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Because resources are scarce and
may be employed to produce many different products
the economic cost of using resources
to produce any one of these products is an opportunity cost: The amount of other products
that cannot be produced.
- In money terms
the costs of employing resources
to produce a product are also an opportunity cost: the payments a firm must make to the
owners of resources to attract these resources away from their best alternative
opportunities for earning incomes. These costs may be either explicit or implicit.
- Normal profit is an implicit cost and is the
minimum payment that entrepreneurs must receive for performing the entrepreneurial
functions for the firm.
- Economic
or pure
profit is the revenue a firm
receives in excess of all its explicit and implicit economic (opportunity) costs. (The
firm’s accounting profit is its revenue less only its explicit costs.)
- The firm’s economic costs vary as the
firm’s output varies
and the way in which costs vary with output depends on whether
the firm is able to make short-run or long-run changes in the amounts of resources it
employs. The firm’s plant is a fixed resource in the short run and a variable
resource in the long run.
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| 2. |
In the short run the firm cannot change the
size of its plant and can vary its output only by changing the quantities of the variable
resources it employs.
- The law of diminishing returns determines the
manner in which the costs of the firm change as it changes its output in the short run.
- The total short-run costs of a firm are the sum
of its fixed and variable costs. As output increases
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- the fixed costs do not change;
- at first the variable costs increase at a
decreasing rate
and then increase at an increasing rate;
- and at first total costs increase at a decreasing
rate and then increase at an increasing rate.
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- Average fixed
variable
and total costs are
equal
respectively
to the firm’s fixed
variable
and total costs divided by the
output of the firm. As output increases
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- average fixed cost decreases;
- at first average variable cost decreases and then
increases;
- and at first average total cost also decreases
and then increases.
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- Marginal cost is the extra cost incurred in
producing one additional unit of output.
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- Because the marginal product of the variable
resource increases and then decreases (as more of the variable resource is employed to
increase output)
marginal cost decreases and then increases as output increases.
- At the output at which average variable cost is a
minimum
average variable cost and marginal cost are equal
and at the output at which
average total cost is a minimum
average total cost and marginal cost are equal.
- On a graph
marginal cost will always intersect
average variable cost at its minimum point and marginal cost will always intersect average
total cost at its minimum point. These intersections will always have marginal cost
approaching average variable cost and average total cost from below.
- Changes in either resource prices or technology
will cause the cost curves to shift.
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| 3. |
In the long run
all the resources employed by
the firm are variable resources
and therefore all its costs are variable costs.
- As the firm expands its output by increasing the
size of its plant
average total cost tends to fall at first because of the economies of
large-scale production
but as this expansion continues
sooner or later
average total
cost begins to rise because of the diseconomies of large-scale production.
- The economies and diseconomies of scales
encountered in the production of different goods are important factors influencing the
structure and competitiveness of various industries.
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- Minimum efficient scale (MES) is the smallest
level of output at which a firm can minimize long-run average costs. This concept explains
why relatively large and small firms could coexist in an industry and be viable when there
is an extended range of constant returns to scale.
- In other industries the long-run average cost
curve will decline over a range of output. Given consumer demand
efficient production
will be achieved only with a small number of large firms.
- When economies of scale extend beyond the market
size
the conditions for a natural monopoly are produced
wherein unit costs are minimized
by having a single firm produce a product.
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