Glossary
Accounting Profit
Total revenue minus explicit costs. It measures the straightforward financial gain of a business.
Example:
A small business earns 60,000 in explicit costs (wages, rent); its accounting profit is $40,000.
Average Product (AP)
The output produced per unit of input, calculated by dividing total product by the quantity of input used.
Example:
If 10 workers produce 500 widgets, the average product of labor is 50 widgets per worker (500/10).
Constant Returns to Scale
A long-run phenomenon where output doubles precisely when all inputs are doubled. The firm's average cost per unit remains constant as production scales up.
Example:
A small, independent consulting firm might experience constant returns to scale if doubling its consultants and office space leads to exactly double the number of client projects completed.
Decreasing Returns to Scale
A long-run phenomenon where output less than doubles when all inputs are doubled. This can be due to inefficiencies in managing a very large operation.
Example:
A very large, sprawling multinational corporation might face decreasing returns to scale if doubling its global resources leads to less than a doubling of output due to complex bureaucracy and coordination challenges.
Diminishing Marginal Returns
A phase where the marginal product of an input is decreasing as more units of that input are added, while other inputs are held constant.
Example:
After a certain point, adding more fertilizer to a fixed plot of land will result in diminishing marginal returns, meaning each additional bag of fertilizer yields less extra crop than the previous one.
Economic Profit
Total revenue minus both explicit and implicit costs (opportunity costs). It provides a more comprehensive measure of profitability by considering foregone alternatives.
Example:
If a business owner's accounting profit is 50,000, their economic profit is -$10,000, indicating they are not making the best use of their resources.
Fixed Costs (FC)
Costs that do not change with the level of output produced in the short run. These costs must be paid regardless of production volume.
Example:
The monthly rent for a factory building is a fixed cost because it remains the same whether the factory produces 100 units or 10,000 units.
Increasing Marginal Returns
A phase where the marginal product of an input is increasing as more units of that input are added, often due to specialization or better utilization of fixed inputs.
Example:
Initially, adding more workers to an assembly line might lead to increasing marginal returns as tasks can be specialized, making each new worker contribute more than the last.
Increasing Returns to Scale
A long-run phenomenon where output more than doubles when all inputs are doubled. This often occurs due to economies of scale.
Example:
A software company experiencing increasing returns to scale might find that doubling its developers and servers leads to a triple increase in its user capacity due to network effects and platform efficiencies.
Inputs (Factors of Production)
The resources used in the production process, typically categorized as land, labor, capital, and materials.
Example:
For a coffee shop, the inputs include coffee beans, baristas, espresso machines, and the rented storefront.
Law of Diminishing Marginal Product (or 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:
In a small kitchen, adding more and more chefs will eventually lead to the law of diminishing marginal product as they start getting in each other's way, reducing the additional meals each new chef can contribute.
Marginal Product (MP)
The additional output generated by adding one more unit of a variable input, while holding all other inputs constant.
Example:
If adding an 11th worker increases total output from 500 to 540 widgets, the marginal product of the 11th worker is 40 widgets.
Negative Marginal Returns
A phase where adding more units of an input actually causes total output to decrease, meaning the marginal product is negative.
Example:
If a small office is already overcrowded, adding another desk and worker might lead to negative marginal returns as productivity drops due to lack of space and increased distractions.
Outputs
The final goods or services produced by a firm using its inputs.
Example:
The freshly baked bread and pastries sold at a bakery are its outputs.
Production
The process by which firms transform inputs (resources) into outputs (goods or services). It is the fundamental activity of creating value in an economy.
Example:
A car manufacturer engages in production by taking steel, plastic, and labor to assemble a finished vehicle.
Profit
The financial gain realized when the revenue generated from business activities exceeds the expenses, costs, and taxes involved in sustaining the activity.
Example:
A software company achieves profit when the money earned from selling its applications is greater than the costs of development, marketing, and salaries.
Total Product (TP)
The total quantity of output produced by a firm using a given amount of inputs.
Example:
A factory with 10 workers produces 500 widgets per day; 500 widgets is the total product.
Total Revenue (TR)
The total amount of money a firm receives from the sale of its goods or services. It is calculated as Price (P) multiplied by Quantity (Q) sold.
Example:
If a lemonade stand sells 50 cups of lemonade at 100.
Variable Costs (VC)
Costs that change directly with the level of output produced. As production increases, these costs typically increase.
Example:
The cost of raw ingredients like flour and sugar for a bakery is a variable cost because more ingredients are needed to bake more cakes.