Costs of production Flashcards
What is the marginal product of labour?
The extra output produced by an extra unit of labour (change in quantity/change in labour = MPL)
What is the marginal product of capital?
The extra output produced by an extra unit of capital (change in quantity/change in capital). Applies more in long run factors
What does an isoquant show?
All possible combinations of inputs that yield the same output
What are isoquant maps used for?
Used to describe a production function. They are downward sloping and convex, and the slope at any point measures MRTS.
What does a higher isoquant mean on an isoquant map?
Greater output (from both increasing capital and increasing labour on all points on a curve - like indifference curves)
Isoquants enable us to assess relative costs. This means that:
If labour is expensive and machinery is cheap, a capital method of production would be more appropriate. If machinery is expensive and labour is cheap, a labour method of production would be more appropriate.
What is the Marginal Rate of Technical Substitution (MRTS)?
How much we have to REDUCE one input when an extra unit of something else is used, so that the output remains constant
What is the MRTS formula?
- change in capital / change in labour (Y axis/X axis)
Why does the MRTS diminish?
As there is more labour, it becomes increasingly difficult to use labour intensive production methods (more capital is used for every unit of labour) - this is why the slope increasingly flattens further down
What do straight isoquants show?
A constant MRTS (the rate at which capital and labour can be substituted is the same, no matter the level of input)
What do L-shaped isoquants show?
Only one combination of L and K can be used to produce a given level of output (adding extra L or K does not increase output)
What are returns to scale? (Nb. Scale = size of the business)
The boost to output (extra output) that we would receive if the business were to expand with more labour and capital [The rate at which output rises as inputs are both increased in the same proportion)
What does an increasing return to scale mean?
Output more than doubles when inputs are doubled (require large amounts of both L and K, can use both more efficiently and produce more output; isoquants move closer together as inputs are increased)
What does a constant return to scale mean?
Output doubles when all inputs are doubled (isoquants are equally spaced as output increases proportionally)
What does a decreasing return to scale mean?
Output less than doubles when all inputs are doubled (increasingly difficult to deliver output efficiently the more K and L are used)
Is MRTS more likely in the long or short term?
In the short term (the only way to produce more in a short time frame is to add units of labour, which can be inefficient - not enough time to generate new sources of capital through machinery, this is a long term concern)
If capital is purchased, how do we work out the cost of using that capital?
The interest rate cost of the money used to buy it, plus depreciation costs (rate + depreciation)
If capital markets were efficient, what would the rental costs and user costs be like?
They would be the same
Total cost (C) of producing output (O) =
(market wage rage x wage) + (rental cost (interest + depreciation) x capital)
What is the isocost equation?
K = C/r - (w/r)
How do you work out the slope of the isocost line?
change in K/change in L = -(w/r) [wage rage / quantity of labour]
What does the isocost line represent?
The ratio of the wage rate to the cost of capital
What do ascots lines describe?
The combination of inputs that cost the same amount to the firm
What does a tangent between the isocost line and the isoquant curve show?
The minimum cost of a given combination of labour and capital
What happens to the isocost curve when the price of labour does up, relative to the price of capital?
It is steeper
What do production costs include?
Capital costs, labour costs, cost of obtaining materials, components and energy
What do indirect costs include?
Time and money that could have been obtained by investing money elsewhere
What are total costs?
Fixed costs + Variable costs (FC+VC)
What are average costs?
Total cost per unit of output produced: Total costs/Quantity
What are averaged fixed costs?
Fixed cost per unit of output produced: AFC = FC/Q
What are average variable costs?
The variable cost per unit of output produced: AVC = VC/Q
The components of average total costs are:
AFC + AVC
If a firm is creating more output, what does this mean in terms of cost?
Its fixed costs fall because the output is spread out across the machinery/equipment being used
What does marginal cost show?
How production costs change as output changes; the change in total cost arising from the production of an extra unit of output [change in TC / change in Q]
What is the cost component that changes in the short run?
Variable cost [marginal cost is equivalent to the change in VC incurred when output expands = change in VC / change in Q]
What do marginal costs include?
The firm’s costs that vary with output - depends on the VC components; depends on the behaviour of the marginal product of labour and decreases as more labour is employed (change in VC / change in output)
When output rises, what is the labour cost incurred?
Unit input cost of labour (wages) x no of extra labour units (L)
What does it mean when MPL declines when output rises and more labour is employed?
This means that even if material costs per unit of output remain constant, the diminishing marginal productivity of labour must eventually cause marginal cost to rise as output rises
On a graph, what does the marginal cost MC cross?
Crosses the average variable cost and average total cost curves at their minimum points
