Summary of firm theory

  • A firm may face inflexibility in the short run, with some factors being fixed in quantity and only some being variable.
  • The long run is defined in this context as the period in which a firm is free to vary all of its factors, in the short run at least one is fixed.
  • The production function shows how output can be efficiently produced through the input factors of production.
  • The law of diminishing returns states, if a firm increases the input of a variable factor while holding the input of a fixed factor constant, eventually the firm will get diminishing marginal returns to output from the variable factor. As a factor has to be fixed, it is solely a short run phenomenon.
  • Short-run costs can be classed as fixed and variable. Fixed costs do not change with output, variable do.
  • Sunk costs are a type of fixed costs which have to be paid, even when a firm produces no output.
  • There is a clear an immutable relationship between total, average and marginal costs.
  • For a U-shaped average cost curve, marginal cost always cuts the minimum point of average costs.
  • The minimum efficient scale is the point at which the long-run average cost curve stops sloping downwards due to previous economies of scale.
  • In practice, long-run average costs curves may take a variety of shapes, according to the technology of the industry concerned.
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