Term
| Firm definition and it's goal? |
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Definition
• Name given to describe any business.
• Purpose of a business is to take inputs to produce output.
• Goal: maximize profit |
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Term
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Definition
a period of time in which at least one
input is fixed. The time period is too short for firms
to be able to expand or contract their capacity (plant
size) or to leave one market to enter another market. |
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Term
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Definition
a period of time in which all inputs can
vary. The firm capacity is able to vary and firms are
able to leave and enter markets. |
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Term
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Definition
| • Total Revenue ‐ Total Cost |
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Term
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Definition
• Total Cost to an accountant is the explicit cost:
direct outlays of money (payments to non‐owners of a firm for their resources). |
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Term
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Definition
forgone payments of money
for self‐employed self‐owned resources. |
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Term
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Definition
• Total Cost to an economist is both the explicit cost
plus the implicit cost
• Total Cost to an economist is called the Economic
Cost.
– this is the total opportunity cost (explicit and implicit).
IMPLICIT + EXPLICIT |
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Term
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Definition
| Equal to TR ‐ Explicit Cost |
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Term
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Definition
• Earning as much in this business as the other choice.
No more, no less.
• Earning a normal rate of return:
Normal Profit (Accounting Profit is almost always
greater than zero when a firm is earning “Normal Profit”). |
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Term
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Definition
• Earning more in this business than the other choice.
• Earning above a normal rate of return |
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Term
| Economic loss, normal profit, economic profit |
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Definition
• TR < Economic Cost: Economic Loss (Negative
Economic Profit).
• TR = Economic Cost: Normal Profit (Zero Economic
Profit).
• TR > Economic Cost: Economic Profit (Above Normal
Profit). |
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Term
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Definition
Short Run: at least one input is
constant (capital)
• The short run for a business is when it is limited by its physical
size. It takes time to expand in a current business or to move
into a new business. In the meantime, the owner(s) needs to
make decisions (short run decisions) concerning the
employment of labor and the production amount.
• Throughout this course, we will assume (for simplicity) that
there is only one input (factor of production) that is variable.
The input is labor.
– A variable input is a factor of production that the business can change
the amount employed from one day to another. |
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Term
| Total Product of Labor (TP) |
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Definition
Total maximum production (Q) when labor is added to the
production process holding capital and technology
constant.
– TP = Q |
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Term
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Definition
on average the amount of
output produced by each worker.
– Productivity of Labor
– AP = TP/L or Q/L |
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Term
| Marginal Product of Labor (MP) |
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Definition
the increase in TP when one more worker is added to
production.
– MP = ΔTP/ΔL or ΔQ/ΔL |
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Term
| Increasing Marginal Returns |
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Definition
• As more and more of a variable input (labor) is initially added
to a production process, holding at least one other input
constant (capital), the resulting increments of production
(MP) will, many times, increase.
– it is recognized when the MP is increasing
– labor is the variable input where we see Increasing Marginal Returns
• This happens when labor is being initially added to the
production process. When more and more workers are being
added, they can specialize more and more in particular types
of tasks. |
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Term
| Law of Diminishing Marginal Returns |
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Definition
• The benefits of specialization will eventually end
as more and more labor is added.
– This is not due to differences between workers. It is
due to the lack of additional equipment for the
workforce. As more and more workers are added to
production, eventually there will be less and less
equipment (capital) to be used by the new employees.
• As more and more of a variable input (labor) is
added to a production process, holding at least
one other input constant (capital), the resulting
increments of production (MP), after some point,
will diminish.
– Due to additional workers having, after some point,
less & less capital to work with.
– Once the MP starts to decline, we are experiencing
Diminishing Marginal Returns.
– Every business will come across Diminishing Marginal
Returns if the business adds more and more of a
variable input. |
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Term
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Definition
| If MP is above AP, AP increases and if MP is below AP, AP decreases |
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Term
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Definition
at least one input is constant
(plant capacity is fixed) |
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Term
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Definition
| Costs that change with the level of output |
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Term
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Definition
labor, raw materials, fuel,
etc.
• In our simple world: labor |
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Term
| • Total Variable Costs (TVC): |
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Definition
combined total
variable costs. Wage x Labor or (W x L) |
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Term
| Average Variable Cost (AVC) |
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Definition
): variable cost per
unit of output.
AVC = TVC/Q |
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Term
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Definition
Costs that do not vary with the level of output
• As output increases the AFC always declines: |
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Term
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Definition
loans, insurance, capital
construction, long term leases, salaried staff,
etc.
• In our simple world: capital |
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Term
| • Total Fixed Cost (TFC): |
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Definition
combined total of all
fixed costs. |
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Term
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Definition
fixed cost per unit of
output. AFC = TFC/Q.
• As output expands, AFC declines.
• TFC = $1,000,000 (1 million dollars)
• If Q = 1, AFC = $1,000,000/1 = $1,000,000
• If Q = 10, AFC = $1,000,000/10 = $100,000
• If Q = 100, AFC = $1,000,000/100 = $10,000
• If Q = 1,000, AFC = $1,000,000/1,000 = $1,000
• If Q = 1 million, AFC = $1,000,000/1,000,000 = $1 |
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Term
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Definition
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Term
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Definition
on average the dollar
amount each unit of output cost to make.
• ATC = TC/Q
• ATC = AVC + AFC |
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Term
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Definition
• MC tells the firm the change in TC due to a
unit increase in production (what it costs to
make one more unit of output).
• MC = ΔTC/ΔQ |
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Term
Relating Production with Cost
Relationship Between AP & AVC |
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Definition
• AP = Q/L
• AVC = TVC/Q
– AVC = (W x L)/Q since TVC = W x L
– AVC = W x (L/Q)
– AVC = W x (1/AP) since 1/AP = L/Q
– AVC = W/AP
• If AP increases, AVC decreases.
• If AP decreases, AVC increases.
• Thus AP & AVC are inversely related. |
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Term
| Relationship Between MP & MC |
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Definition
• MP = ΔQ/ΔL
• MC = ΔTVC/ΔQ as well as ΔTC/ΔQ
– MC = Δ(W x L)/ΔQ since TVC = W x L
– MC = W x ΔL/ΔQ W does not change
– MC = W x (1/MP) since 1/MP = ΔL/ΔQ
– MC = W/MP
• If MP increases, MC decreases.
• If MP decreases, MC increases.
• Thus MP & MC are inversely related. |
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Term
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Definition
No fixed inputs
• The Long Run is when a business (firm) has
enough time to change the physical size of its
business or to leave its current market and/or
enter another market.
• Capital is now a variable input, just like labor.
• In the Long Run, the firm needs to decide
what market(s) to be in and the size of the
business in the market(s). |
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Term
| Long Run Average Total Cost Curve |
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Definition
• Cost curve that shows the lowest average cost
of producing at each possible company size.
Used in the long run. |
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Term
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Definition
gives all the long run positions
(all the possibilities). |
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Term
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Definition
$ When the(LRATC)Cost curve is downward sloping this represents, what is known as, Economies of Scale.
• Benefits of Large Scale Production: double your inputs you
more than double your output. As a firm increases its size it
can lower the average cost.
Eventually,
opportunities of
economies of scale
run out and the
LRATC curve
stops falling |
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Term
| Economies of Scale are due to: |
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Definition
• (1) Greater labor specialization: assembly line
• (2) Greater management specialization
• (3) Utilize more efficient capital: robotics |
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Term
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Definition
When the LRATC is sloping upward
• Inefficiencies of Large Scale Production:
double your inputs you less than double your
output. As a firm increases its size its average
cost increases. |
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Term
| Diseconomies of scales are due to: |
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Definition
• Coordination problems: as a business
increases in size, it, after some point, will
become increasingly more difficult to operate. |
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Term
| Constant Returns to Scale |
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Definition
• Duplicate the current production facilities.
When there are not any Constant Returns, then Q
the LRATC is U shaped. |
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