ECON 2306 1st EditionExam # 2 Study Guide Lectures: 6 - 9Lecture 6 (September 24)Chapter 6: Businesses and Their CostsThe Business PopulationPlant: an establishment-factory, farm, mine, store, website, warehouse ect. Firm: org that employs resources to produce goods and services and operates one or more plant. Industry: a group of firms that produce the same, or similar products. Multiplant firms may be organized horizontally with several plants performing the same function. Vertically integrated firms own plants that perform different functions in different stages of production process. Congolmerates have plants that are in different industries. Advantages of Corporation: Stocks: ownership shares of a corporation. Bonds: certificates indicating obligations to pay the principal and interest on loans at a specific time in the future. No ownership with bonds. Limited liability: restriction of the maximum loss to a shareholder to the amount paid for the stock. Risk only what they paid for. Corporations are for long-term growth. The Principal-Agent Problem: Ownership or corporations is large. Principal-agent problem: a conflict of interest that occurs when agents (managers) pursue their own objectives to the detriment of the principals' (stockholders') goals. Like when executives have too many perks, the firm's cost will be excessive and won't maximize profits. Economic CostsFirms have costs because they need resources to produce their products. Economic cost: a payment thatmust be made to obtain and retain the services of a resource. Explicit and Implicit Costs: Two types of economic costs, implicit and explicit. Explicit costs: the monetary payments a firm must make to an outsider to obtain a resource. Cash transaction. Explicit are opportunity costs. Implicit costs: the monetary income a firm sacrifices when it uses a resource it owns rather than supplying the resource in the market. Opportunity costs of using the resources it already owns to make the firm's own product rather than selling resources to outsiders for cash. Economic costs = explicit costs + implicit costs. Accounting Profit and Normal Profit: Accounting profit: the total revenue of a firm less its explicit costs. This is the net income. Ignores implicit costs. Normal profit: a payment that must be made by a firm to obtain and retain entrepreneurial ability. Uses implicit costs. Economic Profit: Accounting profit = revenue - explicit costs. Economic profit: a firm's total revenue less its total cost (= explicit cost + implicit cost). Economic profit = revenue - explicit costs - implicit costs. If a firm breaks even, they are doing fine. Economists focus on economic profits than accounting profits because economic profits direct how resources are allocated. Economic shows if the venture is good or not. Short Run and Long Run: Firm's profitability sometimes depends on how quickly it can adjust amounts of various resources itemploys. It can quickly change quantity of resources like hourly labor, raw materials, fuel, and power. Plant capacity, however, is long run. Short Run: Fixed Plant: Short run: a time period in which producersare able to change the quantities of some but not all of the resources they employ. No change in plant capacity. Changes in materials or labor ect. Long Run: Variable Plant: Long run: a time period sufficiently long to enable producers to change the quantities of all the resources they employ. Changes in plant capacity. Short and long run are conceptual, not actual time frames. Short-Run Production RelationshipsResource supply and demand determine resource prices. Total product (TP): the total output of a particular good or service produced by a firm. Marginal product (MP): the extra output or added product associated with adding a unit of a variable resource (labor) to the production process.Marginal product is change in total product divided by change in labor input. Average product (AP): the total output divided by the quantity of the resource employed (labor). Average product is total productdivided by units of labor. Law of Diminishing ReturnsLaw of diminishing returns: the principle that as successive units of a variable resource are added to a fixed resource, the marginal product of the variable resource will eventually decline. Relevancy for Firms: As producers add more units of a variable input like labor to a fixed input like capital, marginal product of labor will start to decline. Assumes all units of labor are of equal quality. Short-Run Production CostsCan be fixed or variable. Fixed, Variable, and Total Costs: Fixed Costs: Fixed Costs: costs that do not change in total when the firm changes its outputs. Fixed costs are like rental payments, interest on a firm's debts, a portion of deprecation on equipment and buildings, and insurance premiums. Variable Costs: Variable costs: costs that increase or decrease with a firm's output. Like payment for materials, fuel, power, transportation services, most labor ect. Total Cost: Total cost: the sum of fixed cost and variable cost. TC = TFC + TVC. Fixed costs are beyond manager's current control and are incurred in the short run. Per-Unit of Average Costs: Average-cost useful for making comparisons for product price. AFC:Average fixed cost (AFC) a firm's total fixed cost divided by output. TFC/Q. AVC: Average variable cost (AVC): a firm's total variable cost divided by output. TVC/Q. ATC: Average total cost (ATC): a firm's total cost (= total fixed costs + total variable costs) divided by output. Marginal Cost: Marginal cost (MC): the extra or additional cost of producing 1 or more unit of output. Change in TC/ change in Q. Marginal Decisions: Marginal costs are costs the firm can control directly and immediately. Marginal decisions are usually to produce a few more or few less units. Long-Run Production CostsThe industry can change plant capacity. Firm Size and Costs: Good larger plants will reduce ATC. The Long-Run Cost Curve: Intersecting curves show when firms should change plant size to realize lowest attainable average total costs of production. Long-run ATC curve is made up of segments of short-run ATC curves for various plant sizes. Long-run ATC curve also called planning curve. Economies and Diseconomies of Scale: U shape of long run ATC is due to economies and diseconomies of large scale production. Law of diminishing returns does not apply to production in the long run. Economies of Scale:Economies of scale: reductions in