Short-run and long-run costs, marginal analysis, and profit maximization in perfectly competitive markets.
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- Distinguish between explicit costs and implicit costs.
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Explicit costs are direct out-of-pocket payments for resources; implicit costs are the opportunity costs of using resources the firm already owns.- In the short run, capital equipment and factory size cannot be changed. What type of cost does this create?
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Fixed costs, which do not vary with the firm's output level.- If a firm owns its building and uses it in production but pays no rent, what type of cost is incurred?
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An implicit cost, specifically the opportunity cost of what that building could earn in its best alternative use.- Define marginal product.
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The additional output produced when one more unit of input is added, holding all other inputs constant.- Define average product.
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Total output divided by the total quantity of input used.- State the law of diminishing marginal returns.
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As more of one input is added while other inputs remain fixed, the marginal product of that input will eventually decline.- For a perfectly competitive firm, what is the relationship between marginal revenue and the market price?
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Marginal revenue equals price; they are identical for a perfectly competitive firm.- Why is the MR = MC condition the profit-maximizing output level?
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At MR = MC, the revenue from one more unit exactly equals its cost. Producing more would lower profit, and producing less would forgo profit.- What three values are equal in long-run equilibrium in perfect competition?
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Price, marginal cost, and average total cost are all equal.- In perfect competition, when do new firms enter a market?
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When incumbent firms earn positive economic profits, meaning price exceeds average total cost.- What causes firms to exit a perfectly competitive market?
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Persistent negative economic profits, typically caused by new firm entry driving the price below average total cost.- Define economies of scale.
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A situation where average total cost falls as the firm increases its output level.- Define diseconomies of scale.
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A situation where average total cost rises as the firm increases its output level.- Define constant returns to scale.
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A situation where average total cost remains unchanged as the firm increases its output level.- Why is the long-run average total cost curve drawn as an envelope of short-run curves?
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Because in the long run the firm can choose any plant size and will select the one that minimizes ATC for each output level; the LRATC touches the lowest point of each relevant SRATC.
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