Chapter 8: Producers in the long run Flashcards
What is the key difference between short and long runs?
Short run: (at least) one factor is fixed. Long run: All inputs are variable
What does it mean when a firm tries to be technically efficient?
Firms try to maximize profits, so they want to maximize their outputs. This is done when a given number of inputs are combined in a certain configuration
True/False? Technical efficiency is not enough for profits to be maximized.
False
True/False? There is only one technically efficient option
False
Which technically efficient option do firms use to maximize profit?
The one that has the lowest cost (the lowest combination of labor and capital)
Why is profit maximization only available in the long run?
Because all factors are variable, so the cheapest configuration of labor and capital can be chosen
What is cost minimization?
An implication of profit maximization Choosing the lowest possible cost
If a firm can substitute one factor for another, while keeping output constant but reducing total cost, the firm (is/is not) minimizing cost
Is not
How is profit maximization/cost minimization calculated?
MP(K)/p(K) = MP(L)/p(L) or MP(K)/MP(L) = p(K)/p(L)
When is there an opportunity for factor substitutions (that would reduce costs)?
Whenever the ratio of (the marginal product of each factor) to (its price) is not equal for all factors (for a given level of output)
How can the firm reduce cost?
Using more L and less K
What does of the principle of substitution suggest?
More of a cheaper factor and less of a more expensive factor will be used
Eg ATMs instead of bank tellers
What is considered when all factors of production can be varied (as is the case in the long run)?
The least-cost method of production
What does the LRAC indicate? What does it represent on a graph? What is its shape?
Long Run Average Cost
Indicates the minimum achievable cost for each level of output
Separates unattainable and attainable cost levels (given technology/factor prices)
Curve is typically U-shaped
Why is there no AVC, AFC, and ATC curve in the long run?
There are no fixed factors, just variable factors
When does a firm have ‘economies of scale’?
When the long run average cost curve is falling (left half of U shape)
What results in an economy of scale?
An expansion in the scale of a firm’s operations so that more of all inputs is being used
What can a firm enjoy over the descending portion of a long run average curve?
Increasing returns
Output increases more than in proportion to inputs as the scale of a firm’s production increases
What happens when the U shaped LRAC curve is at its apex?
The firm is at its minimum efficient scale (The smallest output at which LRAC reaches its minimum)
The firm experiences constant returns (the output increases in proportion to inputs as the scale of production is increased)
What happens over the rising portion of the LRAC curve?
The firm experiences decreasing returns (output increases less than in proportion to inputs as scale increases)
What do decreasing returns imply for the firm?
They imply that the firm suffers from diseconomy of scale
In a LRAC curve, attainable levels of cost ____ the curve, whereas Unnatailable levels of cost are ____ the curve
Above
Below
How are LRAC and SRATC curves related?
The LRAC shows the lowest cost of producing any output when all factors are variable
Each SRATC curve shows the lowest cost of producing any output when one or more factors are fixed
No SRATC curve can fall below the LRAC because the LRAC curve represents the lowest attainable cost for each possible output
Each SRATC curve is tangent 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)
What is the very long run? What is an effect of the very long run?
Changes in available techniques and resources
Result is a shift in the LRAC curve due to changes in technology/factor prices (price increase: upwards shift - price decrease: downwards shift)
What is productivity and what is its unit? What are two widely used measures of productivity?
The extent of technological change
output produced/unit of input X
Output/work
Output/hour of work
What do firms do in search of profit?
Invent and innovate new products and processes
Because of this, technological change is endogenous to the economic system (rather than something that occurs for unknown reasons)
A firm that develops a new product or new process before anyone else gets an advantage over its competitors that persists until others can copy them
What are 3 aspects of technological change?
New techniques - process innovation (building roads/generating energy)
Improved inputs (quality of labor increase by higher education/health)
New products (3D printers, driverless cars)
What can firms do when faced with an increase in the price of an input?
Substitute and/or innovate away from that input
substitute away: change production techniques within confines of existing technology
Innovate away: develop new production techniques
eg if coal is more expensive, firms can switch to other fuels or design a way to need less fuel
What is a problem with invention and innovation? What is a consequence of this?
They are subject to great uncertainties that are difficult to estimate in advance
Firms must produce large profits when if they succeed to induce investing firms to incur the costs of taking such risks
