Chapter 9: Production

Total Variable Cost (TVC)

+ curved slope up The number of workers you hire or the amount of hours your employees work can often fluctuate in the short run. This is a variable cost. Variable costs will increase as you produce more units. Cost increases with increased quantity.

Compare and contrast the short-run relationships between total product, average product, and marginal product. Define and describe the law of diminishing marginal products.

- When marginal product is a POSITIVE number total product increases. - When marginal product is ZERO total product is at its maximum value -When marginal product is a negative number, total product decreases Average product is total product divided by the number of employees. Marginal product is the change in total product that occurs when another employee is added to the firm, or the extra output from an additional employee --> Marginal product declines in the short run as more employees are added to a fixed-size plant with a fixed amount of technology and machinery. A firm can increase output in the short run by adding more employees and purchasing more raw materials: in general, using the fixed resources more efficiently.

Suppose that a business incurred explicit costs of $1.5 million and implicit costs of $300,000 last year. If the firm sold 4,500 units of its output at $450 per unit, its accounting profits were _________ and its economic profits were _________.

525,000 225,000

Average Fixed Cost (AFC)

AFC = TFC/Q (-) slope curving down

Average Variable Cost (AVC)

AVC = TVC/Q + slope curving up (loose U shape)

How do accounting profits compare to economic profits

Accounting profit only considers explicit costs. Accountants subtract the explicit costs from total revenue (Price × Quantity). Economic profit considers all costs incurred by a business: the explicit costs that accountants track and the implicit costs.

fixed costs

Costs that do not vary with the quantity of output produced

economic profit equation

Economic profit = TR - Economic costs *or TR - (Explicit costs + implicit cost)

LRATC curve (long run average total cost)

Economies of scale (left side) Constant returns to sclae (middle) Deseconomies of scale (right)

Economic costs =

Explicit + implicit costs costs associated with the use of resources

marginal product (MP) equation

MP= TP new - TP old / L new - L old

Average Total Cost (ATC)

TC/Q + slope curving up (loose U shape) above AVC

average product equation

TP (total product) / # of units of a resource employed

example of fixed costs

The insurance you must pay for owning a car does not change with how much you use the car. This is a fixed cost.

diminishing marginal returns

a characteristic of production whereby the marginal product of the next unit of a variable resource utilized is less than that of the previous variable resource

Economies of scale

a condition in which the long-run average total cost of production decreases as production increases

Long-Run Average Total Cost Curve

a curve showing the lowest average total cost possible for any given level of output when all inputs of production are variable

when total product is rising: a. marginal product is + b. marginal product is 0 c. marginal product is - d. average product is decreasing

a. marginal product is +

accounting profit equation

accounting profit = total revenue - explicit costs

average product

average amount of output produced per unit of a resource employed

Key understanding: Margianl values drive __________

averages

marginal product: a. declines across all levels of output, except the first unit b. usually increases then decreases, but stays a positive value c. usually increases then decreases and may become nagative d. is always more than total product

c. usually increases then decreases and may become negative

increasing marginal returns

characteristic or production whereby the MP of the next unit of a variable resource utilized is greater than that of the previous variable resource

varaible costs

costs that change with the amount of output produced -increases as production increases -decreases as production decreases

Generally, accounting profits are: a. greater than economic profits, bc accounting profits do not consider explicit costs b. equal to economic profits, bc accounting costs include all opportunity costs c. smaller than economic profits, bc accounting profits do not consider implicit costs d. greater than economic profits, bc accounting profits do not consider implicit costs

d. greater than economic profits, bc accounting profits do not consider implicit costs

Explicit costs "accounting costs"

direct payment a firm must make to others to obtain a resource [land, labor, capital, and entrepreneurial ability] --> typically subtracted from a company's total revenue to calculate the company's accounting profit (difference between money brought in and money paid out)

Should business operating decisions should be made on the basis of economic profit or accounting profit?

economic profit --> If economic profits exist, then the industry will expand as new firms enter the market. If economic losses are incurred, firms will leave the industry and it will contract.

diseconomies of scale

long-run average total cost of production increases as production increases

Example of implicit cost

new business owner using his or her personal savings as start-up capital, using a building that he or she already owns, or giving up a salary at another firm to start that new business.

Implicit costs

opportunity cost of utilizing resources it already owns --> no actual payment is made

Total Fixed Cost (TFC)

straight horizontal line Cost does not increase with increased quantity.

Total Cost (TC)

sum of fixed and variable costs of production TC = TFC + TVC

Marginal cost

the cost of producing one more unit of a good + check shaped slope up

marginal product

the increase in output that arises from an additional unit of input *equal to the change in total product divided by the change in labor.

Long run

the time period in which all inputs can be changed

short run

the time period in which at least one input is fixed (other inputs can be changed) --> fixed input is the size of the factory or plant capacity.

Total Product (TP)

total product (TP) = total output the total amount of output produced with a given amount of resources in order to understand what happens in the short run for firms ..... need to understand how much they can produce without adjusting that fixed input.

Example of explicit costs

wage, rent, morgage and materials

opportunity cost

what a person or business has to give up if they choose to do something --> the value of the next best foregone alternative

constant returns to scale

when long-run average total cost is constant as production increases