Cost and Industry Structure

Question 1

Profit Funtion

Answer 1

Profit = Revenue - Cost

Question 2

Revenue Funtion

Answer 2

Revenue = Price X Quantity

Question 3

What inputs does a firms production depend on?

Answer 3

Labor and Capital

Question 4

Average Total Cost (average cost) in the Short Run Equation and its Definition

Answer 4

Total Cost / Total Quantity of Output

Average total cost is a U-shaped graph. It starts relatively high b/c low levels of production total costs are dominated by fixed costs. As output increases the average cost decreases because cost is spread out over increased production. Eventually the average cost begins to rise with production as diminishing returns kick in.

Question 5

Average Variable Cost Equation and Definition

Answer 5

Variable Cost / Quantity of Output

Costs incurred in the act of producing. The more you produce the greater the variable cost.

This is a constant cost added to the production of a good. It takes exactly x labor hours and y resources to produce one good.

Question 6

Marginal Cost Equation and Definition

Answer 6

Change in Total Cost / Change in Quantity of Output

Additional cost of producing one more unit of output

Question 7

Average Profit (profit margin) Function

Answer 7

Profit / Quantity of Output

or

Average Profit = Price - Average cost

Question 8

Average Revenue Function

Answer 8

Average Revenue = (Price x Quantity Produced) / Quantity Produced

Question 9

Economies of Scale

Answer 9

As quantities of output goes up, the cost per unit goes down

Question 10

Short-Run Average Cost Curves (SRAC)

Answer 10

Shows the total of the average fixed costs and the average variable costs

Question 11

Constant Returns to Scale

Answer 11

An increase in inputs (capital or labor) causes the same proportional increase in output

Question 12

Diseconomies of Scale

Answer 12

Occurs when a firm grows so large that the expansion of output comes with increasing average unit cost

Question 13

Diminishing Marginal Returns

Answer 13

Occur because, at a given level of fixed costs, each additional input contributes less and less to overall production.

Question 14

Fixed Costs in the Short Run

Answer 14

Expenditures that do not change regardless of the level of production

Question 15

How are each of the following calculated, Marginal Cost, Average Total Cost, Average Variable Cost?

Answer 15

Marginal Cost = change in total cost / change in output

Average Total Cost = total cost / total output

Average Variable Cost = variable cost / output

Question 16

Production Technologies

Answer 16

A specific combination of labor, physical capital, and technology that makes up a particular production method.

A firm will search for the production technology that allows it to produce the output at the lowest cost

Question 17

Short-Run Average Cost Curve

Answer 17

Represents the average total cost in the short-run considering fixed costs and average variable costs

Question 18

Long-Run Average Cost Curve

Answer 18

Shows the lowest possible average cost of production when a firm can chose its level of fixed costs.

Left portion of the curve is downward sloping, showcasing economies of scale. The middle of the curve is flat, showing that economies of scale have been exhausted, and we reach constant returns to scale. The right portion of the curve begins to slope upward, and diseconomies of scale take effect in the long run.

Question 19

Method 1: 50 units of labor, 10 units of capital

Method 2: 20 units of labor, 40 units of capital

Method 3: 10 units of labor, 70 units of capital

If hiring labor costs $100/unit and a unit of capital costs $400, what production method should be chosen? What method should be chosen if the cost of labor rises to $200/unit?

Answer 19

Method 1 @ 100/400 = 5000 + 4000 = 9,000

Method 2 @ 100/400 = 2000 + 16,000 = 18,000

Method 3 @ 100/400 = 1000 + 28,000 = 29,000

Method 1 @ 200/400 = 10,000 + 9,000 = 19,000

Method 2 @ 200/400 = 4,000 + 16,000 = 20,000

Method 3 @ 200/400 = 2,000 + 28,000 = 30,000