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Date Submitted: 10/29/2009 12:31 PM

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Chapter three

The supply decision

Short run costs:

Key idea:

Output depends on the amount of resources and how they are used. Different amounts and combinations of inputs will lead to different amounts of output. If output is to be produces efficiently, inputs should be combined in the optimum proportions.

Fixed factor:

An input that cannot be increased in supply within a given time period.

Variable factor:

An input that can be increased in supply within a given time period.

Short run:

The period of time over which at least one factor is fixed.

➢ In the short run, output can be increased only by using more variable factors.

➢ The short run production is subject to diminishing returns.

Key idea:

The law of diminishing marginal returns. When increasing amounts of a variable factor are used with a given amount of a fixed factor, there will come to a point when each extra unit of the variable factor will produce less extra output than the previous unit.

Law of diminishing (marginal) returns:

When one or more factors are fixed, there will come a point beyond which the extra output from additional units of variable factor will diminish.

Long run:

The period of time long enough for all factors to be varied.

Measuring costs of production in short run

Opportunity cost:

Cost measured in terms of best alternative forgone.

➢ It is the cost of any activity measured in terms of sacrifice made in doing it.

In order for people to apply the principle of opportunity cost to a firm.

• Discover what factors of production the firm is using.

• Measure the sacrifice involved.

The two factor categories:

Factors not owned by the firm: explicit costs

The opportunity cost of the factors which are not already owned by the firm is simply the price that the firm has to pay for them.

Explicit costs:

The payment to outside suppliers of inputs.

Factors already owned by the firm: implicit costs

It is when the firm which has already owns the...