Costs of production Flashcards
Describe the profit maximisation rule
when MR = MC
firms should produce as long as the additional revenue of the output is greater than the additonal cost of producing that output
describe the law of diminishing marginal returns
as you add more inputs, the marginal product will eventually begin to fall (additional output for each additional input)
increasing marginal returns in stage 1
- Total product is increasing at an increasing rate due to specialisation
decreasing marginal returns in stage 2
- total product increasing at a decreasing rate due to fixed resources
negative marginal returns in stage 3
- total products falling
how do you calculate marginal cost?
change in total cost/ change in output
marginal cost = change in total cost / change in output
change in output= 1
what is the average variable cost (AVB), average fixed cost (AFC) and average total cost (ATC)?
why does marginal cost decrease then increase?
due to the law of diminishing marginal returns
as you produce more units, the additional cost of one unit begins to fall due to specialisation. However, due to fixed resources, the additional cost of producing one unit will increase
ATC and AVC both intersect with marginal cost at
their minimum
why is average fixed cost decreasing on the cost curve?
Because average fixed cost is calculated by dividing fixed costs (which are by definition fixed) by the quantity produced, average fixed cost must decline as the quantity produced rises.
what is the cost of producing 5 units?
what is the total cost of producing 5 units?
$70
what is the variable cost of producing 5 units?
find the average fixed cost on the cost curve
Why does the ATC go down to a minimum and then increases?
when the marginal cost (additional cost) is below the ATC, it will cause the ATC decrease
When the marginal cost (additional cost) is above the ATC, it will cause the ATC to increase
that is why the marginal cost intersects with ATC at ATC’s minimum
why does the AVC appear like this on the cost curve?
AVC decreases with marginal cost is decreasing
AVC increases when marginal cost is increasing
calculate the total cost and marginal cost
how much is total revenue?
How much is total cost?
total profit?
TR = 10 x 5 = 50
TC = 10 x 12 = 120
TP = -70, making a 70 loss
Find the fixed cost at 10 units
FC = 10 x 5 = 50
describe how marginal product of labour changes
marginal product of labor exists at low levels of production
at higher levels of production, decreasing marginal product of labor exists.
when there is Increasing marginal product of labor,
when there is decreasing marginal product of labour,
Increasing marginal product of labor → it takes fewer workers to produce an additional unit of output –> Decreasing marginal cost
Decreasing marginal product of labor → it takes more workers to produce an additional unit of output —> Increasing marginal cost
Describe MC’s relationship with AVC
If marginal cost is greater than average variable cost, then average variable cost is increasing; if marginal cost is less than average variable cost, then average variable cost is decreasing.
MC meets AVC at its minimum
why is there a small dip in marginal cost at the beginning?
This allows for the possibility of decreasing marginal cost at very low levels of production.
(the marginal product of labor increases and, therefore, marginal cost declines)
as you increase the amount of production (increase qty)
the distance between average total cost and average variable cost gets smaller because the average fixed cost becomes very small as output increases
to maximise profits, firms should produce at
Price = MC
when are we at breakeven point?
when P = ATC
When P>AVC, a firm should
continue to operate in the short run because it is earning enough to cover its variable costs and some, but not all, of its fixed costs. shutting down would eliminate this extra revenue.
thereby by operating, firm is minimizing its losses in the short run
why should a firm shutdown when P
shutting down would eliminate the extra costs. By shutting down, the firm will have to pay its fixed costs in the short run but will not have the burden of any additional losses. (losing even more than its fixed costs)
a firm that is making a loss may choose to
- continue to operate
- shut down
in the long run, what can a firm do?
what happens to fixed and variable costs?
In the long run, the firm can expand by increasing its capital.
Fixed costs increase and variable costs decline at each level of production as the firm expands its capital.
when capital is employed in the long run, what happens to costs?
total costs, and average total cost, are higher at low levels of production and lower at high levels of production
What happens to ATC in the long run?
at lower levels of output, higher fixed costs raise average total cost; at higher levels of output, lower variable costs tend to lower average total cost.
In the long run,
what may the firm do to maximise profits?
the firm adjusts the amount of capital to maximize profits. It will also choose the mix of labor and capital that maximizes profits, so that when the price of labor rises relative to capital, the firm will switch away from labor toward capital, and vice versa. (price of capital rises relative to labour)
when a firm increases capital, what happens to fixedand variable cost?
fixed cost will increase
variable cost will decrease
Total cost will decrease
what is economies of scale?
a situation in which long-run average total cost declines as the output of a firm increases. (as firm expands)
diseconomies of scale
situation in which long-run ATC increases as the output of a firm increases. Sets in when firm becomes to large
what is constant returns to scale:
a situation in which long-run average total cost is constant as the output of a firm changes.
Typical Shape of the Long-Run Average Total Cost Curve
declines at low levels of output, then remains flat, and finally begins to increase at high levels of output.
what is the minimum efficient scale?
smallest scale of production for which long-run average total cost is at a minimum
why may ATC face diseconomies of scale?
As a firm gets very large, administrative expenses, as well as coordination and incentive problems, will begin to raise ATC
why may firms experience economies of scale?
Firms grow and ATC falls as a result of
- increase in capital
- mergers
- bulk purchase
- specialization that the division of labor in larger firms
describe inputs in the short and long run
SR cost measures
find marginal cost, AFC, ATC, AVC
Relationship between MC and AVC (ATC)
If MC
If MC > AVC (ATC), AVC rises
relationship between MPL and MC
Diminishing MPL leads to increasing MC
But at low or very low Q, increasing MPL leads to decreasing MC
another way to express MC
What is AR?
for price-taking firm,
in short run,
firms maximise profits, by producing at Q* where MC = MR
describe relationship between costs and profit
when is there break even point?
when price equals the minimum ATC
P(=AR) = ATC (At Q*)
When is there negative profits?
P (=AR)
FC costs are a what in short run?
Sunk cost
why do firms continue operating even if they are making losses?
fixed costs are a sunk cost
what about long run MC?
relationship between MCLR and ATCLR
MCLR LR then ATCLR falls
MCLR > ATCLR then ATCLR rises
in LR
describe constant returns to scale
describe increasing returns to scale
describe decreasing returns to scale
show typical firm
what is diseconomies of scale
what is economies of scale?
whati s economies of scope
Perfect competition
formula for profit
what is profit-maxising qty?
ATC=
profit = (P-ATC) x Q
P(MB) = MC
ATC = AFC + AVC
when P>AVCmin and producer surplus?
when P > AVCmin, we can always find positive producer surplus
when PS>0 (positive PS), firms covering some part of fixed costs
when Pmin and producer surplus?
when P > AVCmin, negative PS
i.e. PS= (P-AVC) x Q
firm cannot cover ixed costs. Firm incurs loss. It’s goal is to minimise loss. by shutting down, they can minimise loss
Loss> fixed costs
PS
Porifit + fixed cost
Profit=
TR - TC
(PxQ) - (ATCxQ)
= (P-ATC)xQ
producer surplus =
profit + fixed cost
(P-ATC) x Q + AFC x Q
= (P-AVC)xQ
fixed cost =
PS-profit
