ECON 101 Lecture Notes - Lecture 6: Diminishing Returns, Fixed Cost, Opportunity Cost
30 Apr 2018
School
Department
Course
Professor
Economics 101
Lori Leachman
Part 6 • Lecture
• Graph Curves
o AFC: fixed inputs over output - continually declines
o AVC: labor & raw material variable costs over output - declines (specialization) and then
increases (law of diminishing returns) - U-shaped
o ATC: AFC + ATC - U-shaped and above AVC and AFC
o MR: Check-shaped - declines (specialization) and then increases (law of diminishing returns) - U-
shaped
o Relationships determined by Marginal Average Rule
• Assume PERFECT COMPETITION
o Always gonna break-even in long run - firms enter/leave
o Only one decision: how much to produce
o Price is set in the marketplace by market demand and supply
o Since firms are small & products are homogeneous, D = P; demand is infinite @ P*
o Since firm can always sell another unit for P*, P* = MR
▪ For any other industry, must lower price to sell more MR < P
o Decision rule: Q* is set where MR = MC
o Minimum efficient scale (MES): where ATC is minimum at P* and Q* (breakeven)
▪ This is always in long run in PC
o Characteristics & Why Perfect Competition is used as a benchmark
▪ Each firm produces @ MES in long run
▪ Inherent in price is perfect information about scarcity, desirability
• No excess profit, no advertising expenses
o Situations
▪ Breakeven where MC = MR = ATC
• Total cost = total revenue
• Economic breakeven - firm is covering all explicit variable & fixed costs plus
opportunity costs
o Economic profit = 0
o Accounting profit = normal rate of return (opportunity cost)
▪ Profit where MC = MR is above ATC
• Economic profit > 0; accounting profit is also positive and greater than the
normal rate of return for this industry
▪ Loss where MC = MR is below ATC
• Covering all AVC, but only portion of fixed costs AFC
• Better to operate at loss than stop operating b/c fixed costs are being partially
paid off & breakeven in future - minimize losses (less than fixed costs)
o If stopped operating, would pay full fixed cost
• Borderline loss: if P is equal to AVC, firm can either stay or shut down,
depends on financing and vision management
• Serious loss: if P is less than both AVC and ATC, firm shuts down
o Minimize losses by only paying fixed costs, because AVC isn’t covered
▪ Industry Supply is horizontal sum of firms S
• This is why firms leaving and entering affects Industry Supply
o Long Run adjustment (changes in Supply)
▪ Losses in Long Run: lead to firms exiting & remaining firms breakeven
• Some firms exit, supply decreases (fewer firms; supply shift in), price increases,
decreasing losses and resulting in breakeven
• Firms that remain/stay/exist during loss situations are determined by who can
access financing through the losses & management with vision
▪ Profits in Long Run: lead to firms entering & remain firms breakeven
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