9781118041581

Summary 263

maximizes its profit (or minimizes its loss) by setting marginal revenue

equal to marginal cost.

6. In the long run, all revenues and costs are variable. The firm should
   continue production if, and only if, it earns a positive economic profit. A
   multiproduct firm should continue operating in the long run only if
   total revenue exceeds total costs. There is no need to allocate shared
   costs to specific products.

Nuts and Bolts

1. The firm’s cost function indicates the (minimum) total cost of
   producing any level of output given existing production technology,
   input prices, and any relevant constraints.


2. In the short run, one or more of the firm’s inputs are fixed. Short-run
   total cost is the sum of fixed cost and variable cost. Marginal cost is the
   additional cost of producing an extra unit of output. In the short run,
   there is an inverse relationship between marginal cost and the marginal
   product of the variable input: MC PL/MPL. Marginal cost increases
   due to diminishing returns. The short-run average cost curve is
   U-shaped.


3. In the long run, all inputs are variable. The firm chooses input
   proportions to minimize the total cost of producing any given level of
   output. The shape of the long-run average cost curve is determined by
   returns to scale. If there are constant returns to scale, long-run average
   cost is constant; under increasing returns, average cost decreases with
   output; and under decreasing returns, average cost rises. Empirical
   studies indicate L-shaped (or U-shaped) long-run average cost curves for
   many sectors and products.


4. Many firms supply multiple products. Economies of scope exist when the
   cost of producing multiple goods is less than the aggregate cost of
   producing each good separately.


5. Comparative advantage (not absolute advantage) is the source of
   mutually beneficial global trade. The pattern of comparative advantage
   between two countries depends on relative productivity, relative wages,
   and the exchange rate.

Questions and Problems

1. The development of a new product was much lengthier and more
   expensive than the company’s management anticipated. Consequently,
   the firm’s top accountants and financial managers argue that the firm
   should raise the price of the product 10 percent above its original target

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