M6: PRODUCTION AND COSTS

• Consumer Demand => consumers try to maximize utility.
• Production Demand => producers try to maximize profit.
• Explicit Costs => opportunity costs of a firm's resources that take the form of cash payments.
• Implicit Costs => opportunity cost of using resources owned by the firm.
• Examples of Explicit Cost are wages & salaries, rental charges, cost of electricity, cost of materials, cost of medical insurance, and taxes.
• Examples of Implicit Costs are opportunity costs to earn salary as a professional and earning rental payments.
• FORMULAS in Calculating Accounting Profits and Economic Profits:

  
  

  Profit= Total Revenue - Total Cost

  Accounting Profit= Total Revenue - Total Explicit Cost

  Economic Profit= Total Revenue - (Explicit Costs + Implicit Costs)
• Economic Loss refers to a firm having economic profit vale of less than zero.
• Pure Economic Profit refers to a firm earning more than its opportunity costs.
• Normal Profit refers to a firm earning its total revenue equals to its total opportunity costs.
• Fixed Input is any resource for which the quantity cannot change during the period of time under consideration.
• Examples of Fixed Inputs are physical size of a firm's plant and production capacity of heavy materials.
• Variable Input is any resource for which quantity can change during the period of time under consideration.
• Examples of Variable Inputs are labor production, amount of materials, and electricity in production.
• Short Run => at least one resource is fixed.
• Long Run => no resource is fixed
• Marginal Product => the change in total output produced by adding one unit of a variable input, with all other inputs used being held constant.
• Law of Diminishing Returns => the principle that beyond some point the marginal product decreases as additional units of a variable factor are added to a fixed factor.
• Total Fixed Cost (TFC) => costs that do not vary as output varies and that must be paid even if output is zero.
• Total Variable Cost (TVC) => costs that are zero when output is zero.
• FORMULAS in Calculating Short Run Costs:

  Total Cost (TC) = Total Fixed Cost (TFC) + Total Variable Cost (TVC)

  Average Fixed Cost (AFC) = Total Fixed Cost (TFC) / Quantity (Q)

  Average Variable Cost (AVC)=Total Variable Cost (TVC) / Quantity (Q)

  Average Total Cost (ATC) = AFC +AVC/Q

  Marginal Cost (MC) = {(Change in TC)/(Change in Q)} = {(Change in TVC/ Change in Q)}
• Long-Run Production Costs => all inputs that are under the firm's control can be varied, so there are no fixed costs.
• Economies of Scale

  > A situation in which long-run average cost declines as the firm increases its level of production.

  > The reasons for this are: A greater scale of operation allows for greater specialization of labor; A greater scale allows the firm to take advantage of technologically advanced specialized equipment which would not be cost effective at lower output.
• Constant Returns to Scale

  • A situation in which long-run average cost does not change with the level of output. If output doubles, total cost also doubles. Therefore, cost per unit of output remains unchanged. The LRAC curve will become flat as a result of constant returns to scale.
• Diseconomies of Scale

  • A situation in which the long-run average cost curve rises as the firm increases output.
  • A very large-scale firm becomes harder to manage. As the firm grows, the chain of command lengthens, and communication becomes complex.
  • It is no surprise that a firm can become too big, and management problems can cause the average cost of production to rise.