Chapter 8: Producers in the long run

Question 1

What is the key difference between short and long runs?

Answer 1

Short run: (at least) one factor is fixed. Long run: All inputs are variable

Question 2

What does it mean when a firm tries to be technically efficient?

Answer 2

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

Question 3

True/False? Technical efficiency is not enough for profits to be maximized.

Answer 3

False

Question 4

True/False? There is only one technically efficient option

Answer 4

False

Question 5

Which technically efficient option do firms use to maximize profit?

Answer 5

The one that has the lowest cost (the lowest combination of labor and capital)

Question 6

Why is profit maximization only available in the long run?

Answer 6

Because all factors are variable, so the cheapest configuration of labor and capital can be chosen

Question 7

What is cost minimization?

Answer 7

An implication of profit maximization Choosing the lowest possible cost

Question 8

If a firm can substitute one factor for another, while keeping output constant but reducing total cost, the firm (is/is not) minimizing cost

Answer 8

Is not

Question 9

How is profit maximization/cost minimization calculated?

Answer 9

MP(K)/p(K) = MP(L)/p(L) or MP(K)/MP(L) = p(K)/p(L)

Question 10

When is there an opportunity for factor substitutions (that would reduce costs)?

Answer 10

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)

Question 11

How can the firm reduce cost?

Answer 11

Using more L and less K

Question 12

What does of the principle of substitution suggest?

Answer 12

More of a cheaper factor and less of a more expensive factor will be used

Eg ATMs instead of bank tellers

Question 13

What is considered when all factors of production can be varied (as is the case in the long run)?

Answer 13

The least-cost method of production

Question 14

What does the LRAC indicate? What does it represent on a graph? What is its shape?

Answer 14

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

Question 15

Why is there no AVC, AFC, and ATC curve in the long run?

Answer 15

There are no fixed factors, just variable factors

Question 16

When does a firm have ‘economies of scale’?

Answer 16

When the long run average cost curve is falling (left half of U shape)

Question 17

What results in an economy of scale?

Answer 17

An expansion in the scale of a firm’s operations so that more of all inputs is being used

Question 18

What can a firm enjoy over the descending portion of a long run average curve?

Answer 18

Increasing returns

Output increases more than in proportion to inputs as the scale of a firm’s production increases

Question 19

What happens when the U shaped LRAC curve is at its apex?

Answer 19

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)

Question 20

What happens over the rising portion of the LRAC curve?

Answer 20

The firm experiences decreasing returns (output increases less than in proportion to inputs as scale increases)

Question 21

What do decreasing returns imply for the firm?

Answer 21

They imply that the firm suffers from diseconomy of scale

Question 22

In a LRAC curve, attainable levels of cost ____ the curve, whereas Unnatailable levels of cost are ____ the curve

Answer 22

Above

Below

Question 23

How are LRAC and SRATC curves related?

Answer 23

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)

Question 24

What is the very long run? What is an effect of the very long run?

Answer 24

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)

Question 25

What is productivity and what is its unit? What are two widely used measures of productivity?

Answer 25

The extent of technological change

output produced/unit of input X

Output/work

Output/hour of work

Question 26

What do firms do in search of profit?

Answer 26

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

Question 27

What are 3 aspects of technological change?

Answer 27

New techniques - process innovation (building roads/generating energy)

Improved inputs (quality of labor increase by higher education/health)

New products (3D printers, driverless cars)

Question 28

What can firms do when faced with an increase in the price of an input?

Answer 28

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

Question 29

What is a problem with invention and innovation? What is a consequence of this?

Answer 29

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