Chapter 7

Relate the law of diminishing returns to a firm's short-run production costs.

In the short run a firm's plant capacity is fixed. The firm can use its plant more or less intensively by adding or subtracting units of variable resources, but it does not have sufficient time in the short run to alter plant size. The law of diminishing returns describes what happens to output as a fixed plant is used more intensively. As successive units of a variable resource such as labor are added to a fixed plant, beyond some point the marginal product associated with each additional unit of a resource declines.

Explain why economic costs include both explicit (revealed and expressed) costs and implicit (present but not obvious) costs.

The economic cost of using a resource to produce a good or service is the value or worth that the resource would have had in its best alternative use. Economic costs include explicit costs, which flow to resources owned and supplied by others, and implicit costs, which are payments for the use of self-owned and self-employed resources. One implicit cost is a normal profit to the entrepreneur. Economic profit occurs when total revenue exceeds total cost (5 explicit costs,1 implicit costs, including a normal profit).

se economies of scale to link a firm's size and its average costs in the long run.

The long-run ATC curve is generally U-shaped. Economies of scale are first encountered as a small firm expands. Greater specialization in the use of labor and management, the ability to use the most efficient equipment, and the spreading of start-up costs among more units of out-put all contribute to economies of scale. As the firm continues to grow, it will encounter dis economies of scale stemming from the managerial complexities that accompany large-scale production. The output ranges over which economies and dis economies of scale occur in an industry are often an important determinant of the structure of that industry. A firm's minimum efficient scale (MES) is the lowest level of output at which it can minimize its long-run average cost. In some industries, MES occurs at such low levels of output that numerous firms can populate the industry. In other industries, MES occurs at such high output levels that only a few firms can exist in the long run.