Chapter 5 Flashcards
Production function
Defines the maximum amount of output that can be produced with a given set of inputs. Q = F(K,L)
K = Units of capital L = Units of labor
Fixed factors of production
The inputs a manager cannot adjust in the short run
Variable factors of production
The inputs a manager can adjust to alter production
Short run production function
Q = f(L) = F(K*, L)
Total product (TP)
The maximum level of output that can be produced with a given amount of inputs
Average Product (AP)
A measure of the output produced per unit of input. APL = Q / L
Marginal product (MP)
The change in total output attributable to the last unit of an input.
Increasing marginal returns
Range of input usage over which marginal product increases
Decreasing marginal returns
Range of input usage over which marginal product declines
Negative marginal returns
Range of input usage over which marginal product is negative
Average Product of Capital
APK = Q / K
Marginal product of capital
MPK = Chg Q / Chg K
Marginal product of labor
MPL = Chg Q / Chg L
The manager’s role in the production process
Ensure that the firm operates on the production function and to ensure that the firm uses the correct level of inputs
Value marginal product
The value of the output produced by the last unit of an input.
Value marginal product of labor
VMPL = P x MPL
Law of diminishing marginal returns
States that the marginal product of an additional unit of an input will at some point be lower than the marginal product of the previous unit.
Linear production function
A production function that assumes a perfect linear relationship between all inputs and total output.
Leontief production function
A production function that assumes that inputs are used in fixed proportions.
Isoquants
Defines the combinations of inputs that yield the same level of output
Marginal rate of technical substitution
The rate at which a producer can substitute between two inputs and maintain the same level of output
Law of diminishing marginal rate of technical substitution
A property of a production function stating that as less of one input is used, increasing amounts of another input must be employed to produce the same level of output
Isocost line
A line that represents the combinations of inputs that will cost the producer the same amount of money
Changes in isocosts
For given input prices, isocosts farther from the origin are associated with higher costs. Changes in input prices change the slopes of isocost lines.
Cost minimization
Producing output at the lower possible cost
Total cost
Sum of fixed and variable costs
Fixed costs
Costs that do not change with changes in output; include the costs of fixed inputs used in production.
Variable costs
costs that change with changes in output; include the costs of inputs that vary with output.
Short-run cost function
A function that defines the minimum possible cost of producing each output level when variable factors are employed in the cost-minimizing fashion.
Average fixed cost (AFC)
Fixed costs divided by the number of units of output
Average variable cost (AVC)
Variable costs divided by the number of units of output
Average total cost (ATC)
Total cost divided by the number of units of output
Marginal (incremental) cost (MC)
The change in total costs arising from a change in the managerial control variable Q.
Irrelevance of Sunk Costs
A decision maker should ignore sunk costs to maximize profits or minimize losses.
Sunk cost
A cost that is forever lost after it has been paid out.
Cubic cost function
Costs are a cubic function of output; Provides a reasonable approximation to virtually any cost function.
Long-run average cost curve
A curve that defines the minimum average cost of producing alternative levels of output, allowing for optimal selection of both fixed and variable factors of production.
Economies of scale
Exist whenever long-run average costs decline as output increases.
Diseconomies of scale
Exist whenever long-run average costs increase as output increases.
Constant returns to scale
Exist when long-run average costs remain constant as output is increased
Multiproduct cost function
A function that defines the cost of producing given levels of two or more types of outputs assuming all inputs are used effectively.
Economies of scope
Exist when the total cost of producing two products within the same firm is lower than when the products are produced by separate firms.
Cost complementarities
Exist when the marginal cost of producing one output is reduced when the output of another product is increased.
