Demand and Supply Analysis: The Firm

Question 1

What is the calculation for accounting profit?

Answer 1

accounting profit = total revenue − total accounting (explicit) costs

Question 2

What is the calculation for economic profit?

Answer 2

1. accting profit − implicit opportunity costs
2. total revenue − total economic costs
3. total revenue − explicit costs − implicit costs

Question 3

What effect does positive economic profit have on the market value of an equity? What about negative economic profit?

Answer 3

1. Positive economic profit has a positive effect on the market value of equity.
2. Negative economic profit has a negative effect on the market value of equity.

Question 4

What is normal profit?

Answer 4

1. Normal profit is the accounting profit for which economic profit equals zero.
2. Occurs when accounting profit is equal to implicit opportunity costs.

Question 5

what is the calculation for normal profit?

Answer 5

accounting profit – economic profit

Question 6

What is economic rent to a factor of production?

Answer 6

The difference between its earnings and its opportunity cost.

Question 7

What effect does a prefectly elastic supply curve have on economic rent?

Answer 7

When the supply curve is perfectly elastic, there is no economic rent.

Question 8

What effect does a prefectly inelastic supply curve have on economic rent?

Answer 8

Perfectly inelastic supply results in the greatest economic rent.

Question 9

What is total revenue?

Answer 9

price x quantity sold

Question 10

What is average revenue?

Answer 10

Total revenue/quantity

Question 11

What is marginal revenue?

Answer 11

The increase in total revenue from selling one more unit of a good or service.

Question 12

What are a firm’s factor’s of production?

Answer 12

1. The resources a firm uses to produce its output and includes land, labor, materials, and capital (the physical capital or plant and equipment the firm uses in production).
2. For economic analysis, factors of production are often simply grouped into labor and capital.

Question 13

What are fixed costs?

Answer 13

Costs that do not vary directly with the quantity produced (e.g., plant and equipment).

Question 14

What are variable costs?

Answer 14

Those that vary directly with the quantity produced (e.g., labor, raw materials).

Question 15

What are total costs?

Answer 15

total fixed costs + total variable costs.

Question 16

What is a marginal cost?

Answer 16

1. The increase in total variable costs for one additional unit of output.
2. For a given level of fixed costs, marginal cost first decreases and then (at some quantity of output) begins to increase.

Question 17

What is the average fixed cost?

Answer 17

1. Fixed cost per unit of output
2. declines with greater quantities of output.

Question 18

What is Average Variable Cost?

Answer 18

1. Variable cost per unit of output
2. first decreases and then increases with greater quantities.

Question 19

What is average total cost?

Answer 19

1. Total cost per unit of output
2. equal to average fixed costs plus average variable costs.

Question 20

Both AVC and ATC are at their minimum values where they are equal to…?

Answer 20

Marginal cost.

Question 21

The vertical distance between the ATC and AVC curves is equal to…?

Answer 21

Average Fixed Cost(AFC)

Question 22

What is the breakeven point?

Answer 22

1. The level of production where total revenue equals total cost.
2. Equivalent to the quantity of output for which price equals average total cost.

Question 23

In the short run, when fixed costs cannot be avoided, a firm should stop operating (shut down) if total revenue is…?

Answer 23

Less than total variable costs.

Question 24

In the short run, if price is less than average total costs but greater than (…?), the firm should continue to operate.

Answer 24

1. Average variable costs
2. Although economic profit is negative (TR < TC), shutting down operations in the short run would result in greater losses, equal to total fixed costs.

Question 25

In the long run, a firm should shut down if price is expected to be less than..?

Answer 25

1. Average Total Cost(ATC)
2. Because TR < TC and the firm is making economic losses that could be avoided by shutting down.

Question 26

What does the long-run average cost(LRATC) curve indicate?

Answer 26

Shows the minimum average total cost for each level of output assuming that the plant size (scale of the firm) can be adjusted.

Question 27

What does a downward sloping segment of a LRATC curve indicate?

Answer 27

1. Indicates economies of scale (increasing returns to scale).
2. Over such a segment, increasing the scale of the firm reduces ATC.

Question 28

What does an upward sloping segment of a long-run average total cost curve indicate?

Answer 28

Diseconomies of scale, where average unit costs will rise as the scale of the business (and long-run output) increases.

Question 29

What does the flat portion of a long-run average total cost curve represent?

Answer 29

1. Represents constant returns to scale
2. LRATC is constant over that range of output.

Question 30

What is a firm’s minimum efficient scale is represented by?

Answer 30

1. The minimum point on the LRATC curve and is the firm size that will minimize average unit costs.
2. In perfect competition, firms will eventually all operate at minimum efficient scale.

Question 31

What is the profit-maximizing quantity of output?

Answer 31

1. The output for which the difference between total revenue and total cost (TR − TC) is at a maximum.
2. This is equivalent to the output for which marginal cost equals marginal revenue.

Question 32

A firm should increase production as long as marginal cost is less than…?

Answer 32

Marginal revenue, because the addition to total costs from additional production is less than the addition to total revenue from selling the additional output.

Question 33

What is the short run?

Answer 33

A time period during which quantities of some firm resources are fixed.

Question 34

A firm may continue to operate in the short run with economic losses as long as price is greater than…?

Answer 34

1. AVC because the losses are less than total fixed costs.
2. The firm is “maximizing profit” by minimizing losses.

Question 35

What is the long run?

Answer 35

Time period where all factors of production are variable.

Question 36

In the long run a firm will maximize profits at the quantity for which? (price greater than ATC)

Answer 36

Marginal revenue equals marginal cost as long as price is greater than ATC.

Question 37

In the long run, if price is less than ATC, how will a firm minimize losses?

Answer 37

By going out of business and reducing ongoing losses to zero.

Question 38

For a decreasing cost industry, as industry output increases, input prices do what?

Answer 38

1. Decrease as the industry demand for inputs increases.
2. Results in a negatively sloped long-run industry supply curve.

Question 39

What is a constant cost industry?

Answer 39

1. Industry where the price of resources does not change as industry output expands.
2. Results in a horizontal long-run industry supply curve.

Question 40

For an increasing cost industry, as industry output increases, input (factor) prices

Answer 40

1. Increase as the industry demand for inputs increases.
2. Results in a positively sloped long-run industry supply curve.

Question 41

What is the total product of labor(TPL)?

Answer 41

Total product of labor (TPL) is the total output of a firm that uses a specific amount of capital (i.e., plant and equipment are fixed).

Question 42

What is the marginal product of labor(MPL)?

Answer 42

The additional output produced when one more unit of labor is employed.

Question 43

What is the average product of labor(APL)?

Answer 43

The average product of labor (APL) is the TPL divided by the total number of units of labor employed.

Question 44

What is the point of diminishing marginal returns?

Answer 44

1. AKA Decreasing marginal productivity
2. Holding physical capital constant, as labor is increased beyond some quantity, the incremental output from each additional worker declines.

Question 45

What is the marginal revenue product(MRP) of labor?

Answer 45

The additional revenue that a firm would get from selling the additional output (marginal product) of one more unit of labor.

Question 46

How do firms use MRP to know when to hire and stop hiring aditional units of labor?

Answer 46

A firm should employ more labor until the MRP of labor just equals the wage. Beyond this quantity of labor, the value of the additional output of one more worker is less than the worker’s wage.

Question 47

When is the optimal combination of labor and capital inputs reached?

Answer 47

1. When the ratio of the marginal product of capital to its cost equals the ratio of the marginal product of labor to its cost, which is output per dollar of input cost.
2. MPcapital / Pcapital = MPlabor / Plabor.