Page 619 - Krugmans Economics for AP Text Book_Neat

Section 10 Summary

Section 10 Review

Summary
1. The cost of using a resource for a particular activity is spreading effect), and average variable cost, which rises
the opportunity cost of that resource. Some opportu- with output (the diminishing returns effect).
nity costs are explicit costs; they involve a direct pay- 7. When average total cost is U-shaped, the bottom of the
ment of cash. Other opportunity costs, however, are U is the level of output at which average total cost is
implicit costs; they involve no outlay of money but minimized, the point of minimum-cost output. This is
represent the inflows of cash that are forgone. Both ex- also the point at which the marginal cost curve crosses
plicit and implicit costs should be taken into account the average total cost curve from below. Due to gains
when making decisions. Firms use capital and their from specialization, the marginal cost curve may slope
owners’ time, so firms should base decisions on eco- downward initially before sloping upward, giving it a
nomic profit, which takes into account implicit costs “swoosh” shape.
such as the opportunity cost of the owners’ time and
8. In the long run, a firm can change its fixed input and
the implicit cost of capital. Accounting profit, which
its level of fixed cost. By accepting higher fixed cost, a
firms calculate for the purposes of taxes and public re-
firm can lower its variable cost for any given output
porting, is often considerably larger than economic
level, and vice versa. The long-run average total cost
profit because it includes only explicit costs and depre-
curve shows the relationship between output and aver-
ciation, not implicit costs. Finally, normal profit is a
age total cost when fixed cost has been chosen to mini-
term used to describe an economic profit equal to
mize average total cost at each level of output. A firm
zero—a profit just high enough to justify the use of re-
moves along its short-run average total cost curve as it
sources in an activity.
changes the quantity of output, and it returns to a
2. A producer chooses output according to the optimal point on both its short-run and long-run average total
output rule: produce the quantity at which marginal cost curves once it has adjusted fixed cost to its new
revenue equals marginal cost. The marginal revenue output level.
for each unit of output is shown by the marginal rev-
9. As output increases, there are economies of scale if
enue curve. More generally, the principle of marginal
long-run average total cost decreases and diseconomies
analysis suggests that every activity should continue
of scale if long-run average total cost increases. As all
until marginal benefit equals marginal cost.
inputs are increased by the same proportion, there are
3. The relationship between inputs and output is repre- increasing returns to scale if output increases by a
sented by a firm’s production function. In the short larger proportion than the inputs; decreasing returns
run, the quantity of a fixed input cannot be varied but to scale if output increases by a smaller proportion; and
the quantity of a variable input, by definition, can. In constant returns to scale if output increases by the
the long run, the quantities of all inputs can be varied. same proportion.
For a given amount of the fixed input, the total prod-
10. Sunk costs are expenditures that have already been
uct curve shows how the quantity of output changes as
made and cannot be recovered. Sunk costs should be ig-
the quantity of the variable input changes. The mar-
nored in making decisions about future actions because
ginal product of an input is the increase in output that
what is important is a comparison of future costs and
results from using one more unit of that input.
future benefits.
4. There are diminishing returns to an input when its
11. There are four main types of market structure based on
marginal product declines as more of the input is used,
the number of firms in the industry and product differ-
holding the quantity of all other inputs fixed.
entiation: perfect competition, monopoly, oligopoly,
5. Total cost, represented by the total cost curve, is equal and monopolistic competition.
to the sum of fixed cost, which does not depend on
12. A monopolist is a producer who is the sole supplier of
output, and variable cost, which does depend on out-
a good without close substitutes. An industry con-
put. Due to diminishing returns, marginal cost, the in-
trolled by a monopolist is a monopoly.
crease in total cost generated by producing one more
unit of output, normally increases as output increases. 13. To persist, a monopoly must be protected by a barrier
to entry. This can take the form of control of a natural
6. Average total cost (also known as average cost) is the
resource or input, increasing returns to scale that give
total cost divided by the quantity of output. Economists
rise to a natural monopoly, technological superiority,
believe that U-shaped average total cost curves are typ-
or government rules that prevent entry by other firms,
ical because average total cost consists of two parts: av-
such as patents or copyrights.
erage fixed cost, which falls when output increases (the
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