Chapter 7: Production, Costs, and Industry Structure Flashcards
What is a Firm?
An organization that combines inputs (labor, capital, land, and raw material) to produce outputs.
draw mc, atc, afc, and avc in a graph. Draw TC, VC, and FC on a graph. draw mp and tp. recognized diff lrac curves. Identify areas of lrac curve.
Production
The process of combining inputs to produce outputs:
* transportation,
* distribution,
* wholesale and
* retail sales
* manufacturing
The Four Different Market Structures, examples
Look at scale in notes
Perfect competition: many firms are selling identical products (ex. farmers).
Monopolistic competition: many firms selling similar but differentiated products (ex. smartphones, beverages, clothing).
Oglipoly: Few large firms that sell identical/similar products (airlines, automobiles).
Monopoly: Only one firm sells the product and they face no competition (BC Hydro, Canadian Pacific Railway).
Total Revenue, Formula
The income a firm generates from selling its products = Price x Quantity
What is total cost? Fomula
?? the other total cost has different definition?
What the firm pays for producing and selling its products;
production involves the firm converting inputs to outputs, each input has a cost to the firm = the sum of explicit and implicit costs.
The Two Types of Cost
Explicit: Out-of-pocket costs/actual payments (ie. wages paid to employees, rent for an office).
Implicit: The opportunity costs of using resources the firm already owns (ie. salary from another employer that the business owner foregoes, rent that could be made from the occupied building).
Accounting profit, formula
Direct calculation of the difference between dollars brought in and dollars paid out; considers only explicit costs, therefore is usually higher than economic profit =Total Revenue-Explicit Costs
Economic profit
=Total Revenue-Explicit Costs-Implicit Costs
Inputs/factors of production:
- Natural Resources (land, raw materials)
- Labor
- Capital (equipment, machinery, buildings)
- Technology
- Entrepreneurship
Fixed inputs
(K, capital): factors of production that can’t be increased or decreased in the short run. E.g. building of a restaurant.
Variable inputs
(L, labor): factors of production that a firm can easily increase or decreased. E.g. amount of food served at a restaurant.
Production function, and what is it for?
Q=f[NR, L, K, t, E]. It expresses the amount of output the firm can produce given different amounts of input.
Short run
The period of time during which at least some factors of production are fixed (usually only labor is variable, while capital is fixed).
See example of lumberjacks in notes
Long run
The period of time during which all factors of production are variable.
See example of lumberjacks in notes
What is marginal product (MP), formula, slope
very important
the additional output of one or more workers (or one or more variable inputs) = change in TP divided by change in L.
* The slope of any point on the TP line is MP.
Seet graph in notes
Law of diminishing marginal productivity/ diminishing marginal returns of labor.
Why does it happen?
Indicate where on MP and TP graph
States that as a firm employs more labor, eventually the amount of additional output produced declines OR as more units of a variable input are added to a fixed input, after a certain point, the marginal product of the variable input will begin to decrease
Because of constraints of fixed capital in the short run (see graphs in notes).
Factor payments aka costs, types
What the firm pays for use of the factors of production (aka costs).
* Raw material prices for raw material
* Rent for land and building
* Wages and salaries for labor
* Interest and dividends (interest is paid to lender and dividends are paid to owner)
* Profit
See deriving cost function for producing widgets in notes
Average (total) cost formula, shape
Total cost divided by the quantity of output produced (typically u-shaped). ATC=TC divided by Q.
What is marginal (total) cost, shape, formula
The additional cost of producing one more unit of output (generally upward-sloping) MC= change in TC divided by change in Q.
see graph
Average variable cost
= variable cost divided by quantity of output.
* Lies below the ATC curve
* Typically u-shaped or upward-sloping
Average profit/profit margin
*
Determine if the firm is (economically) profitable = price - average total cost.
* If price > average cost, then average profit will be positive.
* If price < average cost, then average profit will be negative.
Variable costs, example
Cost of production that increases with the quantity produced; costs of the variable inputs (e.g. labor, raw material)
Fixed costs/”overhead” costs, example, are there fixed costs in the long run?
Costs of fixed inputs (e.g. capital, rent, insurance) (short run).
* Expenditure that a firm must make before production starts.
* expenses a firm must pay regardless of its output.
There are no fixed costs in the long run
Total cost
How the hell is this different from the other total cost?
Sum of fixed and variable costs of production
Long Run*
long-run average cost (LRAC) curve, how is it formed?
shows the lowest possible average cost of production, allowing all the inputs to production to vary so that the firm is choosing production technology that were used in short-run in order to produce at the lowest cost.
* formed by the bottom edge of the family of SRAC curves.**
It does NOT show total of AFC and AVC like the SRAC bc there are no FC in the long run!
*
short-run average cost (SRAC) curve
the average total cost curve in the short term; shows the total of the average fixed costs and the average variable costs.
production technologies
a mix of capital and labor (inputs) that is used to make a product (outputs).
Economies of scale, why does it happen?
See fig. 7.8 and 7.9
Where the long-run average cost of producing output decreases as total output.
* Because the firm can use cost-saving mass production techniques, so a larger factory can produce at a lower average cost than a smaller factory.
Constant returns to scale
Where expanding all inputs proportionately does not change the average cost of production.
Diseconomies of scale, why does it happen?
the long-run average cost of producing output increases as total output increases.
* because the firm gets too big and difficult to manage.
How are MC and ATC related?
important
If our marginal is greater than our average, our average increases. If the marginal is less than our average, our average decreases. Where MC curve intersects with ATC curve at the min. point of the ATC curve, is the point of transition between where MC is pulling ATC down and where it is pulling it up.
Short-run
What is the relationship between MP and TP?
The MP curve initially increases (specilization), reaches its maximum and then declines. The maximum of MP is reached at the point where law of diminishing marginal product kicks in, and TP starts to increase at a diminishing rate. But TP is always positive even when MP declines.
Per-unit short-run cost curves
MC, ATC, AVC
Entire quantity of output produced cost curves
TC, FC, VC
What is normal profit?
Zero economic profit (breaking even).
