Chapter 22 The firm (cost and output determination) Flashcards
what is production?
any process where resources are turned into goods or services
includes making, transporting, packaging, and selling
What are factors of production(inputs)?
used to transform resources into goods or services.
capital
labor
what is capital?
property, plant, and equipment used to transform resources
what is labor?
human labor used to transform resources
what are substitutes in production?
using one input instead of another
reducing the number of labors you need by increasing the number of machines on the assembly line
What is the short-run?
at least one factor of production is fixed
capital is generally the fixed input (the plant size cannot change in the short run, but its not always the case)
what is long run?
all factors of production can be varied
we can change both labor and capital
What is marginal revenue (MR)?
the additional revenue from selling one more unit
what is marginal cost(MC)?
MC= change in TC/ change in Q
the additional cost of selling one more unit
What is the marginal principle?
we will always want to produce as long as MR is greater than MC
next unit
What happens when MR>MC?
we get more from selling 1 more unit than it costs us to make, so we should continue to produce in this situation
what happens when MR<MC?
we get less from selling 1 more unit than it costs us to make so we shouldn’t continue to produce in this situation
total revenue (Tr) is what equation?
TR= P x Q
total cost (TC) is what equation?
cost per unit x Q= total cost of production at that quantity
profit (pie symbol) is what equation?
TR- TC= proft
what is total product (TP)?
total amount of output produced
what is average product(AP)?
total product divided by the number of units of the variable factor used in the production.
it will either be labor or capital
what is average product labor(APL)?
TP/L
labor can either be the number of workers of the number of total labor hours
what is average product capital(APK)?
TP/K
capital can either be the number of capital units or the number of total capital hours
what is marginal product(MP)?
the change in total output that results from using one more unit of an input
what is marginal product labor(MPL)?
change in TP/ change in L
what is marginal product capital(MPK)?
change in TP/ change in K
what is specialization?
focusing on a specific task in the production process instead of having one person perform all the tasks
(fast food restaurants are fast bc of specialization, everyone has one job to do)
How does marginal productivity affect specialization?
marginal productivity may increase rapidly when the number of workers is low, meaning that if their is a low number of workers then the work typically won’t be able to be specialized.
by increasing the number of workers it will often result in a large increase in marginal productivity due to specialization
but once employees have been specialized the rapid increase in MP will decline if capital remains fixed
what is diminishing MPL?
initially the MPL increasing w each additional unit of labor we add, but there is a point where adding a worker will still have a positive MPL, but be lower than the previous workers.
it’s not exactly a bad thing, it just means you’re starting to get fewer additional units of output from each worker you add
what is diminishing APL?
initially, the APL increases w each additional unit of labor we add, until the average number of units we produce per laborer starts to decrease.
what does the graph look like when MPL>APL?
the APL will slope upward
what does the graph look like when MPL<APL?
diminishing APL will start and the APL curve will slope downward
what is the law of diminishing return?
if resources, such as property, plant, and equipment, are fixed, and increase in the number of units of variable input, such as labor, will eventually result in output increasing by smaller and smaller rates
too many people working, wasting time and space making it harder to do jobs
what is total fixed cost(TFC)?
cost stays constant at all activity levels within the relevant range
doesn’t matter how many units you produce, the cost stays the same
fixed amount over a period of time (f)
property taxes, insurance
what is total variable cost(TVC)?
cost changes in direct proportion to the number of units produced with the relevant range
cost of shirt, computer parts, wages of hourly employees
units used goes up, cost goes up
TVC always begins at the origin (0,0)
what are total costs(TC)?
total fixed costs + total variable costs
TFC + TVC = TC
doesn’t start at origin bc of the TFC
the graph changes in direct proportion to the number of units produced because of the variable costs
what are short run costs?
fixed costs- do not change w changes in output
variable costs- change w changes in output
TC= TVC+ TFC
What are average fixed costs(AFC)?
AFC=TFC/Q
fixed costs allocated to each unit produced
always decrease as we produce more units bc we are allocating the costs among more units
overtime, less & less important
what are average variable costs(AVC)?
AVC=TVC/Q
variable costs allocated to each unit produced
will always be U-shaped bc initial we will be more efficient but as resources get stretched, producing more units of output becomes inefficient
we don’t always produce at the minimum
workers = VC
what is average total costs(ATC)?
ATC= TC/Q
ATC= AFC + AVC
total cost allocated to each unit produced
on average, how much it costs to produce a unit of output
not as much of a U-shape
what is the relationship between ATC, AVC, and MC?
MC will always intersect ATV and AVC at their minimum points
what happens when MC<ATC?
ATC decrease
what happens when MC<AVC?
AVC decrease
what happens when MC>ATC?
ATC increase
what happens when MC>AVC?
AVC increases
what are factors that shift short run cost curves?
- resource prices
- taxes
- regulation
- technology
What happens in a short run cost curve?
reflects the law of diminishing marginal return bc at least one input is fixed
either capital or labor is fixed
what happens in a long run cost curve?
no inputs are fixed
what are planning curves?
another term for long run cost curves
what is the principle of substitution?
when the price of an input is raised, a different input that is cheaper will be used more than the input that just had the price increased
using the principle of substitution, what happens when labor goes up?
if the price of labor goes up, firms will use less labor and more capital
using the principle of substitution, what happens when capital goes up?
if the price of capital goes up, firms will use less capital and more labor
what is cheaper, labor or capital?
capital
what does a long run cost curve show?
shows the lowest cost of producing each level of output when all inputs can be varied
doesn’t distinguish between ATC, AVC, and AFC bc no costs are fixed in the long run
everything can change
What happens to Mc in the long run as opposed to the short run?
MC increases faster in the short run than in the long run bc the amount of capital is fixed in the short run
why does the short run cost curve never fall below the long run cost curve?
it never falls below bc the long run cost curve shows the lowest possible cost for each output level
why can you use the optimal level of inputs in the long run and not the short run?
in the long run you can bc none of your inputs are fixed, but in the short run one of the inputs will be fixed
what is the minimum efficient scale (MES)?
first point of production where ATC is the lowest for a particular firm
what is small MES?
only a small amount of output is required to reach the MES
may result in: 1. many efficient firms and 2. a high degree competition
what is large MES?
large amount of output is required to reach the MES
may result in: 1. small number of efficient firms and 2. small degree of competition
what is capacity quantity?
last point of production where ATC is the lowest for a particular firm
what is economies of scale?
where the ATC decreases as we produce more
occur at smaller levels of output and eventually slow down as output increases
walmart buying products in bulk to sell cheaper
what is constant returns to scale?
where there is no change in ATC as we produce more
suggest that plant is at the ideal size
what is diseconomies of scale?
where ATC increases as we produce more
not worth addition
what are reasons for economies of scale?
- specialization
- dimensional factor
- improvement in production equipment
what is dimensional factor in the economies of scale?
ability to double output without doubling all inputs
lawn mowers mow more lawns by doubling time and not buying more mowers
what are reasons for diseconomies of scale?
- more output=larger plant size= larger firm size
- adding layers of management
- decrease in flexibilty
what is the relationship between short run ATC curves and long run average cost curves?
each short run ATC curve will have exactly 1 point that is tangent to the long run AC curve
what does the tangent point between the short run ATC curve and long run AC curve mean?
the point is the point that output in the short run reaches minimum long run AC for the amount of the input that is fixed in the short run
why is the short run ATC curve steeper than the long run AC curve?
SRATC curves steeper than the LRAC curve when output is increasing bc firms have to make inefficient choices in the short run bc one of their inputs is fixed.
what is a sunk cost?
cost that has already been paid and can’t be recovered
not relevant to current decision making
no effect on future decisions bc they can’t be recovered
