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gogues sometimes claim the economy is run by an omnipotent but imdsible "ruling class" of capitalists, stockholders might better be considered a beleaguered minority.

Even though labor receives roughly 80% of all income and corporate profits amount to far less than 10%, a few radicals claim that corporations should receive nothing because they make no conuibudon to producdon. In this view all value is conuibuted by labor, but since labor receives less than 100% of all income, it is exploited by the difference between what it produces and what it receives.

It is hard to find a more profound misunderstanding of the productive process than that expressed in the foregoing argument Consider a corporation raising funds to pay for plant and equipment through the sale of stock. Every dollar invested represents a dollar which could have been used to finance current

consumption, but which is now put at risk. If the* corporation fails, this money will be lost. The dividends to the companys stockholders should die firm find favor with consumers are the rewards for accepting that risk and for giving up curreni consumption. Without such rewards, the incentive to invest would vanish and society would undergo a slow return to the stone age as existing capital wears out.

One virtue of capitalist economies is that risk bearing is voluntary. Those who buy stock bear the risks. In a government planned economy, on the other hand, the whole society must give up current consumption to finance risky new projects. Even in our own economy, taxpayers were forced to bear the risks of the Chrysler and Lockheed bailouts after private investors refused to jeopardize their money. Congressmen risking taxpayers wealth were notably less cautious.

1 Stigler, George, The Theory of Price {New York: Mac.Millan, 1966) p. 133

2 Alchian. Armen, Armen & Allen, WilBam, Exchange & Production (Belmont, CalifomU; Wadsworth. 1977) pp, 304-305 1817)


We close this section with an algebraic restatement of the principle relations whichyou need to know.

AVERAGE FUNCTIONS: In the theory of the firm, all average functions are functions of quandty, the denominator.

Average Total Cost ( ) TC/q = AFC -H AVC

Average Fixed Cost (AFC) TFC/q

Average Variable Cost (AVC) TVC/q

Average Revenue (AR) = (TR/q) = (Pq/q) = P when the firm charges only one price for its output. Note the following important implications of these definidons:

(1) TC = TFC + TVC

= (AFC)Q+ (AVC)Q = (ATC)Q

= TR - TC)

= Pq-(ATC)q.

= [P-(ATC)]q.

MARGINAL FUNCTIONS: These refer to the (small or large) actual change in the total function in the numerator resuldng from a small change in tlie denominator. These concepts are always written in "A(delta) notadon, where A is always understood to mean "the change in" Thus, marginal cost MC, is defined as the change in total cost resulting from a change in output, i.e., MC = (ATC/Aq), where the change in output, Aq, is small, usually one unit.

Similarly, marginal revenue, MR, is the change in total revenue resulting from a change in output, i.e., MR = (ATR/Aq), where the change in output, Aq, is again small, usually one unit. Since price is a given for the price-taking firm, the change in total revenue, ATR, from selling another unit equals PAq. Cancelling the Aq in the definition above shows that MR = P for a price-taker.


A. The shor! run differs froiu the long run in iliat. (it) there aic some ullaoida e costs in the short I mi (b) tile firm must pay certain fixed costs in the short run (c) the long run is necessarily a long period of time whereas the short run isnt (d) all of the above (e) (a) and (b) only.

B. Total variable cost is usually considered: (a) the total cost of emplo)ing labor (b) the total cost of using both labor and capital (c) the total cost of employing both labor, capital, and land (d) all of these (e) none of these.

C. If tolal cost is §1,500 for producing 100 units, and tolal variable cost is S500, then the average total cost is: (a) S15 (b) SIO (c) flOOO (d) $20 (e) S5.

D. Reanswer for a\erage variable cost.

E. Marginal cost is: (a) another name for incremental cost (b) another name for tolal cost (c) ihe same as average tolal cost (d) the change in total cost resulting from a one unit increase in output (e) both (a) and (d).

F. Profit equals:, (a) total revenue (b) tolal revenue minus total cost (c) the sum of marginal revenue (d) the product of price times quantity (e) none of these.

G. Average revenue in the pricc-iaking firm is always the same as: (a) price (b) marginal revenue

(c) average total (d) all of these (e) answers (a) and (b) only.

H. Economies of scale exist where: (a) is rising (b) is at a minimum (c) where is "U" shaped (d) is falling (e) none of these.

I. If die tolal cost of producing 50 units is $25 and the total of producing 51 units is $27 die marginal cost ofthe 51si unit is: (a) $2 (b) $27 (c) S25

(d) $21 (e) none of these.

J. \Aliich of the following is untrue of (producing) competiii\e firms? (a) the demand curve is perfectly elastic (b) in equilibrium, price equals marginal cost equals marginal revenue (c) the competitive firm can influence market price by producing

more (d) marginal revenue equals average revenue (e) the firms demand curve is perfectly flat.

K. A conipeiiti\e firm will shut down in ihe short run if (a) at all possible levels of output, total revenue is less than total variable cost (b) at all possible le\els of output, losses are greater than tolal fixed costs (c) at all possible levels of output, total cost is greater than total revenue (d) all of the above (e) options (a) and (b) only.

L. We can be sure that a producing firm is failing to maximize profit (or minimize losses) if: (a) marginal cost is less than marginal revenue (b) marginal cost is greater than marginal revenue (c) marginal cost is greater than average total cost (d) marginal cost is equal to price (e) both (a) and (b).

M. If we muldply quanuty .sold by the difference benveen price and average total cost, we would get back: (a) AFC (b) AVC (c) TFC (d) TR (e) profit

N. Average revenue in a price-taking firm: (a) increases with producdon (b)decreases with production (c) increases with average cost (d) decreases and then increases (e) is constant

0. If we add average fixed cost and average variable cost together and then muldplied by quantit)-, we would get back (a) average total cost (b) total revenue (c) marginal cost (d) total variable cost (e) total cost

P. Profits will be exacdy zero whenever (a) P = min (b) P :r min AVC (c) P =min AFC (d) P = min .MR (e) P = AR.

Q. If price is between min and min AVC. then the firm is losing: (a) TFC (b) AVC (c) T\C (d) MC (e) an amount less dian TFC.

R. Which of the following statements is false regarding die average total cost of producing a quantity q ill the long riui? (a) long run is at or below the \ai ious short run (b) the region where is falling is the region of economies of .scale (c) the of producing a given quandty is higher in the long run because die quantity of capital is fixed in the long run (d) average variable cost and average total cost are the same in the long run because all costs are \ariable (e) long run is "U" shaped.

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