70 terms

Profit / Profit Maximization

Total Revenue (qty × price) - Total Cost
Explicit Cost
A cost that requires an outlay of money
Implicit Cost
Does not require an outlay of money; instead it is measured by the value, in DOLLAR forms
Opportunity Cost
Ex. of implicit cost
Basement space that has been converted into work room
Job that I had to give up
Depreciation Value
Reduction in value of the equipments and furnishing they wear out over time
Usually happens in physical capital
Accounting Profit
Business's total revenue minus the explicit cost and depreciation
TR - Explicit cost - depreciation
Economic Profit
Business's total revenue minus the implicit and explicit cost and depreciation cost
TR - Explicit cost - depreciation - Implicit cost
Negative Economic Profit
There are better alternative use for those resources
Normal Profit
Economic profit equal to zero
Might as well just keep running the business
Total Cost
Implicit + Explicit
Principle of Marginal Amalysis
Every activity should continue until marginal benefit equals Marginal Cost
Marginal Benefit = Marginal Cost
Marginal Revenue
The marginal benefit of the additional unit is the additional revenue generated by selling it
Change in total revenue generated by 1 additional unit of output
Marginal Revenue equation
MR = ∆Total Revenue/∆Q
Net Gain
Marginal Revenue - Marginal Cost
Marginal Cost
MC = ∆Total Cost/∆Q
Increase in total cost÷increase in qty output
Total Revenue
Price × Quantity
Optimal Output Rule
Profit is maximized by producing the quantity of output at which the marginal revenue of the last unit equals to its marginal cost
Normal Profit
Economic Profit = 0
When is production profitable?
As long as we have normal profit
Production Function
Relationship between the quantity of inputs a firm uses and the quantity of output it produces
Fixed Input
Inout whose quantity is fixed for period of time
Input can only be fixed in the short run
Variable Input
Inout whose quantity can be varied at any time
i.e. the firm can change the quantity at any time
Capitals, raw materials, workers
Long Run
Firms can adjust the quantity of any inputs
Marginal Product of Labor
Out put produced by each additional variable input (workers)
Keeps decreasing!!!
They only have so much they can produce with fixed amount of resources
Total Product Curve
Increasing at decreasing rate
Because MPL is decreasing
Shows how the quantity of output depends on the quantity of the variable input, for a given quantity of the fixed input
Marginal product of Labor Graph
Downward sloping curve
Diminishing returns to labor
Marginal Product of Input
The additional quantity of output produced by using one more unit of that input, i.e. it is the slope of the total product curve
Diminishing Return to an Input
When an increase in the quantity of that input, holding the levels of all other inputs fixed, leads to a decline in the marginal product of that input
Increased Input
Marginal product of a worker is higher s/he has more of the fixed input to work with
Firm's Total Cost
Fixed cost (FC) + Variable cost (VC)
total cost of producing a given quantity of output is the sum of the fixed cost and the variable cost of producing that quantity of output.
Total Coast Curve
Shows how total cost depends on the quantity of output - Increasing Curve
The curve gets steeper as output increases due to diminishing returns to labor. We will soon see why this is so.
Marginal Cost / Total Cost Curve
Marginal Cost = Slope of the Total Cost Curve
Total cost curve gets steeper as it increases from left to right because marginal cost (slope) rises as output increases
Marginal Product and Average Product
MP and AP crosses on the highest peak of AP
Diminishing Marginal product???
Marginal product/revenue actually increases for a while, but after a certain point, the marginal product decreases successively
Fixed Cost
Cost that does not depend on the quantity of output produced. It is the cost of the fixed input
ex) cost of that lanf
Variable Cost
Cost that depends on the quantity of output produced. It is the cost of the variable input
ex) wages
Total Cost of Producing
Sum of the fixed cost and the variable cost of producing that quantity of output
Total Cost Curve
Increasing at a increasing rate
Marginal cost in Increasing
Qty (x) Cost (y)
Marginal Cost of Production
Slope of the total cost curve
∆TC ÷ ∆Q
Why Marginal Cost Increases
Diminishing Marginal Product! Marginal cost of making double the amount of salsa will need more than double of the input.
Each unit costs more than the previous unit
Average Total Cost
Total Cost divided by quantity of output produced
TC ÷ Q
Average Fixed Cost
FC ÷ Q
Always going down because the fixed cost is always equal and quantity decreases
Average Variable Cost
VC ÷ Q
Always Increasing
ATC Graph
Cost (y) Quantity (x)
Goes down than up
Has a min. cost output exists
Rises as output increases because of the diminishing returns to the variable input
Increasing amounts of variable inputs are required to make another unit
The Spreading Effect
The larger the output, the greater the quantity of output over which fixed cost is spread, leading to lower average fixed cost.
Dominates lower level
Low Levels of Output
Spreading effect is very powerful because even small increases in output causes large reduction in average fixed cost
Lower level - AFC goes down
Diminishing Return Effect
The larger the output, the greater the amount of variable input required to produce additional units, leading to higher average variable cost
Dominates in higher level
Minimum Cost
Where ATC and MC meets
AVC and AFC meets
They all meet @ the same point!!!
Before the min. point, Average > marginal cost
MC curve always slope upward?
People could specialized in certain stuff! MC
We will reach a point where there will be to many ppl, back to diminshing margianl effect
Marginal Cost Curve
Sloped upward
the result of diminishing returns that make an additional unit of output more costly to produce than the one before
Average Variable Cost Curve
Due to diminishing returns - but is flatter than the marginal cost curve because the higher cost of each additional unit of output is averaged across all units.
Average Fixed Cost Curved
Slopes downward because of the spreading effect.
Minimum-cost output
The quantity of output that corresponds to the minimum average total cost
Marginal Cost Curve crosses the lowest point in ATC curve
Minimum Cost Point
Average total cost = marginal cost
At output less than the minimum-cost output
marginal cost is less than average total cost and average total cost is falling
At output greater than the minimum-cost output
marginal cost is greater than the average total cost and average total cost is rising
MC in low level of output
Marginal cost often falls as the firm increases output because hiring additional workers allows greater specialization of their tasks and leads to increasing returns.
MC in High lvl of output
Diminishing returns to additional workers set in and marginal cost rises
AVC is now U-shaped
Add'l Machinery
variable cost of any given output level will be reduced.
Until certain point of output, it is more economical to just have 1 machine instead of buying one more machine
Why Add'l Machine
When output is low, the increase in fixed cost from the additional machine outweighs the reduction in variable cost from higher worker productivity - that is, there are too few units of output over which to spread the additional fixed cost.
Long Run Average Total Cost
Shows the relationship between output and average total cost when fixed cost has been chosen to minimize average total cost for each level of output.
economies of scale
decline in its long-run average total cost as output increases
In the beginning of the production
Decreasing long run average total cost
increasing returns to scale
output increases more than in proportion to an increase in all inputs
Causes Economics of Scale
Constant Return to Scale
Double the input, double the output
Constant increase
Diseconomies of Scale
Happens in the later part of production
Increase in Long Run Average Total Cost
Decreasing Returns to scale
When input doubles, the output is just 1.5
Less than the constant return
Causes diseconomies of scale (high LRATC)
Sunk Cost
Cost that should be ignored
Cost that cannot be repaired
Why Decreasing/Increasing returns to Scale?
Specialization! Firms can increase output by specialization, which usually makes them more productive ∼ Specialized labor and lower AC because of mass production.
At some point firms become too big & become less efficient
AC starts to rise