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# Theory of the firm

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• Slide 9 is incorrect, youve illustrated a Monopolistic market diagram not a Perfect Competition

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### Theory of the firm

1. 1. Theory of the Firm<br />Kanako Nakagawa<br />
2. 2. Costs<br />Fixed costs: costs of production that do not change with the level of output.<br />Variable costs: costs of production that vary with the level of output.<br />Total costs: total costs of producing a certain level of output. [ Fixed costs + Variable costs ]<br />Average costs: average cost of production per unit. [ Total cost / Quantity produced ]<br />Marginal costs: additional cost of producing an additional unit of output. <br />
3. 3. Short-run cost curve<br />MC<br />ATC<br />Cost (\$)<br />AVC<br />Lowest points<br />Output<br />Shape of curves are explained by the concept of diminishing returns.<br />
4. 4. Time<br />Short Run: the period of time in which at least one factor of production is fixed – the production stage.<br />Long Run: the period of time in which all factors of production are variable.<br />
5. 5. Laws<br />Law of diminishing average returns: as extra units of a variable factor are applied to a fixed factor, the output per unit of the variable factor will eventually diminish.<br />Law of diminishing marginal returns: as extra units of a variable factor are applied to a fixed factor, the output from each additional unit of the variable factor will eventually diminish.<br />
6. 6. Scales<br />Economies of scale: any fall in long-run unit (average) costs that come about as a result of a firm increasing its scale of production (output).<br />Diseconomies of scale: any increase in long-run unit (average) costs that come about as a result of a firm increasing its scale of production (output).N<br />
7. 7. Revenues<br />Total revenue: the aggregate revenue gained by a firm from the sale of a particular quantity of output. [ Price x quantity sold ]<br />Average revenue: total revenue received / number of units sold. Price usually = average revenue.<br />Marginal revenue: the extra revenue gained from selling an additional unit of a good or service.<br />
8. 8. Profits<br />Normal profits: the amount of revenue needed to cover the total costs of good or service.<br />Abnormal profits: any level of profit that is greater than that required to ensure that a firm will continue to supply its existing good or service. (Amount of revenue > total costs of production)<br />
9. 9. Normal Profits in Perfect Competition<br />Cost/Price (\$)<br />MC<br />AC<br />P/C<br />D=AR<br />0<br />Output<br />MR<br />In normal profits, Price=Cost<br />
10. 10. Abnormal Profits<br />Cost/Price (\$)<br />MC<br />AC<br />P<br />C<br />D=AR<br />0<br />Output<br />MR<br />
11. 11. Output<br />Profit-maximizing level of output: the level of output where marginal revenue = marginal cost.<br />Shut-down price: price where average revenue is equal to average variable cost.<br />Break-even price: price where average revenue is equal to average total cost. Below this price, the firm will shut down in the long run.<br />