Foundations of Firm Behavior: Production and Cost Analysis

Production Function

The relationship between inputs (resources) and outputs (goods) in a firm.

Short Run

A period in which at least one input is fixed and cannot be changed.

Long Run

A period in which all inputs of production are variable.

Total Product (TP)

The total quantity of output produced with a given amount of inputs.

Marginal Product (MP)

The additional output generated by adding one more unit of a variable input.

Average Product (AP)

The output produced per unit of variable input.

Law of Diminishing Marginal Returns

As more of a variable resource is added to fixed resources, the additional output from each new unit will eventually decline.

Stage I (Increasing Returns)

When specialization allows workers to be more efficient and marginal product is rising.

Stage II (Diminishing Returns)

When each new worker adds to total product but at a decreasing rate, resulting in a falling marginal product.

Stage III (Negative Returns)

When overcrowding causes total product to fall, resulting in negative marginal product.

Fixed Costs (FC)

Costs that do not change with output quantity; incurred even with zero production.

Variable Costs (VC)

Costs that increase as output increases.

Total Cost (TC)

The sum of fixed and variable costs.

Marginal Cost (MC)

The additional cost of producing one more unit of output.

Average Fixed Cost (AFC)

Fixed cost per unit of output.

Average Variable Cost (AVC)

Variable cost per unit of output.

Average Total Cost (ATC)

Total cost per unit of output, derived from total cost divided by quantity.

Economies of Scale

As a firm grows, long-run average costs fall due to increased efficiency.

Constant Returns to Scale

Average costs remain constant as output increases.

Diseconomies of Scale

As a firm becomes too large, long-run average costs rise due to inefficiencies.

Increasing Returns to Scale

Output increases more than proportionately when all inputs are doubled.

Constant Returns to Scale

Output increases proportionately when all inputs are doubled.

Decreasing Returns to Scale

Output increases less than proportionately when all inputs are doubled.

Explicit Costs

Out-of-pocket money payments incurred by a firm.

Implicit Costs

Opportunity costs of owned resources that do not involve direct payments.

Check-Mark Shape

The shape of the marginal cost curve that initially falls then rises steeply.

Vertical Distance between ATC and AVC

Represents average fixed cost, which decreases as quantity increases.

Nikes Swoosh

Mnemonic for the shape of the MC curve, which intersects both ATC and AVC at their lowest points.