Cost and marginal values

Firm

A business organization that buys or hires factors of production in order to produce goods and services that can be sold at a profit.

Industry

Is taken to be the total number of firms producing within the same product group, ie, things which are close substitutes for each other.

Short-run production function

Shows the relationship between the factors of production a firm uses, at least one of which is in fixed supply, and the output it produces.

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Total product is the total quantity of output produced by a firm

Average product = (total product)/(units of labor)

Marginal product is the extra or additional output resulting from one additional unit of the variable input, labor.

MP= (∆total product)/(∆units of labor)

[MP: marginal profit; AP: average profit; TP: total profit]

MP > AP, AP is increasing MP < AP, AP is decreasing MP = AP, AP is maximum

MP is the slope of TP MP > 0 TP increasing MP < 0 TP decreasing MP = 0, TP is the maximum

The law of diminishing returns

States that as more of the variable factors are added to the fixed ones, the contribution of each extra worker to the total output will begin to fall.

Increasing marginal product

As more of the variable factors are added to the fixed ones, the contribution of each extra worker to the total output will increase.

The long run production function

Shows the relationship between the factors of production a firm uses, all of which are variable, and the output it produces.

Return to scale

Are the changes in output which occurs when a firm changes its scale of production by altering all its factors of production. (Economic of scale)

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• Increasing returns to scale: are experience when output increases at a greater rate than inputs
• Constant returns to scale: are when output and input increases at the same rate
• Decreasing returns to scale: occur when output increases at a slower rate than inputs

Costs of production

Include money payments to buy resources plus anything else given up by a firm for the use of resources. The resources include land, labor, capital and entrepreneurship.

Explicit costs

Payments made by a firm to outsiders to acquire resources for use in production.

Implicit costs

Refers to costs involved in the self-owned resources by a firm.

Economic costs

Are the sum of explicit and implicit costs.

Fixed costs

Arise from the use of fixed inputs. Fixed cost are costs that do not change as output change.

Rental payment Property taxes Insurance premiums Interest on loans Advertisement

Average cost falls as output increase.

Variable costs

The costs that are directly related to the level of output.

Marginal costs

The addition to the total cost when making one extra unit and is therefore a variable cost. [marginal costs = marginal variable costs]

No control over price

The price at which the good is sold does not change; this occurs only under perfect competition, where the firm has no control over the price at which it sells it product.

Some control over price

The price at which the good is sold changes as the quantity of output changes. This occurs under all market models other than perfect competition.

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Economic profit = total revenue – economic costs

Normal profit: the minimum amount of revenue that the firm must receive so that it will keep the business running. (Economic profit is 0)

Positive EP: TR>EC (supernormal) Zero EP: TR=EC Negative EP: TR<EC (loss)

The separation of firm management from firm ownership

Increasingly dominates business organization, has meant that firms’ objectives have changed.

Owner managed firm

Firm managers who are hired by the owners to perform management tasks.

Revenue maximization

The goal of firms which to increase sales and maximizing the revenues.