Typically, the goal of the firm is to maximize profits. Sometimes, it may not be - consider the Indian railways. It may also be the goal to maximize sales (equivalently, revenue).
The total revenue is the amount a firm receives for the sale of its output.
The total cost is the market value of the inputs the firm uses in production.
The profit is the total revenue minus the total cost.
Explicit costs are costs that require money, whereas implicit costs are costs that do not (such as opportunity costs). As a result, the accounting profit is thus quite different from the economic profit (since we include opportunity costs in the latter).
When the total revenue exceeds both explicit and implicit costs, the firm earns economic profit. The economic profit is lower than the accounting profit due to the extra opportunity costs incurred.
The relationship between quantity of input and quantity of output is called the production function.
The marginal product of any input in the production process is the increase in output obtained from one additional unit of input. As input increases, the marginal product decreases. This property is known as diminishing marginal product. This is similar to the idiom “Too many cooks spoil the broth”. As marginal product declines, the production function grows flatter.
Fixed costs do not vary with the quantity of output (for example, office space rent) whereas variable costs depend on the quantity of output (for example, the total salaries of workers). The total cost is equal to the sum of the two.
The average total cost is the total cost divided by the quantity of output \(\text{TC}/\text{Q}\). Similarly, we can define average fixed cost and average variable cost.
The marginal cost is the amount the cost increases on increasing production by one unit of output. It is equal to the slope of the total cost function \(\Delta\text{TC}/\Delta\text{Q}\).
The marginal cost is the slope of the total cost function (if it is a continuous cost).
Marginal cost increases with the amount of output produced - this reflects the concept of diminishing marginal product.
The average total cost curve is U-shaped. This is because the average fixed cost decreases whereas the average variable cost increases due to diminishing marginal product.
The average total cost rises (falls) when the marginal cost is greater (less) than than the average total cost.
The marginal cost curve crosses the average total cost curve at the efficient scale . This is the minimum of the average total cost.
In the long run, all fixed costs become variable costs. As a result, the long run cost curves differ a lot from the short run cost curves.