CH7: Cost Of Production Flashcards
What is a firm in economics?
A profit-seeking business that provides goods or services.
What is the main goal of a firm in standard economic theory?
To maximize profit.
What is the principal-agent problem?
A conflict where agents (e.g., managers) pursue goals not aligned with principals (e.g., owners).
How is total revenue calculated?
TR = Price × Quantity sold.
What is average revenue (AR)?
AR = Total Revenue ÷ Quantity sold.
What is marginal revenue (MR)?
The additional revenue from selling one extra unit.
What is profit?
Profit = Total Revenue – Total Cost.
What are explicit costs?
Direct monetary payments for inputs.
What are implicit costs?
Opportunity costs for using self-owned resources.
What is normal profit?
The minimum return needed to keep resources in their current use; part of cost.
What is economic cost?
Economic cost = Explicit costs + Implicit costs.
What is accounting profit?
TR – Explicit Costs.
What is economic profit?
TR – (Explicit + Implicit Costs), including normal profit.
What defines the short run in production theory?
At least one input is fixed.
What defines the long run in production theory?
All inputs are variable.
What is total product (TP)?
The total output produced from inputs.
What is average product (AP)?
AP = TP ÷ Input quantity.
What is marginal product (MP)?
The additional output from using one more unit of input.
What is the law of diminishing returns?
MP decreases as more units of a variable input are added to fixed inputs.
What is total cost (TC)?
The total cost of producing a specific quantity of output.
What is average cost (AC)?
AC = TC ÷ Quantity.
What is marginal cost (MC)?
MC = Change in total cost ÷ Change in quantity produced.
What happens when MC > AC?
Average cost increases.
What happens when MC < AC?
Average cost decreases.
What happens when MC = AC?
Average cost remains unchanged.
What is the production function?
A mathematical relationship showing how inputs (e.g., labour and capital) are converted into output: Q = f(L, K).
What is the difference between variable and fixed inputs?
Variable inputs change with output; fixed inputs stay constant in the short run.
How is the short run defined in production theory?
A period during which at least one input is fixed.
What does the law of diminishing returns state?
As more of a variable input is added to fixed inputs, the marginal product will eventually decline.
What is total product (TP)?
The total quantity of output produced with given inputs.
How is average product (AP) calculated?
AP = Total Product ÷ Units of Labour.
What is marginal product (MP)?
The additional output from using one more unit of a variable input.
What happens to AP when MP is above it?
AP increases.
What happens to TP when MP becomes negative?
TP begins to decline.
When is AP at its maximum?
When AP = MP.
What is fixed cost (FC)?
Cost that does not vary with output.
What is variable cost (VC)?
Cost that varies directly with output.
How is total cost (TC) calculated?
TC = Fixed Cost + Variable Cost.
How is average fixed cost (AFC) calculated?
AFC = Fixed Cost ÷ Output.
How is average variable cost (AVC) calculated?
AVC = Variable Cost ÷ Output.
How is average cost (AC) calculated?
AC = Total Cost ÷ Output.
What is marginal cost (MC)?
MC = Change in Total Cost ÷ Change in Output.
What is the shape of the MC, AVC, and AC curves?
U-shaped.
What is the shape of the AFC curve?
L-shaped; it declines as output increases.
What happens when MC < AC?
AC decreases.
What happens when MC > AC?
AC increases.
Where does MC intersect AVC and AC?
At their respective minimum points.
What happens to marginal cost when marginal product increases?
Marginal cost decreases.
When does average variable cost reach its minimum?
When average product is at its maximum.
Why do MP and MC have an inverse relationship?
Because of the law of diminishing returns.
In the long run, are there fixed inputs or fixed costs?
No. All inputs and costs are variable.
Does the law of diminishing returns apply in the long run?
No, it only applies in the short run.
What are returns to scale?
The relationship between input increases and resulting output increases when all inputs vary proportionally.
What are constant returns to scale?
Output increases by the same percentage as inputs.
What are increasing returns to scale?
Output increases by a greater percentage than inputs.
What are decreasing returns to scale?
Output increases by a smaller percentage than inputs.
What are economies of scale?
Reductions in average cost per unit as production increases.
What causes internal economies of scale?
Factors within the firm, like better management or specialization.
What are external economies of scale?
Cost savings due to external factors like improved infrastructure.
What are diseconomies of scale?
Increases in average cost per unit as output rises.
What are economies of scope?
Cost savings from producing related goods together in one firm.
What does the long-run average cost (LRAC) curve show?
The lowest cost per unit at every output level when all inputs are variable.
What shape does the LRAC curve have under economies of scale?
Downward-sloping.
What happens when LRMC < LRAC?
LRAC is falling.
What happens when LRMC > LRAC?
LRAC is rising.
When does LRMC = LRAC?
At the minimum point of LRAC.
What is the LRAC curve also called?
The envelope curve.
How is the LRAC curve derived?
By joining the lowest points of all short-run average cost (SRAC) curves.
Why is the LRAC curve smooth in theory?
Because it envelops an infinite number of SRAC curves.
