Costs, Revenue and Profit
FoundationFirms plan over the short run and the long run, with costs split into fixed and variable. Total cost yields marginal and average cost; profit is the gap between total revenue and total cost, and at a given price it is maximised where output rises until marginal cost equals price.
- The short run has at least one fixed factor; the long run allows all factors to adjust — neither depends on calendar time
- Fixed cost does not vary with output, variable cost does, and total cost is their sum
- Marginal cost is the extra cost of one more unit; average cost is total cost divided by output
文體小知識：經濟現象說明文——講解廠商的短期與長期、成本結構與利潤極大化，並以香港餐廳餅店的營運情境說明產量決定。
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1A firm's production decisions are separated into the short run and the long run: the short run is a period in which the quantity of at least one factor of production is fixed, while in the long run every factor can be adjusted. Take a Hong Kong restaurant: within the lease term the shop floor cannot change — a fixed factor — though staff and ingredients can be varied daily; when the lease expires the owner can relocate, expand or close, and only then does the long run begin.
2Costs fall into two classes by whether they vary with output. Fixed costs do not change with output — rent, interest and insurance; variable costs rise and fall with output — ingredients, packaging and piece-rate wages. Total production cost yields two key concepts: average production cost, the cost borne per unit of output, and marginal production cost, the extra cost of producing one more unit. Both underpin the analysis of output decisions.
3On the revenue side, total revenue equals price times quantity sold. Profit is the difference between total revenue and total cost, and the economist's total cost includes all opportunity costs: the salary the owner gives up and the interest on invested funds must both be counted. A shop showing an accounting profit may actually be running an economic loss once opportunity cost is deducted — the key difference between accounting and economic profit.
4At a given price, selling one more unit raises profit whenever its marginal cost is below the price; output should expand until marginal cost equals price, where profit is maximised. The marginal cost table is thus the firm's supply table. Yet profit is not the only goal: expanding market share, providing non-profit services and fulfilling corporate social responsibility are also genuine choices made by real-world firms.
1Summary 重點摘要
Firms plan over the short run and the long run, with costs split into fixed and variable. Total cost yields marginal and average cost; profit is the gap between total revenue and total cost, and at a given price it is maximised where output rises until marginal cost equals price.
2Vocabulary cards Vocabulary
A period in which the quantity of at least one factor of production is fixed; unrelated to calendar time.
A period in which the quantities of all factors of production can be changed.
A cost that does not vary with output, such as rent, interest and insurance; it must be paid even at zero output.
A cost that rises and falls with output, such as raw materials, packaging and piece-rate wages.
The addition to total production cost of producing one more unit; total cost change divided by the change in output.
Total production cost divided by output — the cost borne per unit on average.
Price times quantity sold — all the money a firm receives from selling its product.
Total revenue minus total cost, where total cost already includes all opportunity costs.
At a given price, profit is maximised where output expands until marginal cost equals the price.
At a given price the marginal cost table serves as the firm's supply table: each price maps to the quantity it is willing to supply.
3Step by step Steps
- Step 1: Defining the short run and the long runEconomics distinguishes periods by whether inputs can be adjusted: the short run is a period in which the quantity of at least one factor of production is fixed, while in the long run the quantities of all factors can be changed. This has nothing to do with calendar time, and the short run differs greatly across industries. For example, a tea restaurant in Mong Kok signs a three-year lease: during the term the shop floor cannot expand (a fixed factor), while staff and ingredients can be varied daily (variable factors), so the whole lease term is the short run; once the lease expires the owner can relocate or expand — that is the long run.
- Step 2: The law of diminishing marginal returnsIn the short run, with fixed factors unchanged, adding more variable factors keeps raising total output, but marginal output eventually falls — the law of diminishing marginal returns. For example, a kitchen has only four burners; the fifth and sixth cooks get in each other's way, and each new cook adds less extra output than the one before. This law explains why short-run average production cost first falls and then rises, and why output cannot expand without limit — expansion has to be planned.
- Step 3: Fixed cost and variable costCosts are classified by whether they vary with output. Fixed costs do not change with output and must be paid even at zero production — rent, insurance, interest and administrative expenses. Variable costs rise and fall with output and are zero when nothing is produced — ingredients, packaging materials and piece-rate wages. For example, if a bakery halts for one day, the factory rent is still due, but spending on flour and butter drops to zero; in the busy season, overtime pay and material costs climb with output. The two classes must be kept apart.
- Step 4: Total, marginal and average costTotal production cost equals fixed cost plus variable cost. Two key concepts follow from it. Average production cost is total cost divided by output — the cost borne per unit on average. Marginal production cost is the addition to total cost of producing one more unit. For example, when output rises from 100 to 101 units and total cost rises from $8,000 to $8,060, marginal cost is $60; at 100 units and total cost $8,000, average cost is $80 per unit. The relationship between the two is the foundation of output analysis.
- Step 5: Total revenue and the meaning of profitTotal revenue equals price times quantity sold — all the money a firm receives from selling. Profit is the difference between total revenue and total cost, and in economics total cost includes all opportunity costs. For example, Mr Chan quits a $20,000-a-month job to open a small shop and makes an accounting profit of $15,000 a month; counting the $20,000 salary forgone, his economic profit is actually negative. Accounting profit and economic profit are not the same, and whether the business is worth running must be judged by economic profit.
- Step 6: Choosing the profit-maximising outputAt a given price, selling one more unit adds to profit whenever its marginal cost is below the price; output should expand until marginal cost equals price, where profit is maximised. The marginal cost table is therefore the firm's supply table: the higher the price, the more it is willing to supply. For example, cookies sell at $40 a box. If the next box has a marginal cost of $38, it is worth producing; if the marginal cost is $45, making it loses $5 and output should stop in between.
- Step 7: Other goals of the firmProfit maximisation is the standard textbook assumption, but real firms also pursue other goals: expanding market share, providing non-profit services and fulfilling corporate social responsibility. For example, a supermarket chain cuts prices to seize market share, sacrificing short-term profit; a charity runs a social-enterprise restaurant serving the elderly at low prices; many firms cut plastic packaging, absorbing higher costs to meet social expectations. When analysing a question, judge the firm's goal from the context given.
5Worked example Example
Application: a bakery sells cookies at a fixed price of $40 per box. Output and total production cost are as follows: 0 boxes, $12; 1 box, $37; 2 boxes, $57; 3 boxes, $82; 4 boxes, $122; 5 boxes, $172. Calculate the marginal production cost and average production cost at each output, find the profit-maximising output and profit, and determine the output if the price falls to $32.
- Compute marginal cost: each extra box adds $25, $20, $25, $40 and $50 to total cost — the marginal production costs of the 1st to 5th boxes
- Compute average cost: total cost divided by output gives $37, $28.5, about $27.3, $30.5 and $34.4
- Apply the rule: at $40, the marginal costs of boxes 1 to 4 ($25, $20, $25, $40) do not exceed the price, while box 5 ($50) does — produce 4 boxes
- Compute profit: total revenue 40 × 4 ＝ $160, total cost $122, so profit is $38; average cost is lowest near box 3, but profit maximisation rests on marginal comparison
- If the price falls to $32: box 4 has a marginal cost of $40, above the price, so output should fall to 3 boxes
- Answer: The profit-maximising output is 4 boxes: the marginal costs of boxes 1 to 4 are $25, $20, $25 and $40, none above the $40 price, and the fourth box just equals it; box 5 costs $50 and should not be made. Total revenue is $160 and total cost $122, so profit is $38. If the price falls to $32, the fourth box's marginal cost already exceeds the price, and output should fall to 3 boxes. This is exactly what it means for the marginal cost table to be the supply table: as price falls, the firm cuts supply along its marginal cost table.
6Common mistakes Mistakes
7Quick check Quick check
Q1How are the short run and the long run distinguished?
Q2Which of the following are fixed costs: rent, flour, insurance premium, piece-rate wages?
Q3Output rises from 200 to 201 units and total cost rises from $9,000 to $9,065. What is the marginal cost?
Q4At a given price, how does a firm choose the profit-maximising output?
Q5Why is the marginal cost table the firm's supply table?
8Recap Recap
- The short run has at least one fixed factor; the long run allows all factors to adjust — neither depends on calendar time
- Fixed cost does not vary with output, variable cost does, and total cost is their sum
- Marginal cost is the extra cost of one more unit; average cost is total cost divided by output
- Profit is total revenue minus total cost; at a given price it is maximised where marginal cost equals price
- The marginal cost table is the firm's supply table; some firms also pursue market share, non-profit services and social responsibility