4 - Theory Of The Firm Flashcards
What is the difference between explicit and implicit costs?
Answer: Explicit costs require direct outlay of money by the firm (e.g., wages, rent), while implicit costs don’t require direct payments but represent opportunity costs.
How is economic profit different from accounting profit?
Answer: Economic profit considers both explicit and implicit costs, while accounting profit only considers explicit costs. Therefore, economic profit is always smaller than accounting profit.
Define marginal cost.
Answer: Marginal cost measures the increase in total cost that arises from producing one additional unit. It can be calculated as: Change in Total Cost / Change in Quantity.
What is the production function?
Answer: The production function shows the relationship between the quantity of inputs used to make a good and the quantity of output of the good.
Quantity of a good = function(Capital; labor; raw materials, etc.)
Explain diminishing marginal product.
Answer: As you add more of one input while keeping other inputs constant, each additional unit of that input will eventually lead to smaller and smaller increases in output.
Why is the Average Total Cost (ATC) curve U-shaped?
Answer: The ATC curve is U-shaped because:
- At low output levels, ATC is high as fixed costs are spread over few units
- ATC declines as output increases due to spreading fixed costs over more units
- ATC eventually rises again as average variable costs increase substantially due to diminishing marginal returns
What is the efficient scale of the firm?
Answer: The efficient scale is the quantity that minimizes Average Total Cost (ATC), occurring at the bottom of the U-shaped ATC curve where the Marginal Cost (MC) curve intersects it.
What are the three important properties of cost curves?
Answer: 1. Marginal cost eventually rises with output
2. Average total cost curve is U-shaped
3. MC intersects ATC at minimum ATC
How does the short run differ from the long run in terms of costs?
Answer: In the short run, some costs are fixed, while in the long run, all costs become variable.
What are economies of scale?
Answer: Economies of scale refer to when long-run Average Total Cost falls as the quantity of output increases.
What is the profit maximization rule for firms?
Answer: Firms should produce where Marginal Revenue (MR) equals Marginal Cost (MC). If MR > MC, increase production; if MR < MC, decrease production.
In a competitive market, what is the relationship between price and marginal revenue?
Answer: In a competitive market, price equals marginal revenue (P = MR) because firms are price takers and the price is independent of how much an individual firm supplies.
What is fixed cost? Name three examples of fixed costs.
Fixed costs (TFC) don’t vary with the quantity of output produced
Fixed costs include rent, machinery, advertising, R&D, legal fees, and corporate overhead.
What is variable cost? What are three examples of variable costs?
Variable costs (TVC) change with production levels
Variable costs include labor, freight & shipping, energy, materials, and packaging.
How is Average Fixed Cost (AFC) calculated?
Answer: Average Fixed Cost is calculated by dividing Total Fixed Cost by the quantity of output produced.
