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January 20, 2005

Theory of the Firm

A decreasing average cost curve (with a constant marginal cost curve) is easy to describe in terms of a fixed cost and a variable constant proportional to the number of units produced.

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The increase in AC for large Q is due to some additional, limited factor of production. Managerial talent is a good example. Congestion in a limited workspace is another.

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The profit maximizing condition is to produce where the marginal cost equals the sales price. The MC curve then becomes the supply curve.

One interesting extension of this analysis is to consider competing firms with different AC curves. They might, for example, be stores or restaurants with differing locations.

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Posted by bparke at January 20, 2005 09:23 PM

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