Chapter 5

• A firm


  An economic unit that hires factors of production and organises those factors to produce and sell goods and services
• What is a firm's goal?

  Maximise profits.

  Profit= total revenue-total costs

  Economic profit= total revenue- total economic costs
• Opportunity cost


  The highest-valued alternative that must be given up to engage in an activity.
• Explicit cost.


  A cost that involves spending money
• Implicit cost


  A non-monetary opportunity cost
• Examples of opportunity costs

  • economic depreciation- (true reduction in value)
  • forgone interest- (profits form firm need to cover this)
  • business owner's time- (could you have been earning a salary?)
  • Normal profit- (the required profit to make you just willing to run the firm)
• Technology


  The processes a firm uses to turn inputs into outputs of goods and services
• The firm's problem


  Similar to a mathematical problem...

  Goal: Maximise economic profits

  Constraints:

  • Subject to the available technology
  • Subject to consumer demand
• Short run


  The period of time during which at least one of the firm's inputs is fixed
• Long run


  A period of time long enough to allow a firm to vary all of its inputs, to adopt new technology and to increaser decrease the size of its physical plant

  Long run varies between firms- (e.g., small shop in RM vs mining)
• Short run production function


  The relationship between the amount of inputs used by a firm and the maximum output than can be produced with those inputs

  • E.g., if 'labour' is the one input we can vary in the short run, then it is a relationship between 'labour' and 'output'
  • Displayed in a table or on a diagram- labour on horizontal axis, output on vertical axis
• Marginal profit


  Marginal product is the additional output that a firm can produce for one additional unit of input

  MP= Change in output / unit change of input.
• Average product


  The total output divided by the number of units of the input

  AP= quantity of output / quantity of input
• Marginal product


  Increases due to division of labour and specialisation

  • when you get too many workers you are exhausting the benefits of specialisation- too many workers, not enough jobs.
• Law of diminishing returns

  The principles that, at some point, adding more of a variable input, such as labour, to the same amount of a fixed input, such as capital, will cause the MP of the variable input to decline.
• MP and AP both increase and decrease- but their peaks occur at different points.

  • If MP is greater than AP then increase in input/output will increase AP
  • If MP is less than AP then increasing quantity will decrease AP.
• MP must cross AP, at AP's maximum.

  
• Fixed costs


  Costs that stay constant irrespective of the amount of output produced

  • e.g., lights- electricity cost is constant
• Variable costs


  Costs that vary with the amount of output produced.

  • e.g., electricity expenditure from toasty machines in hub
• Total costs


  All costs, including both fixed and variable costs

  TC= Fixed costs (FC) + Variable costs (VC)
• ATC, AFC, AVC

  We often look at the average of each type of cost per unit of output produced. (Q)

  
• Marginal Cost (MC)

  The additional cost per unit of output

  MC= Avg. TC/Avg Q

  
  

  But, as FC does not vary with Q, any changes to TC must come from changes in TVC, so:

  MC= Avg. VC/ Avg Q.
• Cost curves

  Use formulas to fill in the table then plot on graph.

  • U-shaped
• Short run cost curves

  If MC > ATC then ATC increasing as TQ

  MC crosses ATC at ATC's minimum

  MC crosses AVC at AVC's minimum

  If MC < ATC then ATC decreases.

   

  ATC= AVC + AFC

  AFC= ATC - AVC

  
• Economies of scale


  When the long run avg. costs fall as the quantity is increased.

  Can occur due to...

  • technology in that industry can be such that it s cheaper per unit to produce more
  • staff can specialise better in tasks
  • The firm's bargaining power can increase
• Constant returns to scale


  Along the quantities of output, the scale of the firm does not affect the avg. cost.
• Minimum efficient scale

  The minimum of the long run average cost curve is just one point- that is called the efficient scale
• Diseconomies of scale


  When the LRAC is increasing, there are diseconomies of scale.

  LONG RUN CONCEPT

  • At a large size, it may be that the benefits of being big are exhausted, and in fact there might be some disadvantages.