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Chapter 13

Chapter 13 Economics.docx

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Department
Economics
Course
Economics 10a
Professor
Gregory Mankiw
Semester
Fall

Description
Chapter 13 Economics: The Costs of Production • Industrial organization: the study of how firms’decisions about prices and quantities depend on the market conditions that they face • Economists usually assume that the goal of a firm is to maximize profit • Total revenue (output): the amount a firm receives for the sale of its output • Total cost (amount firm pays to buy inputs): the market value of the inputs a firm uses in production (including opportunity cost); it is the sum of the explicit costs and the implicit costs • Profit= total revenue – 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 o Example: the opportunity cost of the financial capital that has been invested in the business • Economists study how firms make production & pricing decisions (explicit & implicit costs) o If someone quit their job and bought a small business, the opportunity cost would be the money lost on the interest of the money used to buy the business as well as the interest paid to the bank on the loan for the additional money to buy the small business • Accountants keep track of money that flows into and out of firms (just the explicit costs) o If someone quit their job and bought a small business, the opportunity cost would just be the interest paid to the bank on the loan for the additional money to buy the small business • Economic profit: total revenue minus total cost, including both explicit and implicit costs o For a business to be profitable, total revenue must cover all the opportunity costs • Accounting profit: total revenue minus total explicit cost o Usually larger than economic profit because it ignores implicit costs • Assume that the size of the firm is fixed and that the quantity supplied of a good can vary only by changing the number of workers (realistic in the short run, but not in the long run) • Production function: the relationship between the quantity of inputs used to make a good and the quantity of outputs of that good • The production function (number of workers vs. quantity of output) gets flatter as the number of workers increases, reflecting diminishing marginal products • The total-cost curve (quantity of output vs. total cost) gets steeper as the quantity of output increases because of diminishing marginal product • Marginal product: the increase in output that arises from an additional unit of input o It represents the change in output as the number of workers increases from one level to another • Diminishing marginal product: the property whereby the marginal product of input declines as the quantity of input increases • The production function’s slope tells us the change in the output of a good (rise) for each additional input of labor (run); it measures the marginal product of a worker • The most important relationship to study firms’production and pricing decisions is between quantity produced and total costs (graphed in the total-cost curve) • The total-cost curve gets steeper as the amount produced rises, whereas the production function gets flatter as the production rises • Fixed costs: costs that do not vary with the quantity of output produced; incurred even when nothing is produced o I.E. rent or a bookkeeper to keep track of bills • Variable costs: costs that vary with the quantity of output produced o I.E. cost of coffee beans, milk, sugar, and cups • Afirm’s total cost is the sum of fixed and variable costs • Average total cost: total costs divided by the quantity of output o Average fixed cost + average variable cost o The cost of the typical unit if total cost is divided evenly over all the units produced • Average fixed cost: the fixed cost divided by the quantity of output • Average variable cost: variable cost divided by the quantity of output • Marginal cost: the increase in total cost that arises form an extra unit of production • If marginal costs rises with the quantity of output produced, this reflects the property of diminishing marginal products • When the quantity of a good produced is already high, the marginal product of an extra worker is low and the marginal cost of an extra unit of a good is large because more workers means more crowded conditions • Average Total Cost (the sum of average fixed cost and average variable cost) is usually U- shaped because average fixed cost always
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