Unit 3: Top 10 Costs of Production Concepts to Know
Unit 3: Top 10 things you need to know about the production costs of a firm, including marginal analyses in the short run and long run. This is geared toward college-level principles of macro and micro courses and students enrolled in AP Economics. Top 10 concepts in this video: #1. Diminishing Marginal Returns, #2. Marginal Product & Average Product, #3. Economic Profit vs. Accounting Profit, #4. Types of Costs, #5. Calculating Costs, #6. Total Revenue & Marginal Revenue, #7. Profit Maximizing Rule, #8. Per-Unit Tax vs. Lump-Sum Tax, #9. Short Run vs. Long Run, and #10. Long-Run Average Total Cost Curve.
All firms have costs. It is important to be able to define and plot graphically these major costs.
Explicit costs are monetary payments a firm must make to an outsider to obtain a resource.
Implicit costs are income a firm sacrifices when it employs a resource it owns to produce a product rather than to sell the resource to someone else.
Fixed costs do not change with output. There are fixed costs only in the short run. The long run is defined as a period in which there are no fixed costs and firms are free to allocate their resources as they please.
Variable costs change with output. Total costs equal fixed costs plus variable costs. Marginal cost is the additional cost of producing an additional unit of output. Marginal cost is very important in determining at what price and output a firm will operate.
Marginal cost eventually rises because of the law of diminishing marginal returns is based on evidence that marginal product declines when equal amounts of a variable factor of production are added to fixed factors of production.
Average total cost = total cost divided by output.
Average variable cost = variable cost divided by output.
ATC and AVC fall when marginal cost is below them and rise when marginal cost is above them.
The marginal cost curve crosses the AVC curve and the ATC curve at their lowest points.
If a firm has more revenue than costs, it makes a profit.
If a firm has more costs than revenue, it operates at a loss.
In the long run, a firm must cover all its implicit and explicit costs, including a normal rate of profit.
A normal profit represents a the opportunity cost of capital and is equal to the average return on investment.
In the short run, a firm can operate at a loss as long as its revenue covers its variable costs.
Economic profits are profits above the normal rate of profit in which a firm just covers its costs. A firm makes an accounting profit when its revenue exceeds explicit costs.
A firm makes an economic profit if it more than covers both its explicit and implicit costs.
The objective of a firm is to maximize profits and/or minimize loss.
Firms maximize profits when they produce where marginal revenue equals marginal cost.
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