The goals of every firm
Economists assume the firm's goal is to max profits
Profit=R-E
Total revenue is the amount a firm receives from the sale of its output
Price per unit * by the quantity sold
The cost is the market value of the inputs a firm uses in production
Total costs includes one-time expenses, like buying a machine, as well as ongoing expenses, like rent, employee salaries, raw materials, and advertising
Costs are more complex and harder to calculate than total revenue
A firm's total cost is defined as
Total cost= fixed costs + variable costs.
Fixed Costs
Costs that do not depend on the quantity of output produced: They are constant as quantity increases
One time, upfront payments before production begins, like buying equipment
Ongoing payments, like monthly rents
Even if a firm produces nothing, it still incurs a fixed cost
Variable Costs
Costs that depend on the quantity of output produced
Includes the cost of raw materials, machinery, and equipment, and labour
Variable cost increases with each additional unit produced
If firm produces nothing, variable cost is zero
Explcit vs Implicit cots
The opportunity cost of something is what you have to give up to obtain it
Opportunity cost has 2 compnents: explicit costs and implicit costs
Both matter for firms' decisions
Explicit costs require an outlay of money
Paying wages to workers
Implicit cots do not require a cash outlay: rather they represent opportunities that could have generated revenue if the firm had invested its resources in another way
The opportunity costs of the owner's time
Both costs must be included to properly account for a firm's total cost.
Economic Profit vs Accounting Profit
When companies report their profits, they provide accounting profit
Accounting profit= total revenue- explicit costs
Accountants keep track of how much money flows into and out of the firm so they ignore implicit costs
As a result, accounting profit may be a misleading indicator of how well a business I really doing.
Economic profit on the other hand accounts for both explicit and implicit costs
Economic profit = accounting profit- implicit costs
Economic profit = (Total revenue - explicit costs)- implicit costs
Economists study the pricing of the production decisions of the firm, which are affected by implicit as well as explicit costs
Since accounting profit ignores the implicit costs, it's always higher than economic profit
The production function
The relationship between the quantity of inputs used to produce a good and the quantity of output that is produced given technology
Indicates what is physically possible to produce
The short run production fucntion is also called the total product function
It can be represented by a table, a graph of an equation
Example
Why is the MPL important?
When the farm hires an an extra worker:
Her costs rises by the wage she pays the worker, w
Her output rises by the MPL
The value of that extra output rises by p * MPL
p * MPL is the farmers's benefit from hiring the extra worker
Comparing the value of the extra output to the increase in costs helps the farmer decide wther she would benefit from hiring the worker
If the benefit exceeds the costs (p *MPL > w, ) hire the extra worker
Why the MPL falls
Why does the farmer's output rise by a smaller and smaller amount for each additional worker she hires?
When output I low, the MPL may increase because workers can work together and specialize in the tasks in which they have a comparative advantage
However as the farmer adds more work the additional worker, wokers will be less productive
MPL will always falls as L rises wether the fixed inpout is land or capital
This relationship between outpout and variable inputs is called the law of diminishing marginal product or returns
The marginal prodict of a variable input envenutally declines as the quantity of the inpout increases
Maginal Costs
The increase in total cost from producting one more unit
MC= deltaTC/deltaQ
Total costs= fixed costs + variable costs (FC = land, VC = Labour) = wL + FC
The MPL is increasing , MC Is falling
The MPl Is at its max, MC is at min
MPL decrasing, MC is rising
Average fixed cost = fixed cost/quantity
Average variable cost = variable cost/quantity of output
Average total cost = TC/Q
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