Total revenue-Total Cost
Accounting profit formula
Total Revenue-Explicit Costs
Total revenue-(explicit costs + implicit costs)
What are explicit costs
Require outlay of money
What does economic profit tell you? Economic profit for firms?
How much better or worse your doing than your next best option.
For firms, 0 economic profit means earning normal rate of return in market
Why is accounting profit and economic profit different?
Accounts are trying to track money.
Economists are trying to explain decisions
What is production function?
Shows the relationship between the quantity of inputs used to produce a good and the quantity of output for that good
What forms can a production function come in?
Table, equation or graph
What is Average Product?
output per worker
additional output that comes from an additional worker, other inputs constant
Marginal product of labor
Tells us how much output increases with the last worker hired
Diminishing marginal product
Each additional input gives less extra production than the last.
Hire best workers first
Each additional worker hired has fewer resources to work with
Law of diminishing marginal productivity?
states as more of an input is added to a process, after some point the added output from the additional input will fall.
Why does MPL diminish
As a company hires more workers, each on increases production (up to a certain point), but by a smaller amount than the last
As we adder workers, the average worker no has fewer factors to work with, is less productive
Firms are intelligent in hiring and hire the most productive workers first
Diminishing absolute productivity
Below 0 marginal product
Total Cost formula
Fixed costs + Variable costs
costs that cost the same no matter how much output is produced, overhead costs such as rent
Costs that change as output changes, such as wages paid to workers, buying materials for production
What happens to the cost as more output is produced
When deciding whether or not to produce another unit of output, firms look at what?
Increase in total cost from producing more output
(Change in total costs) / (change in quantity)
Represents the cost of producing an additional unit
Increases as Q increases
Average total cost
How much does each unit cost on average
This is the cost per unit produced
Average fixed cost
How much of per unit cost comes from fixed expenditures (overhead)
Decreases as quantity of output increases
Average Variable Cost
How much of per unit cost comes from levels of inputs changing
What happens to the TC and VC curves as Q increases?
MC,ATC and AVC curves are..?
AFC curve is always ---- as Quantity increases?
FC curve is always ----
If marginal productivity is rising, then marginal costs are ??
If average productivity is falling, average costs are ----?
Why is marginal cost will be equal to the average total cost at the minimum ATC?
When MC < ATC each additional unit reduces the average
When MC > ATC each additional unit increases the average
So MC= ATC at the minimum point on the ATC curve
The relationship between marginal coast and average cost?
The marginal cost curve goes through the minimum point of the ATC curve
Short- run decisions on the firm details?
Some inputs into production process are fixed
If the firm wants to increase or decrease production they have limited options about how to do so
Long-run production decisions?
No inputs are fixed
Firms can change levels of any and all inputs
Firms do not take level of technology, plant size as a given
Choose combinations of inputs and level of technology that offer the lowest cost
Main difference between short run and long run?
Long run does NOT have fixed costs. You can get out of a rent contract if you want over longer periods, for example, can switch from one factory to two factories and so on.
As a result, we generally think of long run ATC curves as being flatter than those in the short-run. This means firms find the most efficient way to produce good over longer time periods.
What will the long-run cost curve (ATC) look like?
We expect that, as production increases, long run ATC will decrease at first
Economies of scale: when ATC decreases as Q increases, which means the firm is getting more efficient as they produce more
Constant returns to scale- ATC stays the same as Q increases
Diseconomies of Scale: When ATC increases as Q increases, which means the firm is getting less efficient as they produce more
Why is it that production increases, long run ATC will decrease at first
Buying in bulk
Dividing setup costs among more units
This is Economies of Scale
We expect ATC to start to increase as we continue to increase the level of production. Why?
Increasing Monitoring costs
Diminishing marginal product
Minimum efficient level of production: the level of production at which the economies of scale for the firm are exhausted, where the long-run curve flattens out
Economies of Scale
Difference between short-run and long-run production is...?
Flexibility to change all levels of all inputs
Economies and diseconomies of scale describe what?
Relationship between costs and production
Economists normally assume the goal of a firm is to earn....?
Profits that are as large as possible, even if that means reducing output and even if that means higher total costs
Do not require an outlay of money by the firm
A Firm would never choose to continue production when earning 0$ in economic profit. True or False?
How do economists distinguish between the short run and the long run?
By looking at the period of time in which certain inputs and costs are fixed
What are the characteristics of a perfectly competitive market?
Many buyers and seller
Each buyer and seller is a price taker
Free entry and exit of firms
Firms maximize profit
What firms decisions are we interested in?
How much to produce
What price to charge
How many workers to hire
What factors influence these decision?
Actions of those in supply chain
Level of competition in the market
Economists normally assume that a goal of a firm is to....?
What best describes the nature of most production functions?
Output increases at a decreasing rate with additional units of input
The amount of money that a wheat farm could have earned if he had planted barley instead of wheat is an example of ...?
An implicit Cost
The cost of producing an additional unit of output is the firm's...?
Firms are price takers?
This means that the decision of the firm is to look at the market price and costs and decide how much to produce.
Increasing the quantity won't change market price
As a result, Marginal Revenue is constant and always equal to price
Free entry and exit of firms?
Means that if firms in a certain industry are making large profits, there is nothing blocking other firms from coming in and out and competing
Means buyers only care about price
If the conditions of perfect competition are met then..?
Economic forces operate perfectly
Firms that can afford to produce and sell do
Buyers that value at or above buy
If factors change in the market, supply and demand will adjust to bring back to equilibrium
As a result of firms being price takers, MR is...?
constant and always equal to price
Firm maximizes profits by producing quantity where MR=MC....Explain the inequalities?
If MR > MC, you get more than cost for next unit, so produce more.
If MR < MC, you get less than cost for next unit, so produce less
Stop at the level of production where MR=MC
Monopoly firms makes decisions based on what?
Competitive firms make decision based on what?
Price and Quantity
Decision in the short run: shut down or produce?
Shut Down if P is less than AVC. This would mean that you could not cover costs of day-day operations. At this point, fixed costs are sunk costs. Firms might be operating at a loss for a while if they are covering some fixed costs.
Decision in the long run: exit the market?
No fixed costs, so exit the market if P is less than AVC. (The price is not high enough to cover the average cost per unit.
What best describes the decision making of firms in a perfectly competitive market?
Firms have to primarily decide what quantity to produce.
If demand increases in the short run in a competitive market, we expect....?
Firms will make positive profits in the short run and more firms will enter
What is constant for a firm in a competitive market?
Price equals marginal revenue and marginal revenue is constant
If a competitive firm is currently producing at a level of output at which marginal revenue is less than marginal cost, then....?
A one-unit decrease in output will increase the firm's profit
What the most important for determining the level of profits firms will earn in the long run?
Ease of entry and exit in the market
What are the characteristics of a monopoly
On firm selling a particular product
No close substitutes
Firm sets the price
Barriers to entry
What is a monopoly?
Where a key resource required for production is owned by a single firm. Example: DeBeers owns most diamond mines
Barriers to entry?
Control of resources
Government regulation (such as patents)
A single firm can produce output at a lower cost than a larger number of producers
Economies of scale
Example: Electricity production and walmart
Differences between Monopoly and a competitive firm
Market demand curve is downward sloping
Demand curve for the firm is horizontal at market price
We assume a competitive firm can increase quantity without lowering price
Market demand curve is downward sloping
Monopolist is only firm in the market, so firm demand is market demand
To sell larger quantity, the firm will have to lower price
Monopolist revenue formula
Price times Quantity
Monopolist Marginal Revenue Formula
Change in TR/Change in Q
Revenue for each additional unit of output
Changes as quantity changes
For a monopolist, increasing quantity sold has two effects?
In order to sell more in a monopoly, you have to do what?
Lower the price. MR<P
This means that total surplus is no longer maximized
What is the profit maximizing condition of a monopolist?
Monopolists profit formula
(price-ATC) times Quantity