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Economists assume goal of firms is to
maximize profit
Profit = Total Revenue – Total Cost
In other words: Amount firm receives for sale
of output minus amount that the firm pays to
buy inputs
Review – What is TR?
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Firm’s costs of production include all
opportunity cost of producing output
Explicit costs: require an outlay of $
Implicit costs: don’t require an outlay of $
Economic Profit: Total Revenue – Opportunity
Costs of production (implicit & explicit)
Accounting Profit: Total Revenue – Explicit
Costs only
Accounting Profit is greater than Economic
Profit
Production Function: Relationship between
quantity of inputs and quantity of output
 Marginal Product: increase in the quantity of
output obtained by an additional unit of input
- How much more can we produce by hiring
one more worker?
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As more workers are hired, each additional
worker contributes less to the production
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As the quantity produced rises, the total cost
curve becomes steeper
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Total cost is divided into fixed & variable
costs
Fixed costs: do not vary with quantity of
output produced (incurred even if the firm
produces nothing)
Variable costs: Change as the firm alters the
quantity of output produced
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Average Total Cost: Total Cost divided by
quantity of output
Average Total Cost = Average Fixed Cost +
Average Variable Cost
Marginal Cost = Increase in total cost by
increasing production by one unit of output
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Putting 4 curves on costs vs. output graph
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Marginal cost rises with quantity of output
because of diminishing marginal product
When quantity produced is high – marginal
product is low & marginal cost is high
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U-Shaped because AFC declines as output
expands and AVC typically increases as
output expands; AFC is high when output
levels are low.
Bottom of U-shape is quantity that minimizes
average total cost, which is called the
efficient scale of the firm
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When marginal cost is less than ATC, ATC is
falling.
When MC is greater than ATC, ATC is rising
Analogy of your GPA
3 important properties:
1. MC eventually rises with quantity of output
2. ATC curve is U-shaped
3. MC curve crosses ATC curve at minimum of
ATC
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These curves include implicit & explicit costs
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Some costs are fixed in the short run, but ALL
costs are variable in the long run
The long run ATC curve lies along the lowest
points of the short run ATC curve because it
has more flexibility to deal with changes in
production in long run
Still a U-shape
but much flatter
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Economies of scale: long-run ATC falls as
quantity of output increases (specialization)
Diseconomies of scale: long-run ATC rises as
quantity of output increases (coordination
problems)
Constant returns to scale: long-run ATC stays
the same as quantity of output changes