Thomas Tatro's List: ECON TCO3

• Diminishing returns occurs only in the  short run because of this fixed factor of production. After hiring the fourth  worker, diminishing returns may set in if total number of outputs increase but  at a decreasing rate. Diminishing returns occurs because of the slowdown in  production that results from the fact that the production line is  fixed.
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  1. Total Number of Firms in the  Industry--Perfectly competitive industries, for example,  have hundreds of firms in the industry while monopoly industry has only one.  Monopolistic competition industry has dozens of firms while an oligopoly  industry has only a handful of firms that make up the industry.
      
  2. Type of Product produced in the  Industry--While perfectly competitive firms produce a  standardized/homogenous/identical product, a monopoly firm produces a unique  product. Monopolistically competitive and oligopolistic firms produce  differentiated products.
      
  3. Market Power--Perfectly competitive  firms have no market power and are said to be price takers. They take the market  price as given. Because there are hundreds of firms in this industry, each firm  is so small and so insignificant that it cannot influence the market price.  Monopolies have considerable market power and have a high degree of influence on  market price. They are price makers.
      
  4. Barriers to Entry--There are no  barriers preventing new firms from entering a perfectly competitive market.  Similarly, there are no barriers that make it difficult for existing firms in a  perfectly competitive market to exit the industry. In other words, there is easy  entry and exit in perfect competition. With monopoly however, there are  significant barriers to entry which allow only one firm to be successful in this  industry. Barriers to entry could be artificial or natural. Examples of  artificial barriers are patents and licenses. Natural barriers could be in the  form of economies of scale in production whereby only one firm or just a few  firms can be profitable in the market because of the cost structure of the  industry and the high fixed costs to set up the business.
   

  All market firms must be able to answer the following three  questions.

   

   

  1) How much output should we produce?

   

  2) What price should we charge?

   

  3) If we are making a loss, should we shut down or  continue to operate?

   

  To answer the first question, we assume that the aim of business  is to make a profit (and the maximum profit at that). There are other goals that  firms may have, such as to be the largest firm in the industry, have the highest  sales, largest employer of labor, etc. But we assume here that the aim of  business is to maximize profits. With that being the case, the profit maximizing  output level would be the point where marginal revenue is equal to marginal cost  (MR = MC). This is the profit maximizing output level because if MR is greater  than or less than MC, the firm is not maximizing profit. Let’s take the first  case. If a firm is thinking about producing the 15th unit of output and the MR  > MC for this 15th unit, then the firm does better producing the 15th unit of  output. For this additional unit of output, addition to revenue (MR) is greater  than the addition to cost (MC). So why stop at 14 units? The firm is better off  increasing production to 15 units to add to the profit it already has. If MR  < MC to produce the 25th unit of output, then addition to revenue for this  25th unit of output is less than the addition to cost, so it is not worth it to  produce this unit of output. At the point where MR = MC,  addition to profit is zero and all profits have been obtained by the firm. The  firm is at a point of maximum profit

• If the firm cannot even cover TVC with the TR it makes from  making the output, then in such a case, the firm must shut down even in the  short run.

   

  The Decision Rule is therefore as  follows:
  Continue to Operate if TR > TVC
  Shut Down if  TR < TVC

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• Average  total cost (ATC) for any output level is found by dividing total cost  (TC) by that output (Q) or by adding AFC and AVC at that  output:

   

  

• Average  variable cost (AVC) for any output level is calculated by dividing total  variable cost (TVC) by that amount of output (Q):

   

  

   

  Due to increasing and then diminishing returns, AVC declines  initially, reaches a minimum, and then increases again. A graph of AVC is a  U-shaped or saucer-shaped curve, as shown in

• Average fixed cost (AFC) for any output level is  found by dividing total fixed cost (TFC) by that amount of output (Q). That is,

   

  

   

  Because the total fixed cost is, by definition, the same regardless  of output, AFC must decline as output increases. As output rises, the total  fixed cost is spread over a larger and larger output

• Total cost is the sum of fixed cost and variable  cost at each level of output:

   

  TC = TFC + TVC

   

  TC is shown in column 4 of Table 7.2. At zero  units of output, total cost is equal to the firm’s fixed cost. Then for each  unit of the 10 units of production, total cost increases by the same amount as  variable cost.
• Variable costs are those costs that change with the level of  output. They include payments for materials, fuel, power, transportation  services, most labor, and similar variable resources. In column 3 of Table 7.2 we find  that the total of variable costs changes directly with output. But note that the  increases in variable cost associated with succeeding one-unit increases in  output are not equal. As production begins, variable cost will for a time  increase by a decreasing amount; this is true through the fourth unit of output  in Table 7.2.  Beyond the fourth unit, however, variable cost rises by increasing amounts for  succeeding units of output

• Fixed costs are those  costs that do not vary with changes in output. Fixed costs are associated with  the very existence of a firm’s plant and therefore must be paid even if its  output is zero. Such costs as rental payments, interest on a firm’s debts, a  portion of depreciation on equipment and buildings, and insurance premiums are  generally fixed costs; they are fixed and do not change even if a firm produces  more. In column 2 of Table 7.2 we assume that the firm’s total fixed cost is $100. By  definition, this fixed cost is incurred at all levels of output, including zero.  The firm cannot avoid paying fixed costs in the short run.

• Geometrically, marginal product—shown by the MP curve in Figure 7.2b—is the  slope of the total-product curve. Marginal product measures the change in total  product associated with each succeeding unit of labor. Thus, the three phases of  total product are also reflected in marginal product. Where total product is  increasing at an increasing rate, marginal product is rising. Here, extra units  of labor are adding larger and larger amounts to total product. Similarly, where  total product is increasing but at a decreasing rate, marginal product is  positive but falling. Each additional unit of labor adds less to total product  than did the previous unit. When total product is at a maximum, marginal product  is zero. When total product declines, marginal product becomes negative.

• The answers are provided in general terms by the law of diminishing  returns. This law assumes that technology is fixed and thus the  techniques of production do not change. It states that as successive units of a  variable resource (say, labor) are added to a fixed resource (say, capital or  land), beyond some point the extra, or marginal, product that can be attributed  to each additional unit of the variable resource will decline. For example, if  additional workers are hired to work with a constant amount of capital  equipment, output will eventually rise by smaller and smaller amounts as more  workers are hired.

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  • • Total product  (TP) is the total quantity, or total output, of a particular good or  service produced.
   
  • • Marginal product  (MP) is the extra output or added product associated with adding a unit  of a variable resource, in this case labor, to the production process.  Thus,  
    
   
  • • Average  product (AP), also called labor productivity, is output per unit of  labor input:  
     

• In microeconomics, the short run is a  period too brief for a firm to alter its plant capacity, yet long enough to  permit a change in the degree to which the plant’s current capacity is used. The  firm’s plant capacity is fixed in the short run. However, the firm can vary its  output by applying larger or smaller amounts of labor, materials, and other  resources to that plant. It can use its existing plant capacity more or less  intensively in the short run.

• In microeconomics, the long run is a  period long enough for it to adjust the quantities of all the resources that it  employs, including plant capacity. From the industry’s viewpoint, the long run  also includes enough time for existing firms to dissolve and leave the industry  or for new firms to be created and enter the industry. While the short run is a  “fixed-plant” period, the long run is a “variable-plant” period.
• If Boeing hires 100 extra workers for one of its commercial airline plants or  adds an entire shift of workers, we are speaking of the short run. If it adds a  new production facility and installs more equipment, we are referring to the  long run. The first situation is a short-run adjustment; the  second is a long-run adjustment

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• These numbers look very good. In particular, you are happy with your $57,000 accounting  profit, the profit number that accountants calculate by subtracting  total explicit costs from total sales revenue. This is the profit (or net  income) that would appear on your accounting statement and that you would report  to the government for tax purposes
• Please distinguish clearly between accounting profit and economic profit.  Accounting profit is the result of subtracting only explicit costs from revenue:  Accounting Profit = Revenue − Explicit Costs. By contrast, economic profit is  the result of subtracting all of your economic costs—both explicit costs and  implicit costs—from revenue: Economic Profit = Revenue − Explicit Costs − Implicit  Costs

• • A firm’s implicit costs are  the opportunity costs of using the resources that it already owns to make the  firm’s own product rather than selling those resources to outsiders for cash.  Because these costs are present but not obvious, they are referred to as  implicit costs

• As a result, keep in mind that all of the resources  that a firm uses—whether purchased from outside or already owned—have  opportunity costs and thus economic costs. Economists refer to these two types  of economic costs as explicit costs and implicit  costs:
• A firm’s explicit costs are  the monetary payments it makes to those from whom it must purchase resources  that it does not own. Because these costs involve an obvious cash transaction,  they are referred to as explicit costs. Be sure to remember that explicit costs  are opportunity costs because every monetary payment used to purchase outside  resources necessarily involves forgoing the best alternatives that could have  been purchased with the money
• That process is costly for firms because it requires a payment to the resource  owner. This reality causes economists to define economic  cost as the payment that must be made to obtain and retain the services  of a resource. It is the income the firm must provide to resource suppliers to  attract resources away from alternative uses

• To properly calculate a firm’s economic costs, you must remember  that all of the resources used by the firm have an opportunity  cost. This is true both for the resources that a firm purchases from outsiders  as well as for the resources that it already owns.

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