If the firm fails to maximize profit, it's either eliminated or taken over by another firm that seeks to maximize profit
Profit = Total revenue - total cost
Total cost measured as the opportunity cost of production
Firm's OC of production is the sum of the cost of using resources
Firm's OC of using the capital it owns is called the implicit rent rate of capital
Economic depreciation
Interest foregone
ED is the change in the market value of capital over a given period
IF is the return on the funds used to acquire the capital
Return to entrepreneurship is profit
Profit an entrepreneur can expect to receive on average is called normal profit (cost of entrepreneurship and is an OC of production)
Some decisions are critical to firm's survival
Some decisions are irreversible
Other decisions are easily reversed and are less critical to the survival of the firm, but still influence profit
Decisions can be placed in the short and long run
For most firms, the capital, called the firm's plant, is fixed in the short run
Other resources used by the firm (labor, raw materials, energy) can be changed in the short run
Short-run decisions are easily reversed
If a firm's plant has no resale value, the amount paid for it is a sunk cost
Sunk costs are irrelevant to a firm's current decisions
3 concepts describe the relationship between output and the quantity of labor employed:
Total, Average, Marginal Product
Similar to the PPF
Separates attainable and unattainable output levels in the short run
Shows how many extra outputs are created with each additional input
Look at PP for examples
Level of production in which the marginal product of labor increases as the number of workers increases
Initially, the marginal product of a worker exceeds the marginal product of the previous worker
Level of production in which the marginal product of labor decreases as the number of workers increases
Eventually, the marginal product of a worker is less than the marginal product of the previous worker
When marginal product exceeds average product, average product increases
When marginal product is below average product, average product decreases
When marginal product = average product, average product is at its maximum
A firm’s total cost is the cost of all resources used
Total fixed cost is the cost of the firm’s variable inputs. Variable costs do not change with output
Total variable cost is the cost of the firm’s variable inputs. Variable costs do change with output
Total cost = total fixed cost plus total variable cost (TC = TFC + TVC)
Look at PP for graphs, examples
Increase in total cost that results from a one-unit increase in total product
Over the output range with increasing marginal returns, marginal cost falls as output increases (MP curve goes up, MC goes down)
Over the output range with diminishing marginal returns, marginal cost rises as output increases
Average cost measures can be derived from each of the total cost measures: (AC = TC/Q)
Average fixed cost (AFC) is the total fixed cost per unit of output
Average variable cost (AVC) is the total variable cost per unit of output
Average total cost (ATC) is the total cost per unit of output (ATC = AFC + AVC)
Look at PP for graphs, examples
ATC curve is the vertical sum of the AFC curve and the AVC curve.
The U-shape of the ATC curve arises from influence of two opposing forces:
Spreading total fixed cost over a larger output—AFC curve slopes downward as output increases.
Eventually diminishing returns—the AVC curve slopes upward and AVC increases more quickly than AFC is decreasing.
Shapes of a firm’s cost curves are determined by the technology it uses:
MC is at its minimum at the same output level at which MP is at its maximum
When MP is rising, MC is falling
AVC is at its minimum at the same output level at which AP is at its maximum
When AP is rising, AVC is falling
Technology
Prices of factors of production
Technological change influences both the product and cost curves
Increase in productivity shifts the product curves upward and the cost curves downward
If a technological advance results in the firm using more capital and less labor, fixed costs increase and variable costs decrease
In this case, average total cost increases at low output levels and decreases at high output levels
Increase in the price of a factor of production increases costs and shifts the cost curves
Increase in a fixed cost shifts the total cost and average total cost curves upward but does not shift the marginal cost curve
Increase in a variable cost shifts the total cost, average total cost, and marginal cost curves upward
The behavior of long-run cost depends upon the firm’s production function
The firm’s production function is the relationship between the maximum output attainable and the quantities of both capital and labor
Look at PP for examples
A firm’s production function exhibits diminishing marginal returns to labor (for a given plant) as well as diminishing marginal returns to capital (for a quantity of labor)
For each plant, diminishing marginal product of labor creates a set of short run, U-shaped cost curves for MC, AVC, ATC
The average cost of producing a given output varies and depends on the firm’s plant
The firm has 4 different plants: 1, 2, 3, or 4 machines
Each plant has a short-run ATC curve
The firm can compare the ATC for each output at different plants
LOOK AT PP FOR GRAPHS
Made up from the lowest ATC for each output level
We want to decide which plant has the lowest cost for producing each output level
Is the relationship between lowest attainable average cost and output when both the plant and labor are varied
Long-run average cost curve is a planning curve that tells the firm the plant that minimizes the cost of producing a given output range.
Look at PP for graphs
Features of a firm’s technology that lead to falling long-run average cost as output increases
The smallest quantity of output at which the long-run average cost reaches its lowest level
If the long-run average cost curve is U-shaped, the minimum point identifies the minimum efficient scale output level
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