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ECON 1P91 Study Guide - Final Guide: Average Variable Cost, Marginal Revenue, Diminishing Returns

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Professor Cottrel
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Chapter 7 Producers in the Short Run
7.2 Production, Costs, and Profits
intermediate products all outputs that are used as inputs by other producers in a further
stage of production
production function a functional relation showing the maximum output that can be
produced by any given combination of inputs
o Q = f(L,K)
Q = flow of output
K = flow of capital services
L = flow of labour services
f = the production function itself
accounting profits = revenues explicit costs
economic profits = revenues explicit costs implicit costs
o economic profits the difference between the revenues received from the sale of
output and the opportunity cost of the inputs used to make the output
o economic profits in an industry are a signal that resources can profitably be
moved into the industry
π = TR [total revenue] TC [total cost]
short run the length of time over which some of the factors of production of the firm are
long run the length of time over which all of the firm’s factors of production are
variable, but technology is fixed
very long run the length of time over which all factors of production and technology
can be varied
7.3 Production in the Short Run
total product (TP) total amount produced by a firm during in a certain period of time
average product (AP) total product divided by the number of units of the variable factor
used in production
o AP = 
o point of diminishing average productivity is when AP reaches a maximum
marginal product (MP) the change in total output that results from using one more unit
of a variable factor
o MP = 
o point of diminishing marginal productivity where MP reaches a maximum
law of diminishing returns increasing quantities of a variable factor will eventually lead
to a decrease in the marginal product of the variable factor
AP curve slopes upward as long as the MP curve is above it, regardless of the slope of the
MP curve
o in order for average product to rise, marginal product must exceed the average
o to increase the average, the marginal must be greater than the average

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7.4 Costs in the Short Run
total cost (TC) sum of all costs of producing any given level of output
total fixed cost (TFC) all costs of production that do not vary with the level of output
total variable cost (TVC) total costs of production that vary directly with the level of
o TC = TFV + TVC
average total cost (ATC) - total cost divided by number of units of output, or the sum of
average fixed cost and average variable cost
average fixed cost (AFC) total costs divided by the number of units of output
average variable cost (AVC) total variable costs divided by the number of units of
o ATC = 
marginal cost (MC) increase in total cost resulting from increasing output by one unit
o MC = 
the AFC, AVC and ATC curves
o average fixed cost (AFC) curve decreases as output rises because of a
phenomenon called spreading overhead
o average variable cost (AVC) curve declines as output rises, reaches a minimum,
and then begins to rise
o average total cost (ATC) derived by vertically adding the AFC and AVC curves
o the gap between ATC and AVC starts off large but gets smaller as output
the MC curve
o plotted on the midpoint of the output interval
o declines steadily as output initially increases, reaches a minimum, then rises as
outputs increase farther
Why are the cost curves U-shaped?
o product curves are hill-shaped
o cost curves are U-shaped because the relationship between labour input and
output is closely related to the relationship between output and cost
as labour increases, output increases, but begins to decrease at a certain
point output declines then rises; therefore costs decline and rise
eventually diminishing average product of the variable factor implies eventually
increasing average variable cost
eventually diminishing marginal product of the variable factor implies eventually
increasing marginal costs
capacity is the largest output that can be produced without encountering rising average
costs per unit where ATC = MC, at the lowest point of ATC
excess capacity when a firm is producing at an output less than the point of minimum
average total cost
shifts in short-run cost curves
o changes in factor prices as wage increases, variables cost increase, and total
costs also increase upward shift in ATC and MC curves
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