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ECN 104 Study Guide - Final Guide: Predatory Pricing, Average Cost, Variable Cost

Course Code
ECN 104
Tsogbadral Galaabaatar
Study Guide

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Final Exam Review (Chapter 13 –21)
Chapter 13
Total Revenue, Total Cost, Profit
We assume that the firm’s goal is to maximize profit.
Costs: Explicit vs. Implicit
Explicit costs require an outlay of money,
e.g., paying wages to workers.
Implicit costs do not require a cash outlay,
e.g., the opportunity cost of the owner’s time.
Remember one of the Ten Principles:
The cost of something is
what you give up to get it.
This is true whether the costs are implicit or explicit. Both matter for
firms’ decisions.
Explicit vs. Implicit Costs: An Example
You need $100,000 to start your business.
The interest rate is 5%.
Case 1: borrow $100,000
explicit cost = $5000 interest on loan
Case 2: use $40,000 of your savings,
borrow the other $60,000
explicit cost = $3000 (5%) interest on the loan
implicit cost = $2000 (5%) foregone interest you could have
earned on your $40,000.
Economic Profit vs. Accounting Profit
Accounting profit
= total revenue minus total explicit costs
Economic profit
= total revenue minus total costs (including explicit and implicit costs)
Accounting profit ignores implicit costs,
so it’s higher than economic profit.
Costs in the Short Run & Long Run
Short run:
Some inputs are fixed (e.g., factories, land).
The costs of these inputs are FC.
Long run:
All inputs are variable
(e.g., firms can build more factories,
or sell existing ones).

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In the long run, ATC at any Q is cost per unit using the most efficient
mix of inputs for that Q (e.g., the factory size with the lowest ATC).
How ATC Changes as the Scale of Production Changes
Economies of scale occur when increasing production allows greater
workers more efficient when focusing on a narrow task.
More common when Q is low.
Diseconomies of scale are due to coordination problems in large
E.g., management becomes stretched, can’t control costs.
More common when Q is high.
Implicit costs do not involve a cash outlay,
yet are just as important as explicit costs
to firms’ decisions.
Accounting profit is revenue minus explicit costs. Economic profit is
revenue minus total (explicit + implicit) costs.
The production function shows the relationship between output and
The marginal product of labour is the increase in output from a one-
unit increase in labour, holding other inputs constant. The marginal
products of other inputs are defined similarly.
Marginal product usually diminishes as the input increases. Thus, as
output rises, the production function becomes flatter, and the total
cost curve becomes steeper.
Variable costs vary with output; fixed costs do not.
Marginal cost is the increase in total cost from an extra unit of
production. The MC curve is usually upward-sloping.
Average variable cost is variable cost divided by output.
Average fixed cost is fixed cost divided by output. AFC always falls as
output increases.
Average total cost (sometimes called “cost per unit”) is total cost
divided by the quantity of output. The ATC curve is usually U-shaped.
The MC curve intersects the ATC curve
at minimum average total cost.
When MC < ATC, ATC falls as Q rises.
When MC > ATC, ATC rises as Q rises.
In the long run, all costs are variable.
Economies of scale: ATC falls as Q rises. Diseconomies of scale: ATC
rises as Q rises. Constant returns to scale: ATC remains constant as Q
Chapter 14

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Characteristics of Perfect Competition
1. Many buyers and many sellers.
2. The goods offered for sale are largely the same.
3. Firms can freely enter or exit the market.
The Revenue of a Competitive Firm
Total revenue (TR)
Average revenue (AR)
Marginal revenue (MR):
The change in TR from
selling one more unit.
MR = P for a Competitive Firm
A competitive firm can keep increasing its output without affecting the
market price.
So, each one-unit increase in Q causes revenue to rise by P, i.e., MR =
Profit Maximization
What Q maximizes the firm’s profit?
To find the answer, “think at the margin.”
If increase Q by one unit,
revenue rises by MR,
cost rises by MC.
If MR > MC, then increase Q to raise profit.
If MR < MC, then reduce Q to raise profit.
Shutdown vs. Exit
A short-run decision not to produce anything because of market
A long-run decision to leave the market.
A key difference:
If shut down in SR, must still pay FC.
If exit in LR, zero costs.
A Firm’s Short-run Decision to Shut Down
Cost of shutting down: revenue loss = TR
Benefit of shutting down: cost savings = VC
(firm must still pay FC)
So, shut down if TR < VC
Divide both sides by Q: TR/Q < VC/Q
So, firm’s decision rule is:
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