Chapter 8 Flashcards
In the short run, [at least one/all] factor(s) is fixed
at least one
In the long run, [at least one/all] inputs are variable
all
In the long run, there [is one way/are numerous ways] to produce any given output
are numerous ways
When making a profit-maximizing choice, what does the firm try to do?
It tries to be technically efficient
When does technical efficiency occur?
It occurs when a given number of inputs are combined in such a way as to maximize the level of output
What does a firm do in order to maximize profit?
It choses among many technically efficient options and uses the technically efficient option that has the lowest cost. It chooses the lowest cost combination of labour and capital.
What is cost minimization?
It is the implication of profit maximization that firms choose the production method that produces any given level of output at the lowest possible cost
When is the firm not minimizing its costs?
When it is possible to substitute one factor for another to keep output constant while reducing total cost
Using K to represent capital and L to represent labour, and pL and pK to represent prices per unit of the two factors, what is the necessary condition for cost minimization?
MPK/pK=MPL/PL or MPK/MPL=PK/PL
What is the equation for the marginal rate of technical substitution (the negative slope of an isoquant) ?
MPK/MPL
What are isoquants?
They are all combinations of inputs which allow the firm to produce a certain level of output
What is the slope of an isoquant?
ΔK/ΔL=MPL/MPK
What are the two characteristics of an isoquant?
Isoquants have a negative slope and is convex
What can occur whenever the ratio of the marginal product of each factor to its price is not equal for all factors?
There are possibilities for factor substitutions that will reduce costs (for a given level of output)
How do profit-maximizing firms react to changes in factor prices?
By changing their methods of productions
When do methods of production change?
When the relative prices of factors change
Relatively more of the cheaper factor and relatively less of the more expensive factor will be used
What is the principle of substitution?
It is a principle that describes that methods of production will change if relative prices of inputs change, with relatively more of the cheaper inputs and relatively less of the more expensive input being used
What does an isocost line represent?
It represents all combinations of capital and labour which cost the same
What is the slope of the isocost curve?
ΔK/ΔL = -w/r (where w is wage rate PK and r is rental rate of capital PL)
What occurs functionally to the isoquant and isocost lines at the optimal choice?
slope of the isoquant = slope of the isocost
MPL/MPK = w/r = PK/PL
What is the equation of the isoquant line?
y = f(K,L)
What is the equation of the isocost line?
C = wL + rK
When all factors of production can be varied, there exists a what?
A least-cost method of producing any given level of output
How can we obtain the long-run average cost of producing each level of output with the least-cost method of producing any given level of output?
When this cost is expressed in terms of dollars per unit of output
What is the long-run average cost curve? (LRAC)
It is the curve showing the lowest possible cost of producing each level of output when all inputs can be varied
It is the boundary between cost levels that are attainable, with known technology and given factor prices, and those that are unattainable
Over the range of output from zero to Qm the long-run average cost is [rising/falling]. The firm is said to have ___
falling
economies of scale
What is the economies of scale?
It is a reduction of long-run average costs resulting from an expansion in the scale of a firm’s operations so that more of all inputs is being used
Over the range of output from zero to Qm, the firm is experiencing [increasing/decreasing] returns
Increasing
Increasing returns is a situation in which output [increases/decreases] more than in proportion to inputs as production [increases/decreases]
Increases
Increases
At Qm the firm is at its ___ on the long-run average cost curve
minimum efficient scale
What is the minimum efficient scale?
It is the smallest output at which LRAC reaches its minimum
All available economies of scale have been realized at this point
At Qm the firm experiences ____ returns
Constant returns
What are constant returns
Constant returns is a situation in which the output increases in proportion to inputs as production is increased
Over the range of output greater than Qm the firm is experiencing ____ returns
decreasing returns
What are decreasing returns
Decreasing returns is a situation in which output increases less than in proportion to inputs as production increases
What do decreasing returns imply?
That the firm suffers some diseconomies of scale
The LRAC curve shows the [highest/lowest] cost of producing any output when all factors are variable
lowest
The SRATC curve shows the [highest/lowest] cost of producing any output when one or more factors are fixed
lowest
Why can’t any short-run cost curve fall below the long-run cost curve?
Because the LRAC curve represents the lowest attainable cost for each possible output
Each SRATC curve is [tangent/parallel] to the LRAC curve at the level of output for which the quantity of the fixed factor is optimal and lies above it for all other levels of output
tangent
In the long run which average cost curve are firms producing on?
The Long Run Average Cost Curve
In the very long run what kind of changes are there? What do they cause in the LRAC cruve?
There are changes in the available techniques and resources. These changes cause shifts in the LRAC curve
What is a technological change?
It is any change in the available techniques of production
How can we measure the extent of technological change?
By using the notion of productivity
What is productivity?
It is the output produced per unit of some input
What are the 2 widely used measures of productivity?
Output per worker and output per hour of work
Why do firms invent and innovate new products and processes?
In the search of profits
Is technological change exogenous or endogenous?
It is endogenous
What are the 3 aspects of technological change?
- New techniques
- Improved inputs
- New products
When there are increases in the price of input, what may firms do in order to counteract this change?
They may either substitute away or innovate away from input - or do both over different time horizons
Why must firms produce large profits when they do succeed?
So that they may induce inventing firms to incur the costs of pushing into the unknown
