Theory of the

firm
S&N, Ch. 6, 7, Appendix, 7
Mw, pp. 143-158, Ch. 13
Why do firms exist?
Profit
Opportunity cost
Economic Profit (Loss)
Fixed costs Vs. Variable costs
total costs

Total cost =
Fixed Cost + Variable Cost

In the long run, all costs are variable

Marginal costs

Marginal costs
Marginal Cost – Ex.
Q FC VC TC AFC AVC ATC MC
0 55 0 55
30
1 55 30 85 55 30 85
25
2 55 55 110 27.5 27.5 55
20
3 55 75 130 18.33 25 43.33
30
4 55 105 160 13.75 26.25 40
50
5 55 155 210 11 31 42
Marginal Cost – Ex.
Short-run vs. Long-run
SHORT-RUN COSTS
v Total Cost = TC = f(Q)
v Total Fixed Cost = TFC
v Total Variable Cost = TVC
v TC = TFC + TVC
v Average Total Cost = ATC = TC/Q
v Average Fixed Cost = AFC = TFC/Q
v Average Variable Cost = AVC = TVC/Q
v ATC = AFC + AVC
v Average Total Cost = ATC = TC/Q
v Marginal Cost =  TC/ Q =  TVC/ Q
v Marginal cost does not depend on TFC
LONG-RUN COSTS

v Long - Run Total Cost = LTC = f(Q)

v Long – Run Total Variable Cost = TVC = LTC
v Long – Run Average Variable Cost = LTVC/Q
v Long – Run Average Total Cost = LATC = LTC/Q
v LATC = LAVC
v No Fixed Cost in Long Run
v Long – Run Marginal Cost = LMC =  TC/ Q
Short-run vs. Long-run
Co
st SRAC1

SRAC2

SRAC3

LRAC

Quantity
(Dis)Economies of scale
Economies of scale
Economies of scope
 Economies of experience

he cumulative production of firm increases it becomes more efficient

When we hire developers for a project, we all look

for individual experiences in a developer with the
technologies and in the domain the project is. The
longer a developer works with a technology and in
a domain, the more productive he/she is with that
technology and in that domain.
Next Week
 Competitive and Monopolistic Markets
 S&N, Ch. 8, 9
 Mw, Ch. 14, 15