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Microeconomics - Chapter 6: The Costs of Production - Coggle Diagram
Microeconomics - Chapter 6: The Costs of Production
Law of Supply
According to this law, a firm is willing to
produce
and sell a
greater
quantity of a good when the
price
of the good
increases
.
The supply curve has an
upward
slope
Firms
Firm's objective
The goal of a firm is to maximize profit
Profit = Total Revenue (TR) - Total Cost (TC)
Revenue: sale of its output. Cost: market value of the inputs used in production
Firm's
cost of production
includes all the opportunity costs of making its output
include both explicit & implicit cost
Explicit Cost
Input costs that require a direct outlay of money, like worker wag
Implicit Cost
Input costs that do not require a direct outlay of money, like rental value of a property
Economic Profit
Measured by economics as firm's total revenue minus total cost, including both explicit & implicit cost
EP = TR - TC(IC + EC)
When TR > IC + EC, firm earns economic profit
Accounting profit
Measured by accountants, is the firm's TR minus only explicit cost
AP = TR - TC (only EC)
Economic profit is smaller than accounting profit
Production Function
The relationship b/w quantity of inputs and the quantity of output in production process
q
=
f
(L, K, etc.)
Contribution of each input to production of output.
Marginal Product
In the production process is the increase in output that arises from an additional unit of that input
MPx = delta q / delta X
Diminishing Marginal Product
The property where the
MP
of an input declines as the
Q
of the input increases
The slope measures marginal product of an input
When the MP declines, the curve flattens
Production Costs
C = wL + rK + etc
The optimal combination is the 1 with the smallest cost to produce
q
. Known as:
Cost-minimizing cmobination of inputs
If the cost-minimizing combination it is known as:
Cost Function
Relationship b/w the quantity of output,
q
, & cost of producing that output using combination of the input
C = C(q)
This function is also known as Total Cost
Determines pricing decisions of the firm under different market structure.
Cost of Production (TC)
Fixed Cost (FC)
Those cost that do not vary with the quantity of output produced
TC = FC + VC
Variable Cost (VC)
Those costs do vary with the quantity of output produced
Average Cost
Can be determined by dividing the firm's costs by the quantity of output it produces
ATC = TC / q
AFC = FC/q +
AVC = VC/q
Marginal Cost (MC)
Measures increase in TC that arises from extra unit of production
MC = delta TC / delta q
Cost Curves
MC rises with the quantity produced (reflect the property DMP)
The average TC curve is U-shaped
Bottom of the U-shaped ATC curve shows the quantity (q) that minimizes the average TC. This quantity is known as:
Efficient Scale
Quantity that minimizes average TC
Relationship b/w MC & AC
When MC < ATC, ATC is falling
When MC > ATC, ATC is rising
3 Important properties of Cost Curve
MC eventually rises as the quantity of output increases
ATC is U-Shaped
The MC curve crosses the ATC curve at the minimum of ATC
Costs in Short & Long run
In short run, many inputs are fixed, thus, most costs are fixed. hence why in short run many if firm's decision are limited
Thus, the long-run cost is always lower than the short-run cost
Economies of scale
Property whereby long-run ATC falls as the quantity of output increases.
Diseconomies of scale
Property whereby the ATC rises as the quantity of ouptut increases
Constant return to scale
Property whereby long-run ATC stays the same as the quantity of output increases
In longrun, most inputs can be changed & are variable, thus most fixed cost can become variable. A firm's long run cost-curve differ from its short-run cost curves. In long run, a firm has more flexibility and should make better or at least as good as choices in short run
Profit Maximization
Profit = TR - TC
Produce the quantity that maximizes the above difference
To maximize the profit
When MR > MC
Increase q to increase profit, thus profit is not maximized
When MR < MC
Decrease q to increase profit, thus profit is not maximized
When MR = MC
Changes in q cannot improve profit, this profit is maximized
Generla condition to profit maximization by firm