8.1 The Long Run: No Fixed Factors

Question 1

What is the difference between the short-run and the long-run for a firm?

Answer 1

In the short run, when at least one factor is fixed, the only way to adjust output is to adjust the input of the variable factors. In the long run, when all factors can be varied, there are numerous ways to produce any given output.

Question 2

What is technical efficency?

Answer 2

When a given number of inputs are combined in such a way as to maximize the level of output.

The profit-maximizing firm will try to be technically efficient, which means using no more of all inputs than necessary—that is, the firm does not want to waste any of its valuable inputs.

Question 3

What is an example of technical inefficency?

Answer 3

If the firm is able to produce 100 crates per day by using two machines and eight workers, the firm would be technically inefficient if it decided instead to produce only 90 crates per day while still employing the same amount of labour and capital.

Question 4

Other than Technical efficiency, what is required to maximize profits?

Answer 4

Technical efficiency is not enough for profits to be maximized, however. In order to maximize its profit, the firm must choose from among the many technically efficient options the one that produces a given level of output at the lowest cost.

Question 5

The hypothesis of profit maximization is called cost minimization….

Answer 5

An implication of profit maximization that firms choose the production method that produces any given level of output at the lowest possible cost.

Question 6

What is an issue that can prevent a firm from minimize its costs?

Answer 6

If it is possible to substitute one factor for another to keep output constant while reducing total cost, the firm is currently not minimizing its costs.
In such a situation, the firm should substitute one factor for another factor as long as the marginal product of the one factor per dollar spent on it is greater than the marginal product of the other factor per dollar spent on it.

Question 7

What is the necessary condition for cost minimization

Answer 7

Suppose we use K to represent capital, L to represent labor, and pL and pK to represent the prices per unit of these two factors. The necessary condition for cost minimization is then

MP_k/p_k=MP_L/P_L

Question 8

How can we tell when there possibilities for factor substitutions that will reduce costs?

Answer 8

Whenever the ratio of the marginal product of each factor to its price is not equal for all factors, there are possibilities for factor substitutions that will reduce costs (for a given level of output).

Question 9

What does the law of diminishing marginal returns tell us.

Answer 9

the law of diminishing marginal returns says that with other inputs held constant, an increase in the amount of one factor used will decrease that factor’s marginal product.

Question 10

What do profit-maximizing firms adjust the quantities of factors to?

Answer 10

Profit-maximizing firms adjust the quantities of factors they use to the market prices of the factors.

Question 11

What is the Principle of Substitution?

Answer 11

The principle that methods of production will change if relative prices of inputs change, with relatively more of the cheaper input and relatively less of the more expensive input being used.

Question 12

What is the long-run average cost (LRAC) curve?

Answer 12

The curve showing the lowest possible cost of producing each level of output when all inputs can be varied.

The long-run average cost (LRAC) curve is the boundary between attainable and unattainable levels of costs.

The LRAC curve is the boundary between cost levels that are attainable, with known technology and given factor prices, and those that are unattainable.

Question 13

What is the LRAC curve determined by?

Answer 13

The LRAC curve is determined by the firm’s current technology and by the prices of the factors of production.

Question 14

Since all costs are variable in the long run…

Answer 14

Since all costs are variable in the long run, we do not need to distinguish among AVC, AFC, and ATC, as we did in the short run; in the long run, there is only one LRAC for any given set of input prices.

Question 15

What is the shape of the LRAC curve?

Answer 15

The LRAC curve first falls and then rises. Like the short-run cost curves we saw in Chapter 7, this curve is often described as U-shaped, although empirical studies suggest it is often “saucer-shaped.”

Question 16

What are the tree portions of the LRAC?

Answer 16

1. Decreasing Costs
2. Constant Costs
3. Increasing costs.

Question 17

What is economies of scale

Answer 17

Economies of scale are cost advantages reaped by companies when production becomes efficient. Companies can achieve economies of scale by increasing production and lowering costs. This happens because costs are spread over a larger number of goods.

Reduction of long-run average costs resulting from an expansion in the scale of a firm’s operations so that more of all inputs are being used.

Question 18

Why does the decline in long-run average costs decline at the beginning of the LRAC

Answer 18

Because the LRAC curve is drawn under the assumption of constant factor prices, the decline in long-run average cost occurs because output is increasing more than in proportion to inputs as the scale of the firm’s production expands.

Question 19

What are increasing returns?

Answer 19

increasing returns (to scale)
A situation in which output increases more than in proportion to inputs as the scale of a firm’s production increases. A firm in this situation is a decreasing-cost firm.

Question 20

What is the minimum efficient scale? (MES)

Answer 20

minimum efficient scale (MES)
The smallest output at which LRAC reaches its minimum. All available economies of scale have been realized at this point.

Question 21

What are constant returns?

Answer 21

constant returns (to scale)
A situation in which output increases in proportion to inputs as the scale of production increases. A firm in this situation is a constant-cost firm.

Question 22

What are decreasing returns?

Answer 22

A situation in which output increases less than in proportion to inputs as the scale of a firm’s production increases. A firm in this situation is an increasing-cost firm.

Decreasing returns imply that the firm suffers some diseconomies of scale.

Question 23

Why can no short-run cost curve fall below a long-run cost curve?

Answer 23

No short-run cost curve can fall below the long-run cost curve because the LRAC curve represents the lowest attainable cost for each possible output.

Each SRATC curve is tangent at some point to the LRAC curve.

Question 24

Why is the LRAC curve sometimes called an envelope curve?

Answer 24

The LRAC curve is sometimes called an envelope curve because it encloses (or envelops) a series of SRATC cost curves by being tangent to them.

To every point on the LRAC curve, there is an associated SRATC curve tangent at that point.