[Study Notes] Microeconomics – Costs

The basic concepts of Costs, Revenues, and Profits.

The following notes are the basic concepts in the mainstream (Capitalistic, neo-classical) Economics.

Costs

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

Marginal Costs (MC) = Change in TC ⁄ Change in output

  • Marginal cost (MC) is the inverse of MP;
  • MC is the extra cost incurred when one extra unit of output is produced.
    • Each additional factor leads to the more cost -> Diminishing Return

Average Costs (AC)

TC = FC + VC
AC = TC ⁄ Q = FC ⁄ Q + AC ⁄ Q = Average Fixed Costs (AFC) + Average Variable Costs (AVC)

Marginal Costs (MC) vs. Average Costs (AC)

  • MC > AC: pull AC up
  • MC < AC: bring AC down
  • MC will cross AC at the AC’s minimum point

Long-run Costs

  • Economies of Scale
    • The company can reduce the Average Costs (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.

Revenues

Total Revenue (TR) is the measurement of the sales.

Total Revenue (TR) = Price (P) × Quantity (Q)

Marginal Revenue (MR) is the difference in Total Revenue when an additional unit is sold

Marginal Revenue (MR) = change in TR ⁄ change in Quantity

Profits

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

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