CH. 7 Production, costs, and industry structure
Marcie quit her job as a preschool teacher, which paid an annual salary of $28,000, and became a street food vendor. She used $8,000 out of her savings account that paid a 4% annual interest rate to buy a street cart to sell food. In her first year of operations, she spent $10,000 on food and supplies (napkins, cups, plates, etc.) and earned total revenue of $45,000. Marcie's accounting profit is ______ and economic profit is ______.
$35,000; $6680 $45,000 minus direct expenses of $10,000 yields the accounting profit of $35,000. Subtract the foregone salary ($28,000) and the foregone interest on the $8000 ($320) invested into the business, and you get the economic profit of $6680. The $8000 taken from the bank account is not an expense. That is an asset converted from cash to equipment.
____________ tells a firm whether it can earn profits given the price in the market.
Average cost
factors of production
Natural resources, , labor, capital, technology, entrepreneurship
total revenue
Price x Quantity
factor payments
Raw materials prices, rent, wages and salaries interest and dividends, profit for entrepreneurship
What does production entail?
What to produce, how to produce it, how much of it, what price to charge, how much labor should be employed
cost
Workers (L) x Wage Rate per hour
variable cost
a cost that rises or falls depending on the quantity produced
economic profit
accounting profit - implicit costs Total Revenue - Total Costs
explicit costs
actual payments; out-of-pocket costs; production costs
A LRAC curve with a flat bottom...
allows firms to compete because they have a variety of outputs to produce at
diseconomies of scale/decreasing returns to scale
an increase in a firm's scale of production leads to higher costs per unit produced; as Q rises, LRATC rises
economies of scale (increasing returns to scale
an increase in a firm's scale of production leads to lower costs per unit produced; as Q rises, LRATC falls
When LRAC has a clear minimum point...
any firm producing a different quantity will have higher costs
Marginal Product (MP)
change in total product/change in labor (workers)
the price a firm charges for a good, the output produced, and labor employed all depend on...
cost conditions and production conditions
variable costs
costs that vary with the quantity of output produced total costs - fixed costs
The graph above illustrates the total cost function for GoodieCookie Co. The changing slope of the total cost curve reflects this company's:
decreasing marginal costs.
If a solar panel manufacturer wants to look at its total costs of production in the short run, which of the following would provide a useful starting point?
divide total costs into two categories: fixed costs that can't be changed in the short run and variable costs that can be.
According to the definition of profit, if a profit-maximizing firm will always attempt to produce its desired level of output at the lowest possible cost, then it will
do so regardless of what type of competition exists in a market.
When __________________ exist, doubling of all inputs will result in more than doubling output, which means __________________________________________.
economies of scale; a larger factory can produce at a lower average cost than a smaller company
"Constant returns to scale" describes a situation where
expanding all inputs does not change the average cost of production.
fixed cost
expenditure that a firm must make before production starts; a cost that does not change in the short run, no matter how much of a good is produced
Average Fixed Cost (AFC)
fixed cost divided by the quantity of output
average variable cost curve
initially falls because of increasing marginal returns but then rises because of diminishing marginal returns. is generally U shaped. production is relatively inefficient at low levels of production, become more efficient at greater levels of production, but then become inefficient again due to crowding. (VC/QP)
implicit costs
input costs that do not require an outlay of money by the firm; opportunity costs
variable input
input that can change in a short period of time
In their calculation of profit, accountants typically do not take into account
opportunity costs
In their calculation of profit, accountants typically do not take into account:
opportunity costs.
short run
period of time during which at least some factors of production are fixed
Firms will enter an industry when the:
price rises above the minimum of the average total cost curve.
average profit
profit divided by the quantity of output produced; profit margin
If there is a fixed cost, it is. . .
short run
marginal cost curve
shows how the cost of producing one more unit depends on the quantity that has already been produced; upward sloping
long-run average total cost curve
shows the firm's cost per unit at each level of output
average cost...
tells a firm whether it can earn profits given the price in the market.
Marginal Cost (MC)
the extra cost incurred by producing one more unit of a product
long run
the time period in which all inputs (factors of production) are variable
Average Total Cost (ATC)
total costs divided by quantity of output
accounting profit
total revenue - explicit costs
profit
total revenue - total cost
Average Variable Cost (AVC)
total variable costs divided by quantity of output
average total cost curve
typically U-shaped (TC/TQ)
diminishing marginal returns
when the marginal gain in output diminishes as each additional unit of input is added
If a comparison between average cost and price reveals whether a firm is earning profits, then a comparison between average variable cost and price reveals
whether the firm is earning profit if fixed costs are left out of the calculation.
