Biggest decision that an entrepreneur makes is in what industry to establish a firm There are two decision time frames The short run fixed o Short run a time frame in which the quantity of at least one factor of production is Usually capital land and entrepreneurship are fixed factors of production Plant the fixed factors of production o Short run decisions are easily reversed The firm can increase or decrease its output in the short run by increasing or decreasing the amount of labor it hires o Long run a time frame in which the quantities of all factors of production can be varied o To increase output in the long run a firm can change its plant as well as the quantity of labor it hires o Long run decisions are not easily reversed Sunk cost the past expenditure on a plant that has no resale value The long run Short run technology constraint There are three concepts that describe the relationship between output and the quantity of labor Total output Marginal output Average output o The maximum output that a given quantity of labor can produce o The increase in total output that results from a one unit increase in the quantity of labor employed input with all other inputs remaining the same o Measured by slope of total product curve o Change in total output change in total input TP L L labor o Equal to total product output divided by the input labor machinery etc o Tells how productive workers are on average o Upside down u shape curve Product curves graphs of the relationships between employment and the three product concepts Similar to the PPF it separated the attainable from the unattainable Shapes of product curves are similar because almost every production process has two features Increasing marginal returns initially o Occurs when the marginally product of an additionally workers exceeds the marginal product of the previous worker Diminishing marginal returns eventually o Occurs when the marginal product of an additional worker is less than the marginal product of the previous worker o Law of diminishing returns as a firm uses more of a variable factor of production with a given quantity of the fixed factor of production the marginal product of the variable factor eventually diminishes Average product curve For the number of workers at which marginal product exceeds average product average product is increasing For the number of workers at which marginal product is less than average product average product is decreasing Total Cost in the short run Total cost TC the cost of all the factors of production a firm uses o Total fixed cost TFC the cost of the firm s fixed factors Total fixed cost is the same at all outputs Does not depend on quantity produced o Total variable cost TVC the cost of the firm s variable factors Total variable cost changes as output changes o Total fixed cost vertical distance between the TVC and TC curves Total cost TFC TVC Marginal Cost in the short run Marginal Cost the increase in total cost that results from a one unit increase in output o MC Total Cost Quanity check mark shape At small outputs marginal cost decreases as output increases because of greater specialization and the division of labor Marginal cost tells us how total cost changes as output increases When marginal product is at its maximum marginal cost is at a minimum Average Cost in the short run Average fixed cost AFC downward slope o Total fixed cost per unit of output Average variable cost AVC u shaped o Total variable cost per unit of output Average total cost ATC u shaped o Total cost per unit of output TC Q TFC Q TVC Q Q quantity produced or ATC AFC AVC The vertical distance between the average total cost and average variable cost curves is equal to average fixed cost o Distance shrinks as output increases because average fixed cost declines with increasing output Marginal Cost and Average Cost Marginal cost curve MC intersects the average variable cost curve and the average total cost curve at their minimum points o When marginal cost is less than average cost average cost is decreasing o When marginal cost exceeds average cost average cost is increasing Average Total Cost Curve Average total cost is the sum of average fixed cost and average variable cost so the shape of the ATC curve combines the shapes of the AFC and the AVC curves U shape of the ATC curve comes from two influences o Spreading total fixed cost over a larger output When output increases the firm spreads its total fixed cost over a larger output its average fixed cost decreases so the AFC curve slopes downward o Eventually diminishing returns As output increases ever larger amounts of labor are needed to produce an additional unit of output as output increases AVC decreases initially but eventually increases AVC is U shaped At the point of maximum marginal product marginal cost is at a minimum At the point of maximum average product average variable cost is at a minimum Cost Curves and Product Curves Shifts in the Cost Curves Technology o With better technology the same factors of production can produce more output o Lowers the costs of production and shifts the cost curves downward Prices of factors of production o Increases the firm s costs and shifts cost curves depends on which factor price changes Increase in fixed cost shifts the TFC and AFC curves upward and shifts the TC curve upward but leaves the AVC and TVC curves and the MC curve unchanged Increase in variable cost shifts the TVC and AVC curves upward and shifts the MC curve upward but leaves the AFC and TFC curves unchanged Term Symbol Definition Equation Fixed Cost Variable Cost Total fixed cost Total variable cost Total cost Output total product Marginal Cost Average fixed cost Average variable cost Average total cost TFC TVC TC TP MC AFC AVC ATC Long run cost Cost that is independent of the output level cost of a fixed factor of production Cost that varies with the output level cost of a variable factor of production Cost of the fixed factor of production Cost of the variable factors of production Cost of all factors of production Total quantity produced output Q Change in total cost resulting from a one unit increase in total product Total fixed cost per unit of output Total variable cost per unit of output Total cost per unit of output TC TFC TVC MC TC Q AFC TFC Q AVC TVC Q ATC AFC AVC Behavior of long run cost depends on the firm s production function o Production function the relationship between the maximum output attainable and the