• Total output produced using a given amount of variable input (labor)
• Increases with labor input but at a decreasing rate
• Initially increases at increasing rate, then decreasing rate
• Eventually may decline if too much variable input used

$MP = \frac{\Delta TP}{\Delta L}$

• Additional output from one more unit of labor
• Measures productivity of each additional worker
• Initially increases due to specialization
• Eventually decreases due to diminishing returns

$AP = \frac{TP}{L}$

• Average output per unit of labor
• Productivity measure for the workforce
• Important for determining optimal labor use

• As more variable input is added to fixed inputs, marginal product eventually decreases
• Not necessarily declining from the start (may initially increase)
• Occurs because fixed inputs become overcrowded or less effective
• Fundamental principle explaining cost curves

• Fixed Costs (TFC): Costs that don't vary with output in short run
• Examples: Rent, insurance, salaries of permanent staff
• Must be paid even if output = 0
• Variable Costs (TVC): Costs that vary directly with output
• Examples: Raw materials, hourly labor, energy
• = 0 when output = 0

• $AFC = \frac{TFC}{Q}$: Always declining (fixed cost spread over more units)
• $AVC = \frac{TVC}{Q}$: U-shaped (reflects changing productivity)
• $ATC = \frac{TC}{Q} = AFC + AVC$: U-shaped
• ATC = AFC + AVC (sum of average fixed and average variable costs)

• $TC = TFC + TVC$
• Sum of fixed and variable costs
• Increases as output increases (due to TVC)
• Even at zero output, TC = TFC

$MC = \frac{\Delta TC}{\Delta Q} = \frac{\Delta TVC}{\Delta Q}$

• Additional cost of producing one more unit
• U-shaped curve due to diminishing returns
• Initially falls (increasing returns), then rises (diminishing returns)

• MC < ATC: ATC is falling
• MC > ATC: ATC is rising
• MC = ATC: ATC is at minimum
• MC < AVC: AVC is falling
• MC > AVC: AVC is rising
• MC = AVC: AVC is at minimum
• MC curve passes through minimum points of both ATC and AVC curves

• Envelope curve of all possible short-run ATC curves
• Shows lowest possible average cost for each output level
• All inputs are variable in long run
• U-shaped due to economies and diseconomies of scale

• Long-run average cost falls as output increases
• Reasons: Specialization, efficient large-scale equipment, bulk purchasing, technological advantages
• Also called increasing returns to scale
• Most significant at low levels of output

• Long-run average cost rises as output increases
• Reasons: Management complexity, coordination problems, communication issues, bureaucracy
• Also called decreasing returns to scale
• Typically occurs at very high output levels

• Long-run average cost remains constant as output increases
• Input and output increase in same proportion
• No economies or diseconomies of scale
• Range between economies and diseconomies of scale

$Accounting Profit = Total Revenue - Explicit Costs$

• Explicit costs: Actual monetary payments (wages, rent, materials)
• Used for financial reporting and tax purposes
• Does not include opportunity costs

$Economic Profit = Total Revenue - (Explicit Costs + Implicit Costs)$

• Implicit costs: Opportunity costs of resources owned by firm (owner's time, capital)
• Always ≤ accounting profit (includes more costs)
• Determines if firm should stay in industry

• Zero economic profit
• $Total Revenue = Explicit Costs + Implicit Costs$
• Covers all costs including opportunity costs
• Firm earns exactly what it could earn in next best alternative
• Long-run equilibrium in competitive markets

• Produce where Marginal Revenue = Marginal Cost
• $MR > MC$: Increase output (additional revenue exceeds additional cost)
• $MR < MC$: Decrease output (additional cost exceeds additional revenue)
• $MR = MC$: Profit maximized (or loss minimized)
• Applies to all market structures

• $P > ATC$: Positive economic profit
• $P = ATC$: Normal profit (zero economic profit)
• $AVC < P < ATC$: Loss, but continue production (covers variable costs and some fixed costs)
• $P < AVC$: Shut down immediately (cannot cover variable costs)

• Shut down if $P < AVC$ (or $TR < TVC$)
• Continue producing if $P \geq AVC$ (or $TR \geq TVC$)
• Shut-down point: Minimum of AVC curve
• Loss from shutting down = TFC (fixed costs still must be paid)
• Produce if loss from producing < TFC

• Economic profit attracts entry: New firms enter, industry supply increases, price falls
• Economic loss causes exit: Firms leave, industry supply decreases, price rises
• Entry and exit continue until zero economic profit (normal profit)
• Free entry and exit crucial for long-run equilibrium

• $P = MR = MC = minimum ATC$
• Zero economic profit (normal profit)
• Firms earn exactly what they could earn elsewhere
• No incentive for entry or exit
• Stable equilibrium

• Producing at minimum ATC
• $P = minimum ATC$
• Goods produced at lowest possible cost
• Characteristic of long-run competitive equilibrium
• Maximizes society's resources

• Producing optimal quantity from society's perspective
• $P = MC$
• Price reflects marginal benefit to consumers
• MC reflects marginal cost to producers
• Maximizes total surplus (consumer + producer)
• Characteristic of long-run competitive equilibrium

• Many buyers and sellers (no individual has market power)
• Homogeneous (identical) products
• Free entry and exit
• Perfect information
• Price takers (individual firms cannot influence market price)

• Individual firms must accept market price
• Demand curve for individual firm is perfectly elastic (horizontal)
• $P = MR = AR$ (Price = Marginal Revenue = Average Revenue)
• Firm can sell any quantity at market price

• For perfectly competitive firm:
• Demand curve is horizontal at market price
• $MR = P$ (each additional unit sold adds price to revenue)
• $AR = P$ (average revenue equals price)
• Simplifies profit maximization to $P = MC$