Production, Costs, and Market Structures
Core concepts
Short run has at least one fixed input; long run all inputs are variable. Total product, marginal product, and average product describe production; diminishing marginal returns set in as more variable input is added to fixed inputs.
Costs: fixed (FC), variable (VC), total (TC), average total (ATC), average fixed (AFC), average variable (AVC), and marginal (MC). MC typically falls then rises, crossing ATC and AVC at their minimum points. Economies of scale lower long-run average cost; diseconomies raise it.
Market structures:
- Perfect competition: many firms, identical products, free entry/exit, price takers; long-run profit = 0.
- Monopolistic competition: many firms, differentiated products, some pricing power, free entry.
- Oligopoly: few firms, interdependence, strategic behavior (game theory, collusion).
- Monopoly: one firm, barriers to entry, price maker; produces where MR = MC.
Profit maximization rule: produce where MR = MC (for competitive firms, P = MC).
Common traps
- Confusing accounting profit (revenue − explicit costs) with economic profit (also subtract implicit costs).
- Assuming monopolies charge the highest possible price; they maximize profit where MR = MC.
- Mixing short-run shutdown (P < AVC) with long-run exit (P < ATC).
- Thinking zero economic profit means zero accounting profit; it means normal profit.
Worked example
A competitive firm has P = $12, MC = $12 at Q = 200, ATC = $10. Profit = (P − ATC) × Q = ($12 − $10) × 200 = $400. Since P > ATC, the firm earns economic profit; entry will erode it in the long run.
Rule of thumb
Maximize profit where MR = MC. Shut down in the short run only if price falls below AVC; exit in the long run if price stays below ATC.