EC120 Chapter Notes - Chapter 13: Marginal Product, Marginal Cost, Production Function
10/25/15
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EC120 – CHAPTER 13: FIRM BEHAVIOUR AND THE ORGANIZATION OF INDUSTRY
TOTAL REVENUE, TOTAL COST, AND PROFIT
• People open businesses to make money
• Economists assume that the goal of a firm is to maximize profits
• TOTAL REVENUE: The amount a firm receives for the sale of its output
• TOTAL COST: The market value of the inputs a firm uses in production
• PROFIT: Total revenue minus total cost
COSTS AS OPPORTUNITY COSTS
• 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
• Economists keep track of both implicit and explicit costs when studying how
firms make production and pricing decisions
• Accountants only keep track of the explicit costs because those are the ones
that are physically paid
THE COST OF CAPITAL AS AN OPPORTUNITY COST
• An important implicit costs of every business is the opportunity cost of the
financial capital that has been invested in the company
• If that capital investment would have gained a certain percentage in interest,
then that amount is the opportunity cost of her decision
• Accountants look at the flow of money in and out of a company
ECONOMIC PROFIT VS. ACCOUNTING PROFIT
• ECONOMIC PROFIT (EC): Total revenue minus total cost, including both
explicit and implicit costs
• ACCOUNTING PROFIT (AC): Total revenue minus total explicit cost
• Accounting is usually larger than the economic profit due to the fact that
implicit costs are completely ignored.
• When making more than the EC, the company will stay in business
• When making less than the EC, the business owners are not making enough
to cover all costs of production
THE PRODUCTION FUNCTION
• PRODUCTION FUNCTION: The relationship between quantity of inputs used
to make a good and the quantity of output of that good
• MARGINAL PRODUCT: The increase in output that arises from an additional
unit of input, holding all other inputs constant
• DIMINISHING MARGINAL PRODUCT: The property whereby the marginal
product of an input declines as the quantity of the input increases.
o Too many chefs in the kitchen spoils the broth
• As the number of workers increases, the marginal product declines, and the
production function becomes flatter.
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