ECON528 – Module 3

Accounting Profit:

Pretax Profit = Total revenue – Total expenses


Economic Profit:

Economic Profit = Total Revenue – Opportunity Cost

Opportunity Cost = Explicit cost + Implicit cost

Examples of an implicit cost is Wages Foregone, Depreciation of a resource, Opportunity cost of Capital.


Total Cost = Fixed cost + Variable cost

Average Fixed Cost (AFC) = Fixed cost/amount produced

Average Variable Cost (AVC) = Variable Cost/amount produced or Slope between a point and the origin

Average Total Cost (ATC) = Total Cost/Amount produced or AFC + AVC

Marginal Cost (Average) = Change in Total Cost/Change in Amount

Average Marginal Cost = Slope between a point and previous point

Profit = (Marginal Cost X Amount produced)

Profit = (Marginal Revenue X Amount Produced) – (ATC X Amount produced)

Profit = Total Revenue – Total Cost

Law of Diminishing Marginal Product or Law of Diminishing Marginal Return


Production Function

q = f(L, K), where q is quantity produced by a firm, L is labor cost, K is capital cost

In Short Term, one input is fixed. Capital (K) is fixed, Labor (L) is variable. You can get more labor fairly quickly in order to produce more output.

In Long Term, all inputs are variable. Even Capital (K) can be changed in long run. A firm can build a new factory to increase its output. Long term for a firm is defined by how quickly the firm can change its capital.

Law of Diminishing Marginal Product or Law of Diminishing Marginal Returns



Total Cost



Average Total Cost (Per unit cost)

ATC = TC/q or (FC + VC)/q or FC/q + VC/q

Average Total Cost = Average Fixed Cost + Average Variable Cost

Average Variable Cost (minimum) <= Average Total Cost (minimum)

For higher quantity, AVC and ATC converge



Marginal Cost

MC is the derivative of TC.





Impose an excise tax of $m per unit

TC1 = f(q) + m * q

AC1 = f(q)/q + m

AC1 = AC0 + m

MC1 = MC0 + m

ACmin remains the same in q after the excise tax.


So far the K in the production curve has been constant. This is what happens when we start adding more capital (K).


We will get more output with the same number of workers before the curve flattens out.