8th Grade Economics Notetaker

Unit 3C: Production Functions & Costs

Theory of the Firm

• A firm is an organization that employs factors of production to produce a good or service that it hopes to sell
profitably.

• The goal of each firm is to make profits.

• Short-run (SR) is a period of time too short to change the amount of physical capital (such as factory space), but
many other variable resources can be adjusted to production needs. New firms cannot enter the industry, and
existing firms cannot exit.

• Long-run (LR) is a period of time long enough to alter the amount of physical capital. New firms can enter the
industry and existing firms can liquidate or sell physical capital and exit the market.

• Fixed inputs are production inputs that cannot be changed in the short run.

• Variable inputs are production inputs that the firm can adjust in the short run to meet changes in demand for
their output.

Production Functions

• The states that as successive units of a variable resource are added to a fixed resource, at some point the
marginal product declines.

Example 1: Eli and Max run a lemonade stand where their output (in cups of
lemonade) varies with the number of workers they hire to run their stand.
Graph a correctly labeled total product curve, and identify where diminishing
returns sets in and where negative returns sets in.
 • Marginal Product (MP) is the additional output generated when adding one more unit of input.

∆ output
MP=
∆ input

Example 2: Add the marginal product column to the table above. Then graph a correctly labeled marginal product curve,
and identify where diminishing returns sets in and where negative returns sets in.

Example 3: Complete the table. ‘

• When does the production function begin experiencing diminishing marginal returns?
I think that it returns after the peak when the amount of the lemonades start decreasing and when the number of the
laborers also start increasing.

• When does the production function begin experiencing negative marginal returns?

The negative is when the lemonades are selling at –2 so im guessing that they aren’t being bought but the amount of
laborers are still at the highest number on this graph which is 7.

I think these maybe are right but idk for sure if they are.

Costs, Part 1

• ______explicit costs_______ (accounting costs) are direct, purchased, out of pocket costs paid to resource
suppliers outside the firm.

• _____implicit costs______ (economic costs) are indirect, non-purchased, or opportunity costs of resources.

• _____economic profit_______ is the difference between total revenue and total explicit and implicit costs.

• _______accounting profit_______ is the difference between total revenue and total explicit costs.

• To economists, nothing is free. It’s just _____non-priced_____. In other words, implicit costs are always present
(greater than zero).

Example 4: Suppose that a firm produces 100,000 units in a year and sells them all for $5 each. The explicit costs of
production are $350,000 and the implicit costs of production are $100,000. What is the firm’s accounting profit and
economic profit?

Example 5: Suppose that Wally’s Wind Chimes produces 2,000 wind chimes in a year and sells them all for $25 each. The
explicit costs of production are $25,000 (the salary they pay to their workers and the rent they pay for their storefront)
and the implicit costs of production are $23,250 (the money Wally could make managing a restaurant instead and the
interest Wally could earn if he liquidated all of his capital). What is Wally’s Wind Chimes’ accounting profit and economic
profit?
Costs, Part 2

• ___________________________________ are the costs that do not vary with changes in short-run output. They
must be paid even when output is zero.

• ___________________________________ are the costs that change with the level of output. If output is zero,
so are the total variable costs.

• ___________________________________ is the sum of total fixed and total variable costs at each level of
output.

• ___________________________________

Draw properly labeled graphs of TFC, TVC, and TC.

Do you guys understand any of this?

• ___________________________________ is the additional cost of producing one more unit of output.

∆ TC ∆TVC
• MC= =
∆Q ∆Q

• ___________________________________ is the total fixed cost divided by output.

TFC
• AFC=
Q

• ___________________________________ is the total variable cost divided by output.

TVC
• AVC=
Q

• ___________________________________ is total cost divided by output.

TC
• ATC=AFC + AVC =
Q
Draw properly labeled graphs of AFC, AVC, ATC, and MC.

Draw AVC, ATC, and MC all on a single set of axes and write down the important conclusions an economist can draw
from this graph.

Example 6: Complete the table.

Example 7: Explain why fixed cost has no influence on marginal cost.

• The _________________________________________________________ is a “bathtub” that holds all the short-

• ________________________________________ is where LRATC falls as the firm increases output. This is the
result of specialization, lower input costs, or other efficiencies from a larger scale.

• ________________________________________ occur when LRATC is constant over a variety of output levels.

• ________________________________________ is where LRATC rises as the firm increases output. This is

Draw a LRATC curve and label the regions that show economies of scale, constant returns to scale, and diseconomies of
scale.

Understanding Profit

• The goal of every firm is to maximize its ________________. As such, the decisions of where to produce, when
to produce, and what to produce are all dominated by this notion of ________________.

• _________________________ = Total Revenue – Total Cost

• π=P·Q−TC

• _________________________ is found by multiplying price times quantity.

• _________________________ is the change in total revenue, or the extra revenue that results from selling 1
more unit of output.
General rules for businesses:

• If MR > MC, ______________________ it

• If MR < MC, ______________________ it

• Profits are maximized where _______________________

• The point at which marginal revenue equals marginal cost tells us _________ specific things about the producer:

• A firm will always ________________________________________________ where MR=MC.

• A firm will _______________________________________________________ where MR=MC

• A firm will ____________________ any time the MR=MC point is below the average variable cost curve.