1. Costs

1. Total, average, and marginal costs
   
   Average total costs = TC/Q (total costs/quantity of output)
   
   Marginal costs are the additional costs that arise from producing one more unit of output.
   
   Teaching Strategy: Most universities have a fixed tuition for full-time students and charge nothing extra for additional courses. Ask students what the average tuition cost is and the marginal cost of taking an overload?
   
   
2. Why are the cost curves U-shaped?
   
   
3. The law of diminishing marginal returns, which explains the U-shaped cost curves, states that when successive equal amounts of a variable resource (labor) are combined with a fixed amount of a fixed resource (capital), increases in output will eventually decline. Since these resources must be paid, the cost of producing output rises as output rises, but the cost rises slowly at first and then more and more rapidly. This means the per-unit or average cost declines initially and then rises.
   
   Teaching Strategy: Carefully construct Figure 1. Demonstrate the concept of diminishing marginal returns by asking students how the productivity of studying late into the night diminishes the longer one studies.
   
   

2. Maximizing Profit

1. Economic profit is accounting profit less all opportunity costs not accounted for in accounting profit.
   
   Teaching Strategy: Discuss the economic profit of a local pizzeria owner if the owner could have earned a salary managing Burger King instead of owning the pizzeria.
   
   Teaching Strategy: Distinguish between economic profit and accounting profit. Stress that economic profit equals total revenues minus total costs including all opportunity costs, while accounting profit equals total revenues minus total costs except for the opportunity cost of capital.
   
   

• Negative economic profit: Negative economic profit is the profit earned when a firms resources would have a higher value in another use.
  
  
• Zero economic profit, or normal accounting profit, is the profit earned when a firm neither adds value nor subtracts value.
  
  
• Positive economic profit is the profit earned when a firm is returning more to its owners than the owners opportunity cost.
  
  
• Accountants and economic profit: Accountants do not present economic profit in financial statements primarily because of the difficulty of calculating the cost of capital.
  
  

Teaching Strategy: Discuss how the cost of capital could vary from investor to investor.


3. The Profit Maximizing Rule: MR = MC

1. Graphical derivation of the MR = MC rule:
   
   Profit is at maximum when marginal revenue equals marginal cost. MR is the additional revenue obtained from selling one more unit. MC is the additional cost incurred from selling one more unit of output. If MR exceeds MC, expand production. If MC exceeds MR, decrease production. When MR = MC, profits are maximized.
   
   Teaching Strategy: Carefully graph the data in Figure 2 to show that profits are maximized at the output where MR = MC.
   
   Teaching Strategy: Relate MR to the price elasticity of demand. Since total revenue (TR) rises in the price-elastic region of the demand curve, MR is positive in that elastic region; also, since TR declines in the inelastic region of the demand curve, MR must be negative in that inelastic region. Refer carefully to Figure 2 when describing these relationships.
   
   Total fixed costs TFC are the costs that must be paid whether the firm produces or not.
   
   Total variable costs TVC are the costs that rise or fall as production rises or falls.
   
   Total costs = TFC + TVC
   
   
2. What have we learned? Recap the profit-maximizing rule, and stress the difference between accounting and economic profits.