Cost Theory

Economic Profit

Economic profit is different from the general business term ‘profit’. The general assumption is that firms are producing goods to maximize profits.

Economies of Scale

Economies of scale are achieved when increasing the scale of production decreases long-term average costs. In other words, the cost of production per unit decreases as a company produces more units.

Diseconomies of scale are the product of decreasing returns to scale. In other words, they happen when a business grows to the point that its per-unit costs begin to rise, rather than continuing to decrease as with economies of scale.

Perfect Competition

Perfect competition or pure competition is a type of market structure. It is important to note that this form of market structure does not actually exist in the real world and is thus considered to be theoretical.

Oligopoly Market Structure

In an oligopoly market structure, there are just a few interdependent firms that collectively dominate the market. While individually powerful, each of these firms also cannot prevent other competing firms from holding sway over the market.

Monopolistic Competition

In monopolistic competition, there are many small firms who all have minimal shares of the market. Firms have many competitors, but each one sells a slightly different product.

Marginal Cost

The marginal cost of production is an economic concept that describes the increase in total production cost when producing one more unit of a good. It is highly useful to decision-making in that it allows firms to understand what level of production will allow them to have economies of scale.

Total Revenue

Total revenue is the amount of money that a company earns by selling its goods and/or services during a period of time (e.g. a day or a week).

Average Variable Cost

In the field of economics, the term “average variable cost” describes the variable cost for each unit. Variable costs are those that vary with changes in output. Examples of variable costs, otherwise known as direct costs, include some forms of labor costs, raw materials, fuel, etc.

Profit Maximization Rule

The Profit Maximization Rule states that if a firm chooses to maximize its profits, it must choose that level of output where Marginal Cost (MC) is equal to Marginal Revenue (MR) and the Marginal Cost curve is rising. In other words, it must produce at a level where MC = MR.

Monopoly Market Structure

In a Monopoly Market Structure, there is only one firm prevailing in a particular industry. However, from a regulatory view, monopoly power exists when a single firm controls 25% or more of a particular market.

Variable Cost

Costs can be divided quite simply into two basic categories: variable costs and fixed costs. Variable costs are those that vary with production levels.

Monopsony Market Structure

A monopsony is a situation of the market wherein only one buyer exists in a particular area, typically along with many sellers. These sellers end up competing for the buyer’s purchases by lowering their prices.

Contestable Market

The Theory of Contestable Markets states that when barriers to entry into a market are weak or low or in some cases non-existent, and assuming that all entrants have equal access to technology, there is a constant threat of potential entry.

Barriers to Entry

Barriers to Entry are designed to prevent potential competitors from entering the market. Some barriers to entry are placed by the government, while others could be related to cost. These barriers result in different market structures such as monopolies or oligopolies (a few firms).