1. Chapter 10 Production Profit Definitions

2. What is a firm? A firm is a business organization that brings together and coordinates the factors of production for the purpose of supplying goods and services. Goal of the firm – Maximize profits Given it’s Technology Define Technological Change

3. Opportunity Cost and Economic Profit Recall that a firm’s opportunity cost of production is its best foregone alternative. In the firm’s production decision, they face 2 types of costs: 1)Explicit costs – “outlay costs” “accounting costs” – Money used to pay for the use of the factors of production 2) Implicit Costs – opportunities foregone but not paid for directly Where do firms face implicit costs?

4. Implicit Costs Where do firms face implicit costs? 1)Capital a.Economic depreciation (  accounting depreciation) - Change in the market price of capital over a given period b. Interest 2) Owner’s resources - Normal Profit

5. Normal Profit A measure of the implicit costs of owner-supplied resources in a firm over a given period of time (Portion of the firms cost that is not included in the accounting cost) Thus we must note the distinction between “Accounting Profit” and “Economic Profit” Accounting Profit = Total Revenue – explicit costs (uses conventional depreciation approach) Economic Profit = Total Revenue – opportunity costs (uses economic depreciation approach)

6. Production and Costs Production Short-Run Costs

7. Short-Run vs. Long-Run Technically, time does not determine the difference between “short-run” and “long- run” The Short Run is defined by the presence of a factor of production that is fixed in quantity –typically, this is capital (K). In the short-run, firms can only change the amount of non-capital inputs (e.g. Labor) The Long Run is defined by the ability for firms to vary the quantities of all factors of production. The time in which this takes a firm to do so may depend upon the firm as well as the industry.

8. SHORT-RUN PRODUCTION Total Product (TP) (Q): describes how output varies in the SR as more of any variable input is used with the fixed input, under current technology Marginal Product (MP): the increase in output from one more unit of an input when the quantity of all other inputs are unchanged Average Product (AP): the total output produced divided by the number of units of the input used

9. Marginal/Average Product Formulas for MP and AP Since Kapital is fixed in quantity, we are concerned with Marginal and Average products of labor MP L :  TP/  L AP L : TP/L What do the TP, MP L and AP L curves look like? What is the relationship between MP L and AP L ?

10. Law of Diminishing Marginal Produce As a firm uses more a variable input, with a given quantity of fixed inputs, the MP of a variable input eventually diminishes.

11. Short Run Costs Short-run costs can be separated according to the nature of the input: Fixed Costs (Total Fixed Costs) (TFC): total cost to all the fixed inputs (Overhead costs) - must be incurred in the short-run even if don't produce anything Total Variable Cost (TVC): total cost to the variable inputs Total Cost (TC): sum of all the costs of all inputs in the production process SO, TC=TFC+TVC

12. Marginal Costs However, when firms are choosing to maximize profit, they are more concerned with Marginal Costs – the cost of producing 1 more unit of output. MC =  TC/  Q What do we know about the relationship between MC and MP?

13. Average Costs Firms are also concerned with Average Costs. In the short-run, there are 3 average costs: Average Fixed Costs: AFC= TFC/Q Average Variable Costs: AVC=TVC/Q Average Costs: AC=TC/Q Thus, AC=AVC + AFC What do these curves look like? Why are these curves important?

14. GRAPHICAL ANALYSIS OF SR COST Graph 1: TC, TVC, TFC 1) Why is TVC upward sloping ? 2) Why does TC slope upward ? Graph 2: MC, ATC, AFC, AVC 1) Why is AFC downward sloping ? 2) Why is AVC "U-shaped" ? 3) Why is ATC "U-shaped" ? 4) Why does MC curve slope upward ? 5 ) Where does the MC curve intersect AVC ? ATC ?

15. Key Terms Technology Technological Change Short Run vs Long Run Marginal Product of Labor Average Product of Labor Law of Diminishing Returns Economic Profit vs Accounting Profit Explicit Cost Implicit Cost Fixed Cost Variable Cost Total Cost Marginal Cost Average Fixed Cost Average Variable Cost Average Total Cost