Unit 7

Profit

Word	Meaning
total revenue / TR	the amount a firm receives fro the sales of its output
total cost / TC	the market value of the inputs a firm uses in production (explicit costs)
profit / $\Pi$	the firm's total revenue minus its total cost =TR - TC
economic cost of production	all the oppotunity costs of making its output of goods and services
economic profit	TR - economic cost of production
accounting profit	TR - TC

Three Categories of Economic Profit	Meaning
positive economic profits	super high, unexpected profits for firms in that industry attract entrepreneurs and induce nre firms to the market P > ATC
economic losses	negative profits firms that consistently earn losses will eventually leave the industry P < ATC
normal (zero) economic profits	zero economic profits, positive accounting profit no new firms to join, no firms to quit P = ATC

Production

Word	Meaning
production function	the relationship between quantity of inputs used to make a good and the quantity of output
fixed inputs	inputs that cannot vary in quantity for some period of time (a factory, a machine)
variable inputs	inputs that can vary in quantity (labour)
short run	at least one input is fixed
long run	no inputs are fixed
total product / TP	amount of total products produced
marginal product / MP	change in output that arises from an additional unit of that input TP is maximized when the MP = 0 = slope of the production function $= \frac{\Delta\text{total output}}{\Delta\text{number of inputs}}=\frac{\Delta Q}{\Delta L}$
diminishing marginal product	the MP of any input will decrease as the quantity increases if there are fixed inputs
average product / AP	how many outputs each unit of input can produce $= \frac{Q}{\text{number of inputs}}$

• MP = AP when AP at max
• When MP > AP, AP is increasing
• When MP < AP, AP is decreasing

Short Run Costs of Production

Word	Meaning
total fixed costs / TFC	costs that do not vary with the quantity of output produced (rent, loan payments) (only in short run)
total variable costs / TVC	costs that vary with the quantity of output produced (labour costs, raw material costs)
total cost / TC	= total fixed costs + total variable costs = TFC + TVC
average fixed cost / AFC	$=\frac{TFC}{Q}$ decreases as more goods are produced
average variable cost / AVC	$=\frac{TVC}{Q}$ starts high, falls and then rises again as more goods are produced
average total cost / ATC	cost of each typical unit of product $= \frac{TC}{Q}=AFC+AVC$ starts high, falls and then rises again as more goods are produced
marginal cost / MC	the addition to total cost from producing one more unit of output basically an inverse of marginal product starts high, decreases, then increases as more goods are produced = slope of the total cost function $=\frac{\Delta\text{total cost}}{\Delta\text{total output}}=\frac{\Delta TC}{\Delta Q}$
opearting at capacity	the firm's ATC is minimized

in short run:

• MC intersects AVC at min AVG
• When MC < AVC, AVC is decreasing
• When MC > AVC, AVC is increasing
• MC intersects ATC at min ATC
• When MC < ATC, ATC is decreasing
• When MC > ATC, ATC is increasing

Long Run Costs of Production

Word	Meaning
long run average curve / LRAC	in the long run, cost of each typical unit of product
efficient scale	the level of output Q which minimizes LRAC every Q between Q1 and Q2 are at efficient scale
increasing returns to scale / IRS / economies of scale / EOS / scale echonomies	LRAC falls as Q increases occur when increasing producing allows greater specialization
decreasing returns to scale / DRS / diseconomies of scale / DOS	LRAC rises as Q increases due to coordination problems in large organizations
constant returns to scale / CRS	LRAC stays the same over a range of Q

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Last update: November 15, 2021
Created: October 30, 2021