Concepts of costs and revenues; How to maximize profits;
The following notes are the basic concepts in the mainstream (Capitalistic, neo-classical) Economics.
- Total Costs (TC) = Fixed Costs (FC) + Variable Costs (VC)
- The Law of Diminishing Returns
- Marginal Product (MP) = change on total output ⁄ change in the variable factor
- Productivity will be reduced whenever the additional variable factor is added
- Marginal Costs (MC) = change in TC ⁄ change in output
- MC is the inverse of MP; each additional factor lead to the more cost
- Average Costs (AC)
- TC = FC + VC
- AC = TC ⁄ Q = FC ⁄ Q + AC ⁄ Q = Average Fixed Costs (AFC) + Average Variable Costs (AVC)
- MC vs. AC
- MC > AC: pull AC up
- MC < AC: bring AC down
- MC will cross AC at the AC’s minimum point
- Economies of Scale
- The company can reduce the AC when it produces more.
- Diseconomies of Scale
- If the company grows too large, it may find the AC begin to rise again.
- Minimum Efficient Scale (MES)
- The first point of output at which the long-run AC is minimal.
- Total Revenue (TR): the measurement of the sales
- Tr = Price (P) × Quantity (Q)
- Marginal Revenue (MR): the difference in Total Revenue when an additional unit is sold
- MR = change in TR ⁄ change in Quantity
- Profit = Total Revenue (TR) – Total Costs (TC)
- Profit Maximization
- A company should stop producing at the point where Marginal Revenue (MR) equals Marginal Costs (MC)
- MR > MC: extra unit will make a profit
- MR = MC: no extra profit
- MR < MC: extra unit will be a loss