Chapter 7

constant long run average cost

A condition that occurs if, over some range of output, long-run average cost neither increases nor decreases with changes in firm size

long run average cost curve

A curve that indicates the lowest average cost of production at each rate of output when the size, or scale, of the firm varies; also called the planning curve

Summary 2

A firm may initially experience increased marginal returns as it takes advantage of increased specialization of the variable resource. But the law of diminishing marginal returns indicates that the firm eventually reaches a point where adding more units of the variable resource yields a decreasing marginal product.

implicit cost

A firm's opportunity cost of using its own resources or those provided by its owners without a corresponding cash payment

long run

A period during which all resources under the firm's control are variable

short run

A period during which at least one of a firm's resources is fixed

variable cost

Any production cost that changes as the rate of output changes

fixed cost

Any production cost that is independent of the firm's rate of output

variable resouce

Any resource that can be varied in the short run to increase or decrease production

fixed resource

Any resource that cannot be varied in the short run

law of diminishing marginal returns

As more of a variable resource is added to a given amount of other resources, marginal product eventually declines and could become negative

Summary

Explicit costs are opportunity costs of resources employed by a firm that take the form of cash payments. Implicit costs are the opportunity costs of using resources owned by the firm. A firm earns a normal profit when total revenue covers all implicit and explicit costs. Economic profit equals total revenue minus both explicit and implicit costs.

diseconomies of scale

Forces that may eventually increase a firm's average cost as the scale of operation increases in the long run

economies of scale

Forces that reduce a firm's average cost as the scale of operation increases in the long run

Summary 4

In the long run, all inputs under the firm's control are variable, so there is no fixed cost. The firm's long-run average cost curve, also called its planning curve, is an envelope formed by a series of short-run average total cost curves. The long run is best thought of as a planning horizon.

normal profit

The accounting profit earned when all resources earn their opportunity cost; equal to implicit cost

marginal cost

The change in total cost resulting from a one-unit change in output; the change in total cost divided by the change in output, or MC = DTC/Dq

marginal product

The change in total product that occurs when the use of a particular resource increases by one unit, all other resources constant

Summary 3

The law of diminishing marginal returns from the variable resource is the most important feature of production in the short run and explains why marginal cost and average cost eventually increase as output expands.

minimum efficient scale

The lowest rate of output at which a firm takes full advantage of economies of scale

increasing marginal returns

The marginal product of a variable resource increases as each additional unit of that resource is employed

production function

The relationship between the amount of resources employed and a firm's total product

total cost

The sum of fixed cost and variable cost, or TC = FC + VC

average total cost

Total cost divided by output, or ATC 5 TC/q; the sum of average fixed cost and average variable cost, or ATC = AFC + AVC

Average variable cost

Variable cost divided by output, or AVC = VC/q

Summary 1

Variable resources can be varied quickly to increase or decrease output. In the short run, at least one resource is fixed. In the long run, all resources are variable.

economic profit

economic profit A firm's total revenue minus its explicit and implicit costs

explicit cost

explicit cost Opportunity cost of resources employed by a firm that takes the form of cash payments

total product

firms total output

accounting profit

total revenue minus explicit cost