Chapter 6

Question 1

What are final goods?

Answer 1

Goods that are bought by consumers

Question 2

What are intermediate goods?

Answer 2

These are goods used to produce other goods.

Question 3

what is production?

Answer 3

Production is a process by which an entity uses inputs to create a good or service for which others will pay.

Question 4

Name the nine simplifying assumptions about firms’ production behavior.

Answer 4

1. Firm produces a single good
2. Firm has already chosen which product to produce
3. Firm’s goal is to minimize production costs for given output level
4. firm uses two inputs to make products: capital and labor
5. Labor is always variable, capital is fixed in short term and variable in long term
6. Higher input levels cause higher output levels
7. Production has diminishing marginal returns on labor and capital, based on the assumption that you will produce the most if labor and capital are combined
8. Firm can buy as many capital or labor units as it wants against fixed market prices
9. Firm does not have a budget constraint if there is a well-functioning market.

Question 5

What is the short run in production economics?

Answer 5

This is the period of time in which one or more inputs in production cannot be changed.

Question 6

What are fixed inputs?

Answer 6

Inputs of which the quantity cannot be changed in the short term.

Question 7

What are variable inputs?

Answer 7

Inpputs that can be changed in the short term.

Question 8

What is the long run in production economics?

Answer 8

this is the amount of time it takes for all inputs in production process to be completely adjustable

Question 9

What is a production function?

Answer 9

This is a mathematical relationship describing the amount of output that can be made from different input combinations.

Question 10

What is a marginal product?

Answer 10

This is the additional output that can be produced by using one additional unit of an input.

Question 11

What is the marginal production of labor?

Answer 11

This is the change in production output / change in labor

Question 12

what is the diminishing marginal product?

Answer 12

this is the reduction in incremental output derived from adding to labor input.

Question 13

What is average product?

Answer 13

This is the total quantity of output / number of units input to produce output.

Question 14

What is cost minimization?

Answer 14

A firm’s goal of producing a given quantity at minimum cost. Companies can use two concepts, isoquants and isocost lines, to solve its constrained minimization problem.

Question 15

What are isoquants?

Answer 15

This are curves representing the combinations of input necessary to produce a particular quantity of output. These isoquants cannot cross.

When the slope of the isoquant is high (steep), capital can be reduced by a lot and labor increased a little to produce the same output.
When the slope is low (flat), capital can be reduced by a little and labor by a lot to produce the same output.

Question 16

What is the marginal rate of technical substitution (MRTS)?

Answer 16

This is the rate at which the firm can trade capital for labor or vice versa while output remains constant. This can be calculated as Marginal production of L / Marginal production of K

Question 17

What is the shape of the isoquant line if the inputs are close substitutes and when the inputs are close complements?

Answer 17

1. When the inputs are close substitutes and the relative usefulness of inputs won’t vary a lot, the isoquants are straight. This means the MRTS remains constant.
2. When the two inputs are close complements, there is a big curve in the isoquant. If they are perfect complements, they are L-shaped.

Question 18

What are isocost lines?

Answer 18

These are curves that show all the input combinations yielding the same cost. It is given by the function C= RK+WL.

The slope can be calculated by W(wage) / R(rental rate)

Question 19

What do steep and flate isocost lines indicate?

Answer 19

A steep isocost line means that labor is relatively expensive compared to capital

A flat isocost line means that labor is relatively cheap compared to capital.

Question 20

What is the marginal benefit to cost ratio?

Answer 20

At the point where there is a tangency point of the isocost and isoquant curves:

The MP of capital / Renting rate = MP of labor/ wage

Question 21

When do isocost lines get steeper?

Answer 21

Isocost lines get steeper when:
- Wage increases
- Renting rate decreases.

Question 22

What are returns to scale?

Answer 22

This means that there is a change in the amount of output due to a proportional increase in all inputs.

Question 23

What are constant returns to scale?

Answer 23

This is a production function where changing K and L by the same multiple changes the output by exactly that multiple.

Question 24

What are increasing returns to scale?

Answer 24

changing all inputs by the same multiple changes the output more than that multiple.

Question 25

What are decreasing returns to scale?

Answer 25

This is a production function where changing all the inputs by the same proportion changes output by less than that proportion.

Question 26

What is the difference between marginal products and returns to scale?

Answer 26

MPs are about the increase of one input while the other remains constant (short-run). Returns to scale are about increasing both inputs with the same proportion (long-run).

Question 27

What three factors affect return to scale?

Answer 27

1. Duplicability: if production process can be duplicated, the return to scale is constant.
2. Fixed costs: input costs that doesn’t depend on Q. After these fixed costs are paid off, the return to scale will increase.
3. Learning by doing: process where firm becomes more efficient in production as it has produced more.

Question 28

What is the firm’s expansion path?

Answer 28

This is a curve illustrating how the optimal mix of inputs varies with total output.

Question 29

What is a total cost curve?

Answer 29

This is a curve illustrating a firm’s cost of producing particular quantities. This can be derived by plotting the total costs and output quantity located along the expansion path.