce in the ______ ____.
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long run, short run
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the shape of the short run average total cost curve is determined primarily by:
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increasing and diminishing marginal returns from the variable source
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if a firm experiences economies of scale, long run average cost _____ as the scale of the firm _______.
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falls, expands
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as the scale of a firm increases:
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capital substitutes for labor and complex machines substitute for simpler machines
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economies of scale
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forces that reduce a firm's average cost as the scale of operation increases in the long run
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diseconomies of scale
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- forces that may eventually increase a firm's average cost as the scale of operation increases in the long run
- large firms do what they can to reduce diseconomies of scale --> Ex: IBM undertook a massive restructuring program to decentralize into 6 smaller decision making groups
- large firms do what they can to reduce diseconomies of scale --> Ex: IBM undertook a massive restructuring program to decentralize into 6 smaller decision making groups
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diseconomies of scale result from:
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a larger firm size
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diminishing marginal returns result from:
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using more variable resources in a firm of a given size
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long run average cost curve
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- sometimes called the firm's planning curve
- connects portions of the three short-run average cost curve that are lowest for each output rate
- indicates the lowest average cost of production at each rate of output when the size, or scale, of the firm varies
- the envelope of portions of the short run average cost curves
- each short run curve is tangent to the long run average cost curve
- each point of tangency represents the least cost way of producing that rate of output
- connects portions of the three short-run average cost curve that are lowest for each output rate
- indicates the lowest average cost of production at each rate of output when the size, or scale, of the firm varies
- the envelope of portions of the short run average cost curves
- each short run curve is tangent to the long run average cost curve
- each point of tangency represents the least cost way of producing that rate of output
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constant long run average cost
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- a condition that occurs if, over some range of output, long run average cost neither increases nor decreases with changes in firm size
- if neither economies of scale nor diseconomies of scale are apparent over some range of output, a firm experiences:
- if neither economies of scale nor diseconomies of scale are apparent over some range of output, a firm experiences:
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minimum efficient scale
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the lowest rate of output at which a firm takes full advantage of economies of scale
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each point of tangency between a short run average cost curve and a long run average cost curve represents:
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the least cost way of producing that particular rate of output
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we can distinguish between economies and diseconomies of scale at the:
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- plant level (a particular location) and at the firm level (were the firm is a collection of plants (a chain))
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