CH.7 TERMS
the difference between revenue and the total cost to a firm of producing the goods and services it offers for sale
profit
A firm earns an economic profit when
profits are greater than zero after implicit costs are considered
University of Tennessee Neyland Football Stadium Fixed costs
property and equipment - (usually physical capital but some level of labor can be fixed) *costs stadium faces no matter how many people come to the game* -maintenance costs -lighting and sound -referees
normal rate of return
return just sufficient to keep investors satisfied; it therefore represents the opportunity cost of capital.
Variable costs
rise as the level of output increases
Marginal product
the change in output resulting from a one-unit increase in labor (ΔQ/ΔL)
Technology alters the shape of the
long-run ATC curve
long run
a period sufficient for a firm to adjust all factors of production, including plant capacity *Firms can enter or exit the industry
Partnership Advantages
-Ability to share work -Ability to share risks
Sole Proprietorship Advantages
-Control by owner -No layers of management
Corporation Disadvantages
-Costly to organize -Possible double taxation of income
ROLE OF TECHNOLOGY
-Enhances production techniques -Improves global communications -Provides computing power for easier expansion and economies of scale
Corporation Advantages
-Limited personal liability -Greater ability to raise funds
PARTNERSHIPS
-More than one owner -Can divide tasks among partners -Division of labor -Personal assets of all owners subject to unlimited liability -Includes negligence by partners
SOLE PROPRIETORSHIP
-One owner -Easy to start -Limited access to financial capital -Owner's personal assets subject to unlimited liability
CORPORATIONS
-Owners called stockholders -Have legal rights (much like an individual) -Can raise money by issuing stocks and bonds -Owners protected by limited liability -Losses limited to value of stock
Partnership Disadvantages
-Unlimited personal liability -Limited ability to raise funds
Sole Proprietorship Disadvantages
-Unlimited personal liability -Limited ability to raise funds
DISECONOMIES OF SCALE can be due to:
-increased bureaucracy in management -increased cost of a scarce resource used in production -increasingly difficult terrain or rising operational costs
Economies of scale result from
-specialization of labor and management -better use of capital -complementary production techniques
3 types of implicit costs
1) foregone wages/salary 2) foregone interest 3) economic depreciation
WHAT COST IS GENERALLY ASSUMED TO BE FIXED?
A LEASE ON A BUILDING
Average cost
A measure of productivity (in terms of cost efficiency)
Why should sunk costs be ignored for decision making?
A sunk cost is a cost that has already been paid and cannot be recovered. Because no money can be returned, sunk costs should not influence future decisions.
ATC=
AFC + AVC
SUNK COSTS
ALREADY INCURRED; CANNOT BE RECOVERED. RATIONAL DECISIONS ABOUT PRODUCTION IGNORE SUNK COSTS
DIMINISHING RETURNS TO LABOR OCCUR
AS MORE WORKERS ARE USED
List some of the reasons why the long-run average total cost curve has sort of a flat bowl shape. It declines early on, then is rather flat over a portion, and finally slopes upward.
As a firm expands its output, economies of scale are encountered due to specialization of labor and management. Eventually, a flat region is reached, reflecting the fact that the firm can duplicate its operations at virtually the same cost. Finally, the firm gets so big that it begins to lose control, and costs begin to rise.
Why is the average fixed cost curve not U-shaped? Why does it not turn up as the average variable cost and average total cost curves do?
Because fixed costs are fixed, total fixed costs do not vary, thus as more output is produced, average fixed costs continue to fall as the Q in FC/Q gets larger
COST STRUCTURE
DEPENDS ON THE NATURE OF THE PRODUCTION PROCESS
Role of entrepreneurs
Despite accounting for only about 13 % of the population, immigrants now start more than 1/4 of new businesses in this country. Fast-growing ones, too--more than 20% of the 2014 Inc. 500 CEOs are immigrants.
EXPLICIT COSTS
EXPENSES PAID DIRECTLY TO SOME ENTITY (WAGES, LEASE PAYMENTS, RAW MATERIALS, TAXES, ETC.)
What is the difference between explicit and implicit costs? What is the difference between economic and accounting profits? Are these four concepts related? How?
Explicit costs are those out-of-pocket expenses paid to others, while implicit costs are opportunity costs. Economic profits are profits after both explicit and implicit costs are deducted, while accounting profits typically do not have implicit costs deducted. The four concepts are related in how they are defined, with implicit costs playing an important role.
TC=
FC + VC
AFC = average fixed cost
FC/Q
Average fixed cost
FC/Q Fixed cost divided by the quantity of output produced
LONG RUN PRODUCTION COSTS firms/plants
Firms choose the plant size appropriate for their market; plant size can be adjusted as output levels change Each plant size is associated with a unique long-run cost structure
If marginal cost is less than average total cost, are average total costs rising or falling? Alternatively, if marginal cost is more than average total cost, are average total costs rising or falling? Explain how this example might apply to a basketball player attempting to achieve a high average points per game.
If marginal cost is less than average total cost, then average total cost is falling and vice versa. A baseball player hitting .333 (gets a hit one-third of the time on average) will see his average rise when he gets a hit and fall when he does not. If the average income of your class is $15,000 (some people work), and Tom Cruise decides to take a refresher course in economics and joins your class, the average income rises, and vice versa if someone with no income joins the class. A basketball player's average points per game (ppg) is calculated based on all games played to date in a season. Suppose a player's average is 10 ppg. If the player scores 15 points in the next game, her marginal score (15) is greater than her average (10), which means that her average will rise. Alternatively, if she scores only 5 points in the next game, her marginal score (5) is less than her average (10), which means her average will fall.
The movie industry earns a substantial portion of its total revenues through Internet streaming and downloads. Although producing a movie can cost tens of millions of dollars, the marginal cost of producing another copy or download is practically nothing. For this industry, would short-run ATC and MC still be U-shaped? If not, what would these curves look like?
In industries that have very high fixed costs and virtually no marginal costs, the short-run ATC and MC curves would not have the typical U-shape of more traditional industries. Instead, when MC = $0, the curve is nearly horizontal. This means that the average total cost curve would continuously fall as more quantity is produced, and would resemble an average fixed cost curve.
How does the short run differ from the long run? Is the long run the same for all industries? Why or why not?
In the short run, one factor of production is fixed, but in the long run all factors can vary, and firms can enter or leave the industry. The long run differs for industries and firms because the time required to expand plant capacity differs among industries. Some industries (chemical and nuclear power plants) are heavily regulated, while others (restaurants and retail establishments) are not, and these regulations take more or less time to fulfill.
ECONOMIC COSTS
Include both explicit and implicit costs
What is the difference between marginal cost and average total cost?
Marginal cost is the additional cost of producing one more unit, while average total cost is the average cost per unit of all units produced. Marginal cost is used by businesses to determine whether to expand or restrict production, while average total cost provides an overall indicator of performance that will determine if a business remains in the industry over the long run.
IF TOO MANY WORKERS ARE USED
NEGATIVE RETURNS TO LABOR CAN RESULT
IMPLICIT COSTS
OPPORTUNITY COSTS OF USING RESOURCES (DEPRECIATION, ASSET DEPLETION, FORGONE WAGES)
REVENUE =
PRICE PER UNIT × QUANTITY
ECONOMIES OF SCOPE
PRODUCING INTERDEPENDENT PRODUCTS (AS DOES PROCTER & GAMBLE) HELPS TO REDUCE PRODUCTION AND MARKETING COSTS
TYPES OF FIRMS
SOLE PROPRIETORSHIP PARTNERSHIPS CORPORATIONS
ATC= average total cost
TC/Q
Average total cost
TC/Q
PRODUCTION
THE PROCESS OF TURNING INPUTS INTO OUTPUTS
THE GOAL OF BUSINESSES IS
TO MAXIMIZE PROFITS
ECONOMIC PROFIT
TOTAL REVENUE − EXPLICIT COSTS − IMPLICIT COSTS
ACCOUNTING PROFIT
TOTAL REVENUE − EXPLICIT COSTS
PROFITS =
TOTAL REVENUE − TOTAL COST
Marginal cost
The change in total cost from the production of one more unit of output. MC = ΔTC/ΔQ
PRODUCTION COSTS IN THE SHORT RUN Marginal cost
The change in total cost from the production of one more unit of output. MC = ΔTC/ΔQ
In order to take this class, you had to pay tuition, buy the textbook, and buy a new laptop. Which of these items (if any) would be considered a sunk cost? Explain your reasoning.
The tuition you paid is most likely a sunk cost if the university does not provide any refunds if you drop the course. A textbook is not a sunk cost, because you may be able to sell the book to the bookstore at the end of the term for a small amount of money. A laptop is not a sunk cost, because a used laptop can be sold at any time.
If you work hard building your business and end up earning zero economic profit for the year, would this be considered a failed business to an economist? Why or why not?
To an economist, earning zero economic profit is not a bad outcome at all. Zero economic profit means that a business is earning normal profits, a level of profits that would be earned under the next best alternative use of resources. In other words, economic profit takes into account all opportunity costs, including the value of the time and money given up to pursue the business.
AVC= average variable cost
VC/Q
Average variable cost
VC/Q Variable cost divided by the quantity of output produced
Why should a firm never hire a worker when negative marginal returns set in?
When marginal returns are negative, hiring an additional worker causes total production to fall. Therefore, a firm would be better off not hiring that worker.
In the long run, firms build plants that
achieve the lowest possible average cost based on the output level
PRODUCTIONS COSTS IN THE LONG RUN
all inputs can be adjusted; therefore, there are no fixed costs in the long run
A normal profit equals
an economic profit of zero
AVC and ATC curves
are U-shaped
MP crosses the AP
at its maximum
average total cost is the sum of
average fixed cost plus average variable cost
increase in the marginal product
can result from the division of labor and from specialization
University of Tennessee Neyland Football Stadium In the short-run
capacity of the stadium is fixed
what earns the Majority of Revenue and Profits
corporations
marginal cost curve
crosses the minimum points of the ATC and AVC curves
SHORT RUN COST CURVES At relatively low levels of output
curves slope downward, reflecting increasing returns as average costs fall
average fixed cost curve always
decreases as production increases
MARGINAL PRODUCT falls as (short run)
diminishing returns set in
SHORT RUN COST CURVES As production rises
diminishing returns set in, and average costs rise
As firms continue to grow, they eventually encounter
diseconomies of scale as average total costs rise
Fixed costs (overhead)
do not vary with the quantity produced
If a firm's rate of return on capital falls below the normal rate of return
investors will put their funds to use elsewhere
short run
is a period when at least one factor of production is fixed and cannot be altered *Plant capacity is fixed
As a firm's output increases
its long-run average total costs tend to fall
MARGINAL PRODUCT rises as (short run)
more workers are hired
Average long-run costs change with
output as economies of scale wear out
Total costs
sum of fixed and variable costs
University of Tennessee Neyland Football Stadium Variable costs
technology, labor, materials *costs that vary depending on attendance* -number of police officers -number of workers to sell -concessions -amount of concessions available
University of Tennessee Neyland Football Stadium If UT expects more people to attend on average
they can expand capacity in the long run
Average product
total output divided by the amount of labor input (Q/L)
when the marginal product of labor is increasing
total output increases at an increasing rate
when the marginal product of labor is decreasing, but still positive
total output increases, but at a decreasing rate