Glossary
Accounting Profit
Total revenue minus explicit (out-of-pocket) costs.
Example:
A freelance graphic designer earns 10,000 in software subscriptions and office supplies, resulting in an accounting profit of $40,000.
Average Fixed Cost (AFC)
The fixed cost per unit of output, calculated by dividing total fixed cost by the quantity produced.
Example:
A software company's annual server lease of 12 per license.
Average Product (AP)
The total output produced divided by the total quantity of an input used, often calculated as total product per worker.
Example:
If 10 workers produce 100 widgets, the average product per worker is 10 widgets.
Average Total Cost (ATC)
The total cost per unit of output, calculated by dividing total cost by the quantity produced.
Example:
If producing 100 custom mugs costs 5.
Average Variable Cost (AVC)
The variable cost per unit of output, calculated by dividing total variable cost by the quantity produced.
Example:
If it costs 4.
Capital
A factor of production consisting of tools, machinery, equipment, and infrastructure used to produce other goods and services.
Example:
The robotic arms on an assembly line that build cars are an example of physical capital.
Constant Returns to Scale
A situation where output increases by the same proportion as the increase in all inputs, meaning long-run average costs remain unchanged.
Example:
A chain of identical fast-food restaurants might experience constant returns to scale if opening a new, identical branch doubles inputs and exactly doubles output.
Decreasing Returns to Scale
A situation where output increases by a smaller proportion than the increase in all inputs, leading to an increase in long-run average costs.
Example:
A massive, sprawling corporation might face decreasing returns to scale as its sheer size leads to bureaucratic inefficiencies and coordination problems.
Diseconomies of Scale
A phenomenon where the long-run average total cost increases as the firm's output increases, often due to management difficulties or coordination issues in very large organizations.
Example:
A rapidly expanding global corporation might experience diseconomies of scale as communication breaks down and decision-making becomes slow and inefficient.
Economic Profit
Total revenue minus both explicit and implicit (opportunity) costs.
Example:
If the graphic designer from the previous example could have earned 40,000 (accounting profit) - 5,000.
Economies of Scale
A phenomenon where the long-run average total cost decreases as the firm's output increases, often due to specialization or bulk purchasing.
Example:
A large online retailer benefits from economies of scale by buying products in massive quantities, securing lower per-unit prices from suppliers.
Entry (of firms)
The process by which new firms join an existing market, typically occurring when existing firms are earning positive economic profits.
Example:
Seeing the high profits of existing organic food stores, new entrepreneurs might decide on the entry of their own organic grocery businesses into the market.
Exit (of firms)
The process by which existing firms leave a market, typically occurring when firms are incurring economic losses.
Example:
After years of declining sales and losses, many Blockbuster video stores were forced into exit from the market.
Fixed Costs (FC)
Costs that do not vary with the level of output produced in the short run.
Example:
The monthly rent for a factory building is a fixed cost because it must be paid regardless of how many units are produced.
Free Entry and Exit
A characteristic of a market where there are no significant barriers preventing new firms from entering or existing firms from leaving.
Example:
The ease with which new food trucks can start up or shut down in a city demonstrates free entry and exit in that local market.
Homogeneous Products
Products that are identical or indistinguishable from one another, regardless of which firm produces them.
Example:
In a perfectly competitive market, all bags of sugar are considered homogeneous products; consumers don't care which farm produced them.
Increasing Returns to Scale
A situation where output increases by a larger proportion than the increase in all inputs, leading to a decrease in long-run average costs.
Example:
When a small tech startup scales up, doubling its engineers and servers might more than double its software output, demonstrating increasing returns to scale.
Labor
A factor of production representing the human effort, both physical and mental, used in producing goods and services.
Example:
The skilled artisans handcrafting custom furniture are providing labor to the production process.
Land
A factor of production referring to all natural resources used in the production process.
Example:
A farmer uses fertile soil, which is a form of land, to grow crops.
Law of Diminishing Marginal Returns
A principle stating that as more units of a variable input are added to a fixed input, the marginal product of the variable input will eventually decrease.
Example:
Adding too many baristas to a small coffee shop with only one espresso machine will eventually lead to the law of diminishing marginal returns, as they start getting in each other's way.
Long-Run
A period of time in which all inputs are variable, allowing a firm to adjust its scale of operations, including factory size or capital equipment.
Example:
In the long-run, the pizza shop can decide to build a larger kitchen or open a second location to meet increased demand.
Long-Run Average Total Cost (LRATC)
A curve that shows the lowest possible average cost of producing each level of output when all inputs are variable.
Example:
A car manufacturer uses its long-run average total cost curve to decide the optimal factory size for different production volumes.
Marginal Cost (MC)
The additional cost incurred by producing one more unit of output.
Example:
If increasing production from 99 to 100 cars adds 15,000.
Marginal Product (MP)
The additional output generated by adding one more unit of a variable input, typically labor, while holding other inputs constant.
Example:
If hiring one more software engineer increases the number of apps developed per month from 10 to 13, the marginal product of that engineer is 3 apps.
Marginal Revenue (MR)
The additional revenue generated from selling one more unit of output.
Example:
If selling the 101st smartphone adds 700.
Market Equilibrium (Perfect Competition)
In the long run of perfect competition, a state where firms earn zero economic profit, and price equals the minimum of average total cost.
Example:
After new firms enter the highly profitable organic vegetable market, the increased supply drives prices down until the industry reaches market equilibrium, where existing firms only earn a normal profit.
Normal Profit
The minimum level of profit needed to keep a firm in the market in the long run, occurring when economic profit is zero.
Example:
When a competitive coffee shop is earning a normal profit, it means its revenue is just enough to cover all explicit and implicit costs, including the owner's opportunity cost.
Perfect Competition
A market structure characterized by many buyers and sellers, homogeneous products, free entry and exit, and firms being price takers.
Example:
The market for agricultural commodities like wheat or corn often approximates perfect competition, with many farmers selling identical products.
Perfectly Elastic Demand Curve
A horizontal demand curve faced by an individual firm in a perfectly competitive market, indicating that the firm can sell any quantity at the market price but nothing at a higher price.
Example:
For a single hot dog stand in a crowded park, the demand for its hot dogs is a perfectly elastic demand curve at the going market price; if it raises its price, it sells nothing.
Price Takers
Firms that have no market power and must accept the prevailing market price for their product.
Example:
A single wheat farmer is a price taker because they must sell their wheat at the market price, as they are too small to influence it.
Profit (π)
The financial gain realized when total revenue exceeds total cost.
Example:
If a lemonade stand earns 30 in costs, its profit is $70.
Profit Maximizing Rule (MR = MC)
The principle that a firm maximizes its profit by producing the quantity of output where marginal revenue equals marginal cost.
Example:
A toy manufacturer will continue increasing production as long as the revenue from the next toy (MR) is greater than its cost (MC), stopping when MR = MC to achieve maximum profit.
Short-Run
A period of time in which at least one input (typically capital or factory size) is fixed and cannot be changed.
Example:
A pizza shop operating in the short-run cannot instantly expand its kitchen size, even if demand for pizza surges.
Short-Run Shutdown Rule
A firm should cease production in the short run if the market price falls below its average variable cost (P < AVC) at the profit-maximizing output.
Example:
During a sudden drop in tourism, a beachside hotel might apply the short-run shutdown rule and close its doors if the revenue from guests can't even cover the daily costs of cleaning and utilities.
Total Cost (TC)
The sum of a firm's fixed costs and variable costs at a given level of output.
Example:
If a t-shirt printer pays 3 per shirt in materials and labor (VC) for 100 shirts, their total cost is 3 * 100) = $800.
Total Product (TP)
The total quantity of output produced by a firm using a given amount of inputs.
Example:
A bakery that produces 500 loaves of bread in a day has a total product of 500 loaves.
Total Revenue (TR)
The total amount of money a firm receives from selling its output, calculated as price multiplied by quantity sold.
Example:
A concert venue selling 5,000 tickets at 250,000.
Variable Costs (VC)
Costs that change directly with the level of output produced.
Example:
The cost of raw materials like flour and cheese for a pizza restaurant are variable costs because they increase as more pizzas are made.