REVIEW

PART 1: MICROECONOMICS
CHAPTER 6: COSTS, REVENUES AND PROFIT
THEORY
1. Costs: 1. Which of the following costs can be positive when output is
- Total cost (TC): Total cost are the complete cost of zero?
producing output. A. total variable cost
- Total fixed cost (TFC): TFC is the total cost of the fixed B. marginal cost
assets that a firm uses in a given time period. Since the C. total fixed cost
number of fixed assets is, by definition, fixed, TFC is a D. average variable cost
constant amount. E. None of the above because when output is zero there are
- Total variable cost (TVC): TVC is the total cost of the no costs.
variable assets that a firm uses in a given time period.
TVC increases as the firm uses more of the variable
factor.
- Average cost (AC): AC is the total cost per unit of
output. Average fixed cost (AFC): AFC is the fixed cost
per unit of output.
- Average variable cost (AVC): AVC is the variable cost
per unit of output.
- Marginal cost (MC): MC is the increase in total cost of
producing an extra unit of output
2. Revenues: 2. Marginal revenue is the change in revenue that results from a
- Total revenue (TR) is the total amount of money that a one-unit increase in the
firm receives from selling a certain amount of a good or A. variable input
service in a given time period. B. variable input price
- Average revenue (AR) is the revenue that a firm receives C. output level
per unit of its sales. D. output price
- Marginal revenue (MR) is the extra revenue that a firm E. fixed cost
gains when it sells one more unit of a product in a given
time period.
 3. Profit:
- Total profit (TPr or 𝝅𝝅) is the positive gain remaining for
a business after all costs and expenses have been
deducted from total revenue.
- Average revenue (APr) is the profit that a firm receives
per unit of its sales.
- Marginal profit (MPr): MPr is the increase in total profit
of producing an extra unit of output
4. Product curves 3. When the average product is at its maximum,
- Total product (TP) is the total quantity of output A. total product is at its minimum.
produced by a firm. B. total product is also at its maximum.
- Marginal product (MP) is the extra or additional output C. the marginal product is negative.
resulting from one additional unit of the variable input D. it is equal to the marginal product
- Average product (AP) is the total quantity of output per E. the marginal product is increasing as output increases.
unit of variable input; this tells us how much output each
unit of input produces on average.
5. The law of diminishing returns (also known as the law 4. Which of the following is the correct definition of the law of
of diminishing marginal product), as more and more
diminishing returns?
units of a variable input (such as labour) are added to one
A. If extra units of one variable input are added to a fixed
or more fixed inputs (such as land), the marginal product
amount of all other inputs, then sooner or later the
of the variable input at first increases, but there comes a
marginal returns will get smaller.
point when it begins to decrease. This relationship
presupposes that that the fixed input(s) remain fixed, and B. If extra units of one variable input are added to a fixed
that the technology of production is also fixed. amount of all other inputs, then the marginal returns will
always get smaller.
C. If extra units of all variable inputs are added to a fixed
amount of all fixed inputs, then the marginal returns will
always get smaller.
D. If extra units of all variable inputs are added to a fixed
amount of all fixed inputs, then sooner or later the
marginal returns will get smaller.

Answers:

1.C 2.C 3.D 4.A

CHAPTER 6: COSTS, REVENUES AND PROFIT
DIGRAM AND CALCULATION
Costs:
TFC = constant

TC = TVC + TFC

𝑇𝑇𝑇𝑇 𝑉𝑉𝐶𝐶 𝐹𝐹𝐶𝐶

AC = AVC = AFC = : always decreasing as Qoutput increases
𝑄𝑄 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑄𝑄 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑄𝑄 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜

AC = AFC + AVC

∆𝑇𝑇𝑇𝑇 ∆𝑉𝑉𝐶𝐶 ∆𝐹𝐹𝐶𝐶

MC = (TC)’= MVC = (VC)’ = MFC = (FC)’ = =0
∆𝑄𝑄 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 ∆𝑄𝑄 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 ∆𝑄𝑄 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜

MC = MFC + MVC = MVC

- The U-shape of cost curves is explained by the law of diminishing marginal returns
- The vertical gap between TC and VC is unchanged as it is FC – a constant.
- AFC falls as output increases and, since it is the difference between ATC and AVC, the vertical gap between ATC and AVC
gets smaller as output grows.
- The MC curve cuts the AVC and AC curves at AVC min and AC min.

Revenues:
TR = P x Q

𝑇𝑇𝑇𝑇
AR =
𝑄𝑄 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜

∆𝑇𝑇𝑇𝑇
MR = (TR)’=
∆𝑄𝑄 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜

- The inverse U-shape of cost curves is explained by the law of diminishing marginal returns

Profit:
TPr (or 𝜋𝜋) = TR – TC = (AR – AC) x Qoutput

𝑇𝑇𝑃𝑃𝑃𝑃
APr = = AR – AC
𝑄𝑄 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜

∆𝑇𝑇𝑇𝑇𝑇𝑇
MPr = (TPr)’=
∆𝑄𝑄 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜
Product curves
TP = Q output = f (Q input)

𝑇𝑇𝑃𝑃
AP =
𝑄𝑄 𝑖𝑖𝑖𝑖 𝑝𝑝𝑝𝑝𝑝𝑝

∆𝑇𝑇𝑇𝑇
MP = (TP)’=
∆𝑄𝑄 𝑖𝑖𝑖𝑖 𝑝𝑝𝑝𝑝𝑝𝑝

• When the Marginal Product (MP) increases, the Total Product is also increasing at an
increasing rate. This gives the Total product curve a convex shape in the beginning as
variable factor inputs increase. This continues to the point where the MP curve reaches its
maximum.
• When the MP declines but remains positive, the Total Product is increasing but at a
decreasing rate. This gives the Total product curve a concave shape after the point of
inflexion. This continues until the Total product curve reaches its maximum.
• When the MP is declining and negative, the Total Product declines.
• When the MP becomes zero, Total Product reaches its maximum.

When the marginal product curve lies above the average product curve (MP > AP), average product is increasing; and when the
marginal product curve lies below the average product curve (MP < AP), average product is decreasing. This means the marginal
product curve always intersects the average product curve when this is at its maximum.
Optimization:
Revenue maximization:

TR max MR = 0

Cost minimization:

TC min MC = 0

AC min MC = AC

Profit maximization:

TPr max MPr = 0 (TR – TC)’ = (TR) ’ – (TC) ’ = MR – MC = 0 MR = MC

If a firm finds that at its present level of output the cost of producing another unit (MC) is less than the revenue that the unit would
bring in (MR), it is clear that the firm could increase its profits by producing more. Wherever the firm finds that MR > MC, it should
increase production.

Profit is maximised by producing where MC = MR, at a level of output of q.

Product maximization

TP max MP = 0

AP max MP = AP

The law of diminishing returns explains why the AVC and MC curves are mirror
images of the AP and MP curves.
Questions:

1. Chuck owns a factory that produces leather footballs. His total fixed cost equaled $86,000 last year. His total cost equaled
$286,000 last year. Hence Chuck's
A. incurred an economic loss.
B. total variable cost was zero.
C. total variable cost equaled $372,000.
D. total variable cost equaled $200,000.
E. None of the above answers is correct
2. If average variable costs increase as output increases, then
A. output must be zero.
B. total fixed cost must be increasing also.
C. total cost must be constant.
D. average total cost must be increasing also.
E. marginal cost must be greater than average variable cost.
3. The marginal cost curve is U-shaped. Over the range of output for which the marginal cost is falling as output increases, the
marginal product is
A. decreasing.
B. increasing.
C. constant.
D. probably changing, but there is no stable relationship between the marginal cost and the marginal product.
E. not defined.
4. When the price of a Caesar salad is $5.00, the demand for Caesar salads is elastic, and when the price is $4.00, the demand is
inelastic. If Mike’s Roadside Restaurant cuts the price from $5.00 to $4.00, its total revenue from Caesar salads ____.
A. will increase
B. will decrease
C. will remain the same
D. might increase, decrease, or remain the same

Answers:

1.D 2.E 3.B 4.D