# ECO101H1 Study Guide - Midterm Guide: Average Cost, Average Variable Cost, Marginal Cost

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ECO 100 Term Test 2 Study Notes
13.The Costs of Production
Goal of firms is to maximize profit (= total revenue total cost)
When analyzing a firms behaviour, important to include all the opportunity costs of
production. Some (e.g. wages) are explicit; others (e.g. wages firm owner gives up by
working in firm rather than another job) are implicit
Firms costs reflect its production process. Production function typically becomes flatter
as the quantity of an input increases (diminishing marginal product), firms total-cost
curve becomes steeper as quantity produced rises
Firms total cost can be divided between fixed & variable costs.
From a firms total cost, 2 related measures of cost are derived: ATC is TC÷Q and
MC=TCrise if output increases by 1 unit
Often useful to graph ATC & MC. Typically, MC rises with Q(output) & ATC first falls
as output increases & then rises as output increases further. MC curve always crosses
ATC curve at min of ATC
Firms costs often depend on time horizon many costs fixed in short run but variable in
long run (ATC may rise more in short than long run when Q)
Accounting profit TR TC[explicit]
Constant returns to scale property whereby long-run ATC stays same as Q(output) changes
Diseconomies of scale property whereby long-run ATC rises as Q(output) increases
Economic profit TR TC (including both implicit & explicit costs)
Economies of scale the property whereby long-run ATC falls as Q(output) increases
Efficient scale the quantity of output that minimizes average total cost
Explicit costs input costs that require an outlay of money by the firm
Implicit costs input costs that do not require an outlay of money by the firm
°Whenever MC < ATC, ATC is falling. Whenever MC > ATC, ATC is rising.
°MC curve crosses the ATC curve at its minimum.
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14.Firms in Competitive Markets
Because a competitive firm is a price taker, its revenue is proportional to the amount of
output it produces. Price of good = both firms average revenue & marginal revenue.
To maximize profit, firm chooses Q of output such that MR = MC. Because MR for a
competitive firm = Pm, firm chooses Q so that P = MC. firms MC curve is its supply
curve
In short run when firm cannot recover its FC, firm will choose to shut down temporarily
if P of good < AVC. In long run when firm can recover both FC & VC, will choose to exit if
P < ATC
In market with free entry & exit, profits are driven to 0 in long run. In LReq, all firms
produce @ efficient scale, P = min of ATC, & # of firms adjusts to satisfy Q demanded @
this P
Changes in demand have different effects over different time horizons. In short run,
increase in D raises P & leads to profits, & decrease in D lowers P & leads to losses. But
if firms can freely enter & exit market, in long run # of firms adjusts to drive the market
back to 0-profit eq.
°Competitive market:
1.Many buyers & sellers in the market
2.Goods offered by various sellers are largely the same
3.Perfect knowledge of prices & technology
4.Firms can freely enter or exit the market in the LR
°For all firms, average revenue = P of good
°For competitive firms, MR = P of good
°At the profit-maximizing level of output, MR & MC are exactly =
°Because firms MC curve determines the Q of good firm is willing to supply @ any price,
it is the competitive firms supply curve
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°The firm shuts down if the revenue that it would get from producing < variable costs of
production
°Shut down if:
TR < VC
P < AVC
°The firm exits the market if the revenue it would get from producing < total costs
°Exit if:
TR < TC
P < ATC
°Enter if:
P > ATC
°Profit = (P ATC) X Q
°@ end of process of entry/exit, firms that remain in market must be making zero
economic profit
°Process of entry & exit ends only when P & ATC are driven to equality
°LReq of a competitive market with free entry & exit must have firms operating @
efficient scale
°Because firms can enter & exit more easily in the LR than in SR, LR supply curve
is typically more elastic than the SR supply curve
15.Monopoly
°A monopoly is a firm that is sole seller in its market. Arises when a single firm
owns a key resource, when govt gives a firm exclusive right to produce a good or
when single firm can supply the entire market @ smaller cost than many firms
could
°Because monopoly is sole producer in its market, faces a downward-sloping
demand curve. When monopoly increases production by 1 unit, causes price of
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