Summary 577
Summary
1.The cost of using a resource for a particular activity is
the opportunity cost of that resource. Some opportu-
nity costs are explicit costs;they involve a direct pay-
ment of cash. Other opportunity costs, however, are
implicit costs;they involve no outlay of money but
represent the inflows of cash that are forgone. Both ex-
plicit and implicit costs should be taken into account
when making decisions. Firms use capital and their
owners’ time, so firms should base decisions on eco-
nomic profit,which takes into account implicit costs
such as the opportunity cost of the owners’ time and
theimplicit cost of capital. Accounting profit,which
firms calculate for the purposes of taxes and public re-
porting, is often considerably larger than economic
profit because it includes only explicit costs and depre-
ciation, not implicit costs. Finally, normal profitis a
term used to describe an economic profit equal to
zero—a profit just high enough to justify the use of re-
sources in an activity.
2.A producer chooses output according to the optimal
output rule:produce the quantity at which marginal
revenue equals marginal cost. The marginal revenue
for each unit of output is shown by themarginal rev-
enue curve.More generally, the principle of marginal
analysissuggests that every activity should continue
until marginal benefit equals marginal cost.
3.The relationship between inputs and output is repre-
sented by a firm’s production function.In the short
run,the quantity of a fixed inputcannot be varied but
the quantity of a variable input,by definition, can. In
thelong run,the quantities of all inputs can be varied.
For a given amount of the fixed input, the total prod-
uct curveshows how the quantity of output changes as
the quantity of the variable input changes. The mar-
ginal productof an input is the increase in output that
results from using one more unit of that input.
4.There are diminishing returns to an inputwhen its
marginal product declines as more of the input is used,
holding the quantity of all other inputs fixed.- Total cost,represented by the total cost curve,is equal
to the sum of fixed cost,which does not depend on
output, and variable cost,which does depend on out-
put. Due to diminishing returns, marginal cost, the in-
crease in total cost generated by producing one more
unit of output, normally increases as output increases.
6.Average total cost(also known as average cost) is the
total cost divided by the quantity of output. Economists
believe that U-shaped average total cost curvesare typ-
ical because average total cost consists of two parts: av-
erage fixed cost,which falls when output increases (the
spreading effect), and average variable cost,which rises
with output (the diminishing returns effect).
7.When average total cost is U-shaped, the bottom of the
Uis the level of output at which average total cost is
minimized, the point of minimum-cost output.This is
also the point at which the marginal cost curvecrosses
the average total cost curve from below. Due to gains
from specialization, the marginal cost curve may slope
downward initially before sloping upward, giving it a
“swoosh” shape.
8.In the long run, a firm can change its fixed input and
its level of fixed cost. By accepting higher fixed cost, a
firm can lower its variable cost for any given output
level, and vice versa. The long-run average total cost
curveshows the relationship between output and aver-
age total cost when fixed cost has been chosen to mini-
mize average total cost at each level of output. A firm
moves along its short-run average total cost curve as it
changes the quantity of output, and it returns to a
point on both its short-run and long-run average total
cost curves once it has adjusted fixed cost to its new
output level.
9.As output increases, there are economies of scaleif
long-run average total cost decreases and diseconomies
of scaleif long-run average total cost increases. As all
inputs are increased by the same proportion, there are
increasing returns to scaleif output increases by a
larger proportion than the inputs; decreasing returns
to scaleif output increases by a smaller proportion; and
constant returns to scaleif output increases by the
same proportion.- Sunk costsare expenditures that have already been
made and cannot be recovered. Sunk costs should be ig-
nored in making decisions about future actions because
what is important is a comparison of future costs and
future benefits.
11.There are four main types of market structure based on
the number of firms in the industry and product differ-
entiation: perfect competition, monopoly, oligopoly,
and monopolistic competition.
12.Amonopolistis a producer who is the sole supplier of
a good without close substitutes. An industry con-
trolled by a monopolist is a monopoly.
13.To persist, a monopoly must be protected by a barrier
to entry.This can take the form of control of a natural
resource or input, increasing returns to scale that give
rise to a natural monopoly,technological superiority,
or government rules that prevent entry by other firms,
such as patentsorcopyrights.
Section 10 Review
Section 10 Summary