Eco IBdeconomics notes

Economists define the short-run as being a time period where at least one of the
factors of production (land, labour, capital or enterprise) is fixed. This means, for
example, that if a firm wishes to increase its output and produce more goods or
services it could purchase additional capital goods (e.g., machinery) and/or employ
additional labour reasonably quickly. However, purchasing additional land and/or
building a new factory takes considerably longer. Thus, if even one of the factors of
production (e.g., land) is fixed, then the firm is operating in the short run

The long-run is a time period where each and every input could be changed – land
can be purchased and new factories could be built. Thus, in the long-run a firm can
produce as much output as it wants by introducing additional resources into its
production processes. All inputs are variable in the long run.

Total product (TP): the number of units of output that are produced in a specified
time period. 
Average product (AP): the number of units produced in a specified time period per
unit of a variable factor 
Marginal product (MP): the change in total output (TP) that occurs when an
additional unit of the variable input is added to the production process.

Capital is fixed in the short term because additional new ovens, works benches,
sinks and kitchen equipment, etc. would require a larger bakery and new land would
need to be purchased by the firm and a larger bakery built and fitted out. Each baker
is a variable input unit in the production of making cakes. The amount of labour our
firm employs can be changed in the short-run. In our bakery, labour is
variable and capital is fixed.

As additional units are of a variable input (such as labour; e.g., bakers) are added to
at least one fixed input (such as capital; e.g., a bakery), the marginal product
increases at first. So initially, each new baker added to the bakery produces
successively more buns.
However, there is a point where the addition of one more variable input does not
produce as much as the previous variable unit. Marginal product will continue
increasing up to a point, and from that point on, each new variable unit added to the
production process will contribute less to TP than the previous one

Thus, diminishing returns is the decrease in the marginal (incremental) output of a

production process.
adding more people to a job, or assembling a car on a factory floor. At some point,
adding more workers causes problems such as workers getting in each other's way
or frequently finding themselves waiting for access to a part. In all of these
processes, producing one more unit of output per unit of time will eventually cost
increasingly more, due to inputs being used less and less effectively.

The opportunity cost of producing a good or service is its real economic cost of

production. Resources are scarce and firms need to make decisions about what they
will produce. To make good A, the firm must use resources which cannot then be
used to make a good B, which would be the next best alternative. We can price the
opportunity cost of the decision by valuing the gain to the firm that would have
accrued had a firm’s resources been used to produce the good that was the next
best alternative.
If we sum explicit and implicit costs, we have the true economic costs of
production.

Explicit costs are those payments a firm will make to purchase or acquire the
resources it needs for its production processes. The wages and salary it pays its
employees, rent for its offices, legal fees and the purchase of IT equipment are all
examples of explicit costs.

Implicit costs on the other hand is the opportunity cost of using the resources which
the firm already owns and do not need to be purchased.

Implicit costs:
$130 000 salary forgone
+$15 000 investment income foregone
$145 000
 
Explicit costs:
 +$30 000 rent
+$5 000 electricity
+$10 000 marketing expenses
+$15 000 other general expenses
  $60 000
 
Economic costs = total opportunity costs:
$145 000 (implicit costs)
+$60 000 (explicit accounting costs)
$205 000

Thus, Annabel’s new consultancy business would need to generate an income of

$205 000 before it makes economic sense for her to undertake her new consultancy
venture

Fixed costs: A fixed cost is a cost that does not vary in the short term, irrespective
of changes in production or sales levels, or other measures of activity. A fixed cost is
a basic operating expense of a business that cannot be avoided, such as a rent
payment. The rent on a building will not change until the lease runs out or is re-
negotiated, irrespective of the level of business activity within that building. The
landlord of the rented building is not interested if the firm is producing 20 000 units or
$80 000 units, she just wants her rent cheque each month. Even if there is zero
output, fixed costs still need to be paid.

Examples of other fixed costs are insurance, depreciation, and property taxes. 

A variable cost is an expense that varies with a firm’s production output. Variable
costs are those costs that vary depending on a company's production volume; they
rise as production increases and fall as production decreases. For example, the
costs of raw materials (such as steel and plastics) will rise for a car manufacturer
such as Nissan as production increases, and falls when the production of cars
decrease

Variable costs differ from fixed costs such as rent, advertising, insurance and office
supplies, which tend to remain the same regardless of production output. Fixed costs
and variable costs comprise total cost.

total costs = fixed + variable costs

Average cost is the cost incurred per unit of output 

The shape of the cost curves is largely determined by the law of diminishing
marginal returns. Law of diminishing returns: as additional units are of a variable
input (such as labour; e.g., bakers) are added to at least one fixed input (such as
capital; e.g., a bakery), the marginal product increases at first.

So initially, each new baker added to the bakery produces successively more buns.
This means that the AVC per unit of output declines. The wages cost of each new
baker are being divided between ever greater numbers of output and AVC
decreases.

However, there is a point where the addition of one more variable input does not
produce as much as the previous variable unit. Marginal product will continue
increasing up to a point, and from that point on, each new variable unit added to the
production process will contribute less to TP than the previous unit. Now MC begins
to increase and AVC will begin to rise. Each additional variable unit added to the
production process contributes less to TP than the previous one. Thus, the wage of
the new baker is being divided by fewer and fewer units of output, and the average
cost per bun begins to increase as each new baker contributes less buns to total
output than the previous baker did.

When the additional output produced by an extra worker is the most it can be, then the extra
labour cost of producing an additional unit of output is the least it can be.