Ch.7 Businesses and the Costs of Production

short run

(1) In microeconomics, a period of time in which producers are able to change the quantities of some but not all of the resources they employ; a period in which some resources (usually plant) are fixed and some are variable. (2) In macroeconomics, a period in which nominal wages and other input prices do not change in response to a change in the price level.

long run

(1) In microeconomics, a period of time long enough to enable producers of a product to change the quantities of all the resources they employ; period in which all resources and costs are variable and no resources or costs are fixed. (2) In macroeconomics, a period sufficiently long for nominal wages and other input prices to change in response to a change in a nation's price level.

variable costs

A cost that in total increases when the firm increases its output and decreases when the firm reduces its output.

minimum efficient scale

A firm's BLANK BLANK BLANK (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.

average total cost (ATC)

A firm's total cost divided by output (the quantity of product produced); equal to average fixed cost plus average variable cost.

average fixed cost (AFC)

A firm's total fixed cost divided by output (the quantity of product produced).

average variable cost (AVC)

A firm's total variable cost divided by output (the quantity of product produced).

economic cost

A payment that must be made to obtain and retain the services of a resource; the income a firm must provide to a resource supplier to attract the resource away from an alternative use; equal to the quantity of other products that cannot be produced when resources are instead used to make a particular product.

natural monopoly

An industry in which economies of scale are so great that a single firm can produce the product at a lower average total cost than would be possible if more than one firm produced the product.

fixed costs

Any cost that in total does not change when the firm changes its output; the cost of fixed resources.

fixed, variable, total

Average fixed, average variable, and average total costs are fixed, variable, and total costs per unit of output. Average BLANKED cost declines continuously as output increases because a fixed sum is being spread over a larger and larger number of units of production. A graph of average BLANK cost is U-shaped, reflecting increasing returns followed by diminishing returns. Average BLANK cost is the sum of average fixed and average variable costs; its graph is also U-shaped.

Marginal cost

BLANK BLANK is the extra, or additional, cost of producing one more unit of output. It is the amount by which total cost and total variable cost change when one more or one less unit of output is produced. Graphically, the marginal-cost curve intersects the ATC and AVC curves at their minimum points.

total cost

Because some resources are variable and others are fixed, costs can be classified as variable or fixed in the short run. Fixed costs are independent of the level of output; variable costs vary with output. The BLANK BLANK of any output is the sum of fixed and variable costs at that output.

fixed

In the short run a firm's plant capacity is BLANKED. 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.

diseconomies of scale

Increases in the average total cost of producing a product as the firm expands the size of its plant (its output) in the long run.

downward, upward

Lower resource prices shift cost curves BLANKWARD, as does technological progress. Higher input prices shift cost curves BLANKWARD.

economies of scale

Reductions in the average total cost of producing a product as the firm expands the size of plant (its output) in the long run; the economies of mass production.

economic cost

The BLANK BLANK 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 (= explicit costs + implicit costs, including a normal profit).

law diminishing returns

The BLANK of BLANKING BLANKS 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.

marginal product (MP)

The additional output produced when 1 additional unit of a resource is employed (the quantity of all other resources employed remaining constant); equal to the change in total product divided by the change in the quantity of a resource employed.

marginal cost (MC)

The extra (additional) cost of producing 1 more unit of output; equal to the change in total cost divided by the change in output (and, in the short run, to the change in total variable cost divided by the change in output).

variable

The long run is a period of time sufficiently long for a firm to vary the amounts of all resources used, including plant size. In the long run all costs are BLANK. The long-run ATC, or planning, curve is composed of segments of the short-run ATC curves, and it represents the various plant sizes a firm can construct in the long run.

Economies, diseconomies

The long-run ATC curve is generally U-shaped. BLANK 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 output all contribute to economies of scale. As the firm continues to grow, it will encounter BLANK of scale stemming from the managerial complexities that accompany large-scale production. The output ranges over which economies and diseconomies of scale occur in an industry are often an important determinant of the structure of that industry.

minimum efficient scale (MES)

The lowest level of output at which a firm can minimize long-run average total cost.

implicit costs

The monetary income a firm sacrifices when it uses a resource it owns rather than supplying the resource in the market; equal to what the resource could have earned in the best-paying alternative employment; includes a normal profit.

explicit costs

The monetary payment a firm must make to an outsider to obtain a resource.

normal profit

The payment made by a firm to obtain and retain entrepreneurial ability; the minimum income entrepreneurial ability must receive to induce it to perform entrepreneurial functions for a firm.

law of diminishing returns

The principle that as successive increments of a variable resource are added to a fixed resource, the marginal product of the variable resource will eventually decrease.

total cost

The sum of fixed cost and variable cost.

total product (TP)

The total output of a particular good or service produced by a firm (or a group of firms or the entire economy).

average product (AP)

The total output produced per unit of a resource employed (total product divided by the quantity of that employed resource).

economic profit

The total revenue of a firm less its economic costs (which include both explicit costs and implicit costs); also called "pure profit" and "above-normal profit."

accounting profit

The total revenue of a firm less its explicit costs; the profit (or net income) that appears on accounting statements and that is reported to the government for tax purposes.

constant returns to scale

Unchanging average total cost of producing a product as the firm expands the size of its plant (its output) in the long run.