 Economists assume goal of firms is to maximize profit  Profit = Total Revenue – Total Cost  In other words: Amount firm receives for sale of output minus amount that the firm pays to buy inputs  Review – What is TR?

 Firm’s costs of production include all opportunity cost of producing output  Explicit costs: require an outlay of $  Implicit costs: don’t require an outlay of $

Economic Profit: Total Revenue – Opportunity Costs of production (implicit & explicit) Accounting Profit: Total Revenue – Explicit Costs only Accounting Profit is greater than Economic Profit

 Production Function: Relationship between quantity of inputs and quantity of output  Marginal Product: increase in the quantity of output obtained by an additional unit of input - How much more can we produce by hiring one more worker?

 As more workers are hired, each additional worker contributes less to the production

 As the quantity produced rises, the total cost curve becomes steeper

 Total cost is divided into fixed & variable costs  Fixed costs: do not vary with quantity of output produced (incurred even if the firm produces nothing)  Variable costs: Change as the firm alters the quantity of output produced

 Average Total Cost: Total Cost divided by quantity of output  Average Total Cost = Average Fixed Cost + Average Variable Cost  Marginal Cost = Increase in total cost by increasing production by one unit of output

 Putting 4 curves on costs vs. output graph

 Marginal cost rises with quantity of output because of diminishing marginal product  When quantity produced is high – marginal product is low & marginal cost is high

 U-Shaped because AFC declines as output expands and AVC typically increases as output expands; AFC is high when output levels are low.  Bottom of U-shape is quantity that minimizes average total cost, which is called the efficient scale of the firm

 When marginal cost is less than ATC, ATC is falling.  When MC is greater than ATC, ATC is rising  Analogy of your GPA

 3 important properties: 1. MC eventually rises with quantity of output 2. ATC curve is U-shaped 3. MC curve crosses ATC curve at minimum of ATC These curves include implicit & explicit costs

 Some costs are fixed in the short run, but ALL costs are variable in the long run  The long run ATC curve lies along the lowest points of the short run ATC curve because it has more flexibility to deal with changes in production in long run  Still a U-shape but much flatter

 Economies of scale: long-run ATC falls as quantity of output increases (specialization)  Diseconomies of scale: long-run ATC rises as quantity of output increases (coordination problems)  Constant returns to scale: long-run ATC stays the same as quantity of output changes