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total cost
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The total of (1) out-of-pocket costs and (2) opportunity cost of all factors of production. (TC = FC + VC)
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total revenue
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The total amount that a firm takes in from the sale of its product (Price x quantity)
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profit
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the difference between total revenue and total cost
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normal rate of return
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A rate of return on capital that is just sufficient to keep owners and investors satisfied. For relatively risk-free firms, it should be nearly the same as the interest rate on risk-free government bonds.
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optimal method of production
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the production method that minimizes cost for a given level of output
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marginal product
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the additional output that can be produced by adding one more unit of a specific input (labor), ceteris paribus.
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law of diminishing returns
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When additional units of a variable input are added to fixed inputs after a certain point, the marginal product of the variable input declines.
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short run
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The period of time for which two conditions hold: The firm is operating under a fixed scale (fixed factor) of production, and firms can neither enter nor exit an industry.
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long run
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the period of time in which a firm can vary all its inputs, adopt new technology, and increase or decrease the size of its physical plant. (No fixed factors of production and firms can enter and exit the industry)
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economic profit
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total revenue minus total cost, including fixed costs, variable costs, and opportunity costs. (TR - (FC+VC+OC)
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accounting profit
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total revenue minus total cost, including fixed costs and variable costs. TR - (FC+VC). No opportunity cost.
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fixed cost
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Any cost that does not depend on the firms' level of output. These costs are incurred even if the firm is producing nothing. There are no fixed costs in the long run.
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variable cost
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a cost that depends on the level of production chosen
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spreading overhead
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The process of dividing total fixed costs by more units of output. Average fixed cost declines as quantity rises.
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total variable cost (TVC)
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the total of all costs that vary with output in the short run
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marginal cost (MC)
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The increase in total cost that results from producing 1 more unit of output. Marginal costs reflect changes in variable costs.
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average variable cost (AVC)
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total variable cost divided by the number of units of output; a per-unit measure of variable costs.
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average total cost (ATC)
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total cost divided by the number of units of output; a per-unit measure of total costs.
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marginal revenue (MR)
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The additional revenue that a firm takes in when it increases output by one additional unit. In perfect competition, P = MR.
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profit maximization
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firms that want to maximize their profits produce where MC=MR, or as close to it as possible.
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average fixed cost (AFC)
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total fixed costs divided by quantity of output. On the graph, difference between ATC and AVC.
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breaking even
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the situation in which a firm is earning exactly a normal rate of return. Zero economic profit. P = the bottom of the ATC
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minimizing losses
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AVC < P = shut down in long run, operating profit
AVC > P = shut down immediately, operating loss
AVC > P = shut down immediately, operating loss
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shutdown point
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The lowest point on the average variable cost curve. When price falls below the minimum point on AVC, total revenue is insufficient to cover variable costs and the firm will shut down and bear losses equal to fixed costs.
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short-run industry supply curve
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the sum of the marginal cost curves (above AVC) of all the firms in an industry
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economies of scale (increasing returns to scale)
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an increase in a firm's scale of production leads to lower costs per unit produced
Output > Input
Output > Input
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constant returns to scale
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an increase in a firm's scale of production has no effect on costs per unit produced. THIS IS WHERE FIRMS WANT TO BE!!
Output = Input
Output = Input
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diseconomies of scale/decreasing returns to scale
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an increase in a firm's scale of production leads to higher costs per unit produced
Output < Input
Output < Input
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long-run average cost curve (LRAC)
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shows the way per unit costs change with output in the long run
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minimum efficient scale (MES)
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the smallest size at which long-run average cost is at its minimum
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optimal scale of plant
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the scale of plant that minimizes long-run average cost
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long run equilibrium (long run competitive equilibrium)
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when P = SRMC = SRAC = LRAC and profits are zero.
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operating profit
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difference between AVC and P. Zero operating profit is when the bottom of AVC and P meet.
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derived demand
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the demand for resources (inputs) that is dependent on the demand for the outputs those resources can be used to produce
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marginal product of labor (MPL)
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the additional output produced by 1 additional unit of labor
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marginal revenue product of labor (MRPL)
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the additional revenue a firm earns by employing 1 additional unit of an input (labor), ceteris paribus.
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Sources of economies of scale
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purchasing in bulk, improvement in management quality, and improvements or utilization of technologies that increase efficiency.
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Sources of Diseconomies of Scale
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communication breakdown, lack of motivation, lack of coordination, and loss of focus by the management and employees.
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factor substitution effect
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The tendency of firms to substitute away from a factor whose price has risen and toward a factor whose price has fallen.
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