Unit 3 Micro Key Ideas 

Unit 3:   The Theory of the Firm

• All firms have costs.  It is important to be able to define and plot graphically these major costs.
  
  
• Explicit costs are monetary payments a firm must make to an outsider to obtain a resource.
  
  
• Implicit costs are income a firm sacrifices when it employs a resource it owns to produce a
  product rather than to sell the resource to someone else.
  
  
• Fixed costs do not change with output.  There are fixed costs only in the short run. 
  The long run is defined as a period in which there are no fixed costs and firms and free to
  allocate their resources as they please.
  
  
• Variable costs change with output.  Total costs equal fixed costs plus variable costs. 
  Marginal cost is the additional cost of producing an additional unit of output. 
  Marginal cost is very important in determining at what price and output a firm will operate.
  
  
• Marginal cost eventually rises because of the law of diminishing marginal returns is based on evidence that
  marginal product declines when equal amounts of a variable factor of production are added to fixed factors of production.
  
  
• Average total cost and average variable cost are total cost and variable cost divided by output.
  
  
• Average total cost and average variable cost fall when marginal cost is below them and rise
  when marginal cost is above them.
  
  
• The marginal cost curve crosses the average variable cost curve and the average total cost curve
  at their lowest points.
  
  
• If a firm has more revenue than costs, it makes a profit.
  
  
• If a firm has more costs than revenue , it operates at a loss.
  
  
• In the long run, a firm must cover all its implicit and explicit costs, including a normal rate of profit.
  
  
• A normal profit represents the opportunity cost of capital and is equal to the average return on investment
   
• In the short run, a firm can operate at a loss as long as its revenue covers its variable costs.
  
  
• Economic profits are profits and above the normal rate of profit in which a firm just covers its costs. 
  A firm makes an accounting profit when its revenue exceeds its explicit costs. 
   
• A firm makes an economic profit if it more than covers both its explicit and implicit costs.
  
  
• The objective of a firm is to maximize profits and/or minimize loss.
  
  
• Firms maximize profits when they produce where marginal revenue equals marginal cost.
  
  
• Perfect competition exists when there are many producers and many consumers of a homogeneous product.
  
  
• For a perfectly competitive firm, marginal revenue is equal to price.  A perfectly competitive firm
  produces where price equals marginal cost.  A perfectly competitive firm breaks even in the long run.
  
  
• A monopoly occurs when one firms controls the market.
  
  
• Other thing being constant, the most efficient allocation of resources occurs when a firm
  produces at the level of output where price (measuring marginal benefits to buyers) is equal to marginal cost.
  
  
• In the long run, a perfectly competitive firm produces at an output where price equals marginal cost
  and also produces where average total cost reaches its lowers point (vertex).  A perfectly competitive
  firm is allocatively and productively efficient in the long run.
   
• Allocatively efficient means the perfectly competitive firm operates at the point where P=MC.  Productive efficiency
  means the perfectly competitive firm operates at the point where P=MC=minimum ATC in the long run.
  
  
• For a monopoly firm or any firm under imperfect competition, marginal revenue is less than price.
  
  
• A monopoly firm maximizes profits by producing at the quantity where marginal revenue equals
  marginal cost and by setting price according to the demand curve at that quantity.
  
  
• A monopoly can make economic profits in the long run.  However, a long-run economic profit is not guaranteed.
  
  
• In the long run, a monopoly firm charges a higher price and produces at a lower output than a
  perfectly competitive firm with the same cost curves.
  
  
• A monopoly firm will operate where price is greater than marginal cost, causing a misallocation of resources.
  
  
• Oligopoly occurs when a few firms control the market.
  
  
• Monopolistic competition is close to pure or perfect competition except that there is product differentiation.