ECO100Y5 Chapter Notes - Chapter 7: Variable Cost, Marginal Product, Opportunity Cost
Chapter 7
While analyzing the supply side of the market we will have to make certain assumptions:
1. a firm is a single decision making-unit. This allows up to abstract from the firms governance or financial
structures
2. a firm's main goal is to maximize profits
3. produce a single product
Production
• a production functions give the maximum amount of output the firm can produce using with different combinations
of its inputs, labour and capital
• Q(output) = f( L,K) L-labour; K-capital
Profits
• accounting profits = revenue - explicit costs
• economic profits = revenue - (explicit costs + implicit costs)
• implicit costs
◦ a) opportunity cost of time - forgone salary of owners
◦ b) opportunity cost of financial capital - forgone return on next best investment
• total costs (explicit costs + implicit costs)
Profit Maximization
• we assume firms want to choose their inputs (and thus outputs) in order to maximize their economic profits
• economic profits = total revenue - total costs
Time Horizons
• the short run (SR) - a time period over which the quantities of certain inputs (most commonly fixed) cannot be
changed; we call these fixed input
• labour is a variable input
• the long run (LR) - a time period in which all inputs can be changed, but technology cannot change
• the very long run (VLR) - a time period long enough for production technology to change
◦ inputs don't have to change, but they can
Production in the Short Run
• total product (TP) - the total amount produced by a firm during some time period
• average product of labour (APL) - the goal product divided by the number of units of labour used in its production
• marginal product of labour (MPL) - the additional output produced using one more unit of labour
◦ MPL = change in TP / change in L
Activity AP MP
L
TP
AP
MPL
0
1
3
3
> 3
2
7
35
> 4
3
9
3
> 2
4
8
2
> -1
Law of diminishing marginal returns: adding additional units of a variable input will eventually lead to decreasing
marginal product of that input
Average product will be increasing if MP > AP, but decreasing if MP < AP.
• MP interescts AP at maximum point on graph
Costs in the Short Run
Total Cost (TC) – the total cost of producing any given level of output
• TC = TFC + TVC
Total Fixed Cost (TFC) – the cost of the fixed factor of production; does not vary with output
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Document Summary
While analyzing the supply side of the market we will have to make certain assumptions: a firm is a single decision making-unit. This allows up to abstract from the firms governance or financial structures: a firm"s main goal is to maximize profits, produce a single product of its inputs, labour and capital. Production in the short run: inputs don"t have to change, but they can, mpl = change in tp / change in l. Time horizons changed; we call these fixed input. Law of diminishing marginal returns: adding additional units of a variable input will eventually lead to decreasing marginal product of that input. Average product will be increasing if mp > ap, but decreasing if mp < ap: mp interescts ap at maximum point on graph. Total cost (tc) the total cost of producing any given level of output.