Principles of economics openstax chapter7

College
Principles
ofPhysics
Economics
# Chapter
Title
ChapterChapter
7 Cost and
Industry
Structure
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Firm and production cost

Amazon is an American international electronic commerce company that sells books, among many other things, shipping them directly to the consumer.


Market structure

Perfect Competition: Many small firms selling “identical” products

Monopolistic Competition: Many small-medium firms selling “similar” products

Oligopoly: A few big firms selling “differentiated” products

Monopoly: Only one firm selling “unique” products


Market structure

Business Concepts

Cost: expenses of hiring resources for production of
goods and services
Revenue: incomes made from sale of goods and services
Profit = Revenue - Cost


Economic vs. Accounting Cost

Accounting Cost: Out-of-pocket costs or payments to suppliers of resources
(e.g., wage, interest, rent)
Economic Cost: Out-of-pocket cost + Opportunity cost
Opportunity Cost: Cost of using own resources (e.g., managing your own
business; using own vehicle for business)


Production & Cost Functions

Production Function: A graph showing the quantity of inputs used in
production of various quantities of output
Cost Function: A graph showing expenses of producing various quantities
of output


Production Costs

Fixed Costs: Costs of hiring fixed inputs (e.g., rent, insurance premiums)
Variable Costs: Costs of hiring variable inputs (e.g., wages, material costs)

Total cost function

At zero production, the fixed costs
= $160.
As production increases, variable
costs are added to fixed costs.

TC = TFC + TVC


Short-run Cost functions

Marginal Cost: Additional cost of producing an extra unit of output =
ΔTotal Cost / ΔOutput
Average Total Cost = Total Cost / Output
Total cost per unit of output
Average Variable Cost = Total Variable Cost / Output
Variable cost per unit of output
Average Fixed Cost = Total Fixed Cost / Output
Fixed cost per unit of output


Short-run Cost functions

Output

TVC

TFC

TC

MC*

ATC

AVC

AFC

0

0

8500

8500

100

2500

8500

11000

25

110

25

85

200

3800

8500

12300

13

62

19

43

300

4800

8500

13300

10

44

16

28

400

6000

8500

14500

12

36

15

21

500

7500

8500

16000

15

32

15

17

600

9500

8500

18000

20

30

16

14

700

12500

8500

21000

30

30

18

12

800

17000

8500

25500

45

32

21

10.6

900

22500

8500

31000

55

34

25

9.4

1000

32500

8500

41000

100

41

32.5

8.5

* MC is per 100 units of output


Short-run Cost functions


Economies of scale

Economies of scale: In the long-run, Average Cost falls as output expands due to
internal efficiencies (e.g., buying raw materials in large volumes at discounted
prices)
A small factory like S produces 1,000 alarm clocks at AC = $12 per clock. A medium
factory like M produces 2,000 alarm clocks at AC = $8 per clock. A large factory like L
produces 5,000 alarm clocks at AC = $4 per clock.

5-13


Economies of scale
Long-Run AC Declines as more output produced


Long-run average cost

The LRAC is the “envelope” of SRAC curves

The LRAC curve is actually based on a group of SRAC curves, each of which
represents one specific level of fixed costs. More precisely, the LRAC curve
will be the least expensive average cost curve for any level of output.

5-15


Long-run average cost


Long-run average cost

Minimum Efficient Scale (MES)

Plant size at which the LRAC reaches its minimum point as the firm experiences
extended economies of scale

MES helps determine the number of firms in an industry and therefore the level of
competition

5-17


Long-run average cost