Theory of the Firm Flashcards

Only 10 flashcards are shown at a time! Once you’ve mastered these 10 Economic terms, click the shuffle button below for 10 new terms. There are approximately 45 flashcards covering Theory of the Firm

Fixed Costs
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Costs which do not change with the level of output in the short-run. Fixed costs must be paid regardless of the level of output. For example rental payment and interest payments on a bakery remain the same regardless of whether the bakery makes 10 muffins or 10,000 muffins. These costs are fixed.

Fixed Costs
Per unit tax
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A tax levied on producers for every unit produced. In contrast to a lump sum tax, which is a one time payment from producers to the government. A per unit tax increases firm’s marginal cost and average variable cost (thus, also the average total cost), but does not affect fixed costs. A per unit tax will likely cause a firm to reduce its output in the short-run, since MC shifts up and moves along the demand curve.

Per unit tax
Scarcity
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When something is both desired and limited in supply. All resources (land, labor and capital) are limited in supply, yet desired for their use in the production of goods and services.

Scarcity
Average variable cost
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The total variable costs (of labor and raw materials) of a particular level of output divided by the quantity being produced.

Average variable cost
Differentiation
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When firms attempt to set their products apart from the competition through improvements in technology, branding, service, location and other means. The goal is to increase demand for the individual firm’s product at the expense of the competition, giving the firm more price marking power and allowing for economic profits to be earned.

Differentiation
Monopolistic Competition

A market in which a relatively large number of firms competes with one another by differentiating their products from the competition. Economic profits can be earned in the short-run through successful product differentiation, but due to the low barriers to entry they are unlikely in the long-run. Monopolistic competition is the most common market structure, and included restaurants, automobiles, clothes, salons, etc…

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Monopolistic Competition
Shut-down price
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If the price of a good falls below a firm’s minimum average variable cost, there is no way the firm can hope to cover its labor costs in the short-run, thus the firm must shut down.

Shut-down price
Economic profit
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Also called “abnormal” profit. This is the revenues earned by a firm beyond that which is needed to cover all explicit costs (wages, rent and interest) and what the business owner expects to earn (normal profit). Entrepreneurs are attracted to industries in which economic profits can be earned.

Economic profit
Profit
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The payment to the entrepreneur in the resource market. A business owner expects to earn a “normal” level of profit, otherwise it will not be worth his while to remain in a market. In this regard, profit is a cost of production, because if a minimum profit is not earned a firm will shut down.

Profit
Average fixed cost
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The total fixed costs (of land and capital) of a particular level of output divided by the quantity being produced.

Average fixed cost

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