Chapter 6 - Producer behaviour Flashcards
- What are the differences between a firm’s production in the short run and the long run?
- In the short run, a firm’s capital is fixed, while in the long run, a firm can change its quantities of both labor and capital inputs.
- What does a production function tell us?
- A production function shows the relationship between a firm’s inputs (capital and labor) and its output quantity.
- What is the difference between fixed costs and variable costs?
- Fixed costs don’t depend on how much output a firm produces-they are the same whether the firm produces one unit of output or one million units of output or even zero units of output. Variable costs depend on how much the firm produces: As output increases, variable costs increase.
- What is the difference between the short run and the long run?
- In the long run, the firm can adjust the level of each of its inputs. In the short run, at least one input is fixed and cannot be adjusted by the firm.
- How does the amount of output change as the isoquants are farther from the graph’s origin? Why can’t two isoquants cross? Why are isoquants conves to the origin?
Isoquant - a curve representing all the combinations of inputs that allow a firm to make a particular quantity of output
A producer’s isoquants share many of the same characteristics as a consumer’s indifference curves. Isoquants farther from the origin are associated with higher output levels. Isoquants cannot cross because if two isoquants did, it would imply that the same quantities of inputs yield two different quantities of output. - Isoquants are convex to the origin (because using a mix of inputs generally lets a firm produce a greater quantity than it could by using an extreme amount of one input and a tiny amount of the other)
- What is the marginal rate of technical substitution? What does it imply about an isoquant’s shape?
The marginal rate of technical substitution is the rate at which the firm can trade one input (X) for another (Y) holding output constant, and is equal to the marginal product of input X over the marginal product of input Y. For the standard case, the MRTS implies a curved isoquant. As you move down and to the right along the isoquant, the marginal product of labor becomes low relative to the marginal rate of capital.
- What does the curvature of an isoquant imply about the two inputs, capital and labor?
The curvature of the isoquant demonstrates the degree of substitutability between capital and labor. A nearly straight isoquant implies that the MRTS is nearly constant along the isoquant, implying that the two inputs are close substitutes for each other in the production process. A more curved isoquant indicates that capital and labor are poor substitutes for each other in the production process.
- What is an isocost line? What does its slope tell us about the relative cost of labor and capital?
An isocost line is the curve that shows all the input combinations that yield the same cost. Since the slope of the isocost line is the negative ratio of wages to the capital rental rate, - W / R, we can use the slope to determine the cost tradeoff of substituting labor for capital ( or vice versa).
If the isocost line’s slope is steep, labour is relatively expensive compared to capital - if the firm wants to hire more labour without increasing its overall expenditure on inputs, it is going to have to use a lot less capital
If the price of labour is relatively cheap compared to capital, the isocost line will be relatively flat. The firm could hire a lot more labour and not have to give up much capital to do so without changing expenditures
Because of our assumption (8) that the firm can buy as much capital or labour as it wants at a fixed price per unit, the slopes of isocost lines are constant - why they are parallel
- How will a firm react to an increase in the price of one input relative to another?
In reaction to an increase in the price of one input (say, labor), the firm will substitute away from units of that input to another (in this case, capital) in the long run.
- When is a production function said to have constant returns to scale, increasing returns to scale, or decreasing returns to scale?
Returns to scale refers to the change in the amount of output in response to a proportional change in all the inputs. Constant returns to scale indicate that a proportional change in all inputs changes the quantity of output by that same proportion. Increasing returns to scale means that a proportional change in all inputs changes the quantity of output more than proportionately. Finally, decreasing returns to scale imply that a proportional change in all inputs changes the quantity of output less than proportionally.
- What is an expansion path and how does it relate to a firm’s total cost curve?
The expansion path plots the optimal input combinations for each output quantity. The total cost curve plots the output quantities from the expansion path against the total cost of the productive inputs.
What are the nine simplyfying assumptions about firms’ production behaviour?
- The firm produces a single good
- The firm has already chosen which product to produce
- For whatever quantity it makes, the firm’s goal is to minimize the cost of producing it
- The firm uses only two inputs to make its product: capital and labour
- In the short run, a firm can choose to employ as much or as little labour as it wants, but it cannot rapidly change how much capital it uses. In the long run, the firm can freely choose the amounts of both labour and capital it employs
- Short run - the period of time during which one or more inputs into production cannot be changed
- Fixed inputs - inputs that cannot be changed in the short run
- Variable inputs - inputs that can be changed in the short run
- Long run - the period of time during which all inputs into production can be changed - The more inputs the firm uses, the more output it makes
- A firm’s production exhibits diminishing marginal returns to labour and capital
- If the amount of capital is held constant, each additional worker eventually produces less incremental output than the last, and vice versa. - The firm can buy as many capital or labour inputs as it wants at fixed prices
- If there is a well-functioning capital market (e.g. banks and investors), the firm does not have a budget constraint
What is marginal product?
Marginal product - the additional output that a firm can produce by using an additional unit of an input (holding use of the other input constant)
In the short run, the marginal product of labour is more relevant as we assume capital is fixed
What does it mean that the production function exhibits diminishing marginal product of labour?
Production function exhibits diminishing marginal product of labour. As producer uses more labour, while holding capital fixed, marginal product falls.
What is the average product and what happens to the average product when labour increases?
Average product - the quantity of output produced per unit of input (total quantity of output divided by the number of inputs used to produce it)
Average product of labour: AP_L=Q/L
The average product of labour falls as labour inputs increase. This decline occurs because the marginal product of labour is less than the average product at each level of labour in the table, so each unit of labour added on the margin brings down labour’s average product
