ECON 101 Chp 10 - Output + cost Flashcards
define firm
an institution that hires factors of production + organizes those factors to produce + sell goods + services
what’s the goal of a firm
to maximize profit
define depreciation
the fall in the value of a firm’s capital
define economic profit
total revenue - total cost (includes opportunity cost of production)
how is total cost measured in economic profit?
measured as the opportunity cost of production
define opportunity cost of production
the value of the best alternative use of the resources that a firm uses in production
what’s the sum of a firm’s opportunity cost of production
using resources…
1. bought in the market
2. Owned by the firm
3. supplied by the firm’s owner
what’s the opportunity cost of resources bought in the market
the amount spent on these resources is an opportunity cost of production because the firm could have bought different resources to produce some other good or service
what’s the opportunity cost of resources owned by the firm
opportunity cost of production because the firm could sell the capital that it owns and rent capital from another firm
when a firm uses it’s own capital it implicitly rents it from itself
define implicit rent rate of capital
the firm’s opportunity cost of using the capital it owns
what are the components in the implicit rate of capital
- economic depreciation
2, forgone interest
define economic depreciation
fall in the market value of a firm’s capital over a given period
what’s the formula of economic depreciation
economic depreciation = market price of the capital at the beginning of the period - market price of the capital at the end of the period
define forgone interest
funds used to buy capital that could have been used for some other purpose and in their next best use, they would have earned interest
is forgone interest an opportunity cost of production?
yes
what resources are supplied by the firm’s owner
- entrepreneurship
- labour
define entrepreneurship
the factor of production that organizes a firm and makes its decisions
define normal profit
the profit that an entrepreneur earns on average
what’s the costs of normal profit?
- cost of entrepreneurship
- opportunity cost of production
define an owner’s labour services
the owner of a firm might supply labour but not take a wage
what’s the opportunity cost of owner’s labour
wage income forgone by not taking the best alternative job
what 5 decisions does a firm have to make to achieve maximum economic profit
- what to produce + in what quantities
- how to produce
- how to organize and compensate its managers + workers
- how to market and price its products
- what to produce itself and buy from others
what’s the biggest decision that an entrepreneur makes and what does this decision depend on?
what industry to establish a firm
depends on their background knowledge + interest, profit prospects
what are the 2 decision timeframes to study the relationship between a firm’s output decision and its costs
- the short run (decision)
- the long run (decision)
define the short run (decision)
a time frame in which the quantity of at least 1 factor of production is fixed
what are fixed factors of production called?
the firm’s plant
what are usually considered a firm’s fixed or variable factors of production
fixed: capital, land + entrepreneurship
variable: labour
how to increase a firm’s output in the short run
firm must increase the quantity of a variable factor of production (usually labour)
difference between short run + long-run decisions
short-run can easily be reversed, long-runs cannot
define the long-run (decision)
a timeframe in which the quantities of all factors of production can be varied - period in which the firm can change its plant
how can a firm increase output in the long-run
firm can change its plant + the quantity of labour it hires
what do we call the past expenditure on a place that has no resale value?
sunk cost
what costs influences a firms current decisions
- short-run cost of changing its labour inputs
- long-run cost of changing its plant
are sunk costs relevant to a firm’s current decisions?
no
what 3 related concepts describe the relationship between output + quantity of labour
- total product
- marginal product
- average product
define total product
maximum output that a given quantity of labour can produce
define the marginal product of labour
the increase in total product that results from a 1-unit increase in the quantity of labour employed
define the average product
tells us how productive workers are on average
what’s the formula for the average product
average product = total product/quantity of labour employed
define product curves
graphs of the relationships between employment and the 3 product concepts
show how total product, marginal product, and average product change as employment changes
what are some characteristics of the total product curve?
- the curve becomes less steeper as employment increases
- separates the attainable output levels from those that are unattainable
- points that lie below the curve are attainable + inefficient
- points on the curve are attainable + technologically efficient
how is the marginal product measured?
by the slope of the total product curve at a point
what are the characteristics of a marginal product curve?
- reaches its peak quickly then slowly declines
why are the shapes of the total product and marginal product curves similar across different firms + types of goods
- increasing marginal returns initially
- diminishing marginal return eventually
define increasing marginal returns + what does it arise from?
when the marginal product of an additional worker exceeds the marginal product of the previous worker
arises from increased specialization + division of labour in the production process
define diminishing marginal returns + what does it arise from?
diminishing marginal returns = when the marginal product of an additional is less than the marginal product of the previous worker
arises from adding more workers leads to less work for all workers to do –> less productive.
define the law of diminishing returns
as a firm uses more of a variable factor of production with a given quantity of the fixed factor of production, the marginal product of the variable factor eventually diminishes
when is the average product largest
when average product = marginal product
what’s the characteristic of the average product curve?
- curve increases at first than gradually decreases as more workers are added
what 3 concepts explain the short run cost?
- total cost
- marginal cost
- average cost
define a firm’s total cost
cost of all factors of production it uses
how do we separate total cost?
total fixed cost and total variable cost
define total fixed cost
cost of the firm’s fixed factors - stays constant at all outputs
define total variable cost
cost of the firm’s variable factors - total variable cost changes as output changes
what’s the formula of total cost?
TC = TFC + TVC
describe the total cost, TFC, and TVC curves
total cost increases with more output
TVC increases with more output
TFC stays constant
define marginal cost
the increase in total cost that results from a one-unit increase in output
how to calculate marginal cost
increase in total cost/increase in output
describe the marginal cost curve
- u-shaped - at small outputs, marginal cost decreases as output increases due to greater specialization + division of labour. As output increases further, marginal cost eventually increases due to law of diminishing returns
marginal cost tells us how total cost _____ as output increases
changes
what are the 3 average costs of production + define them
- average fixed cost - total fixed cost per unit of output
- average variable cost - total variable cost per unit of output
- average total cost - total cost per unit of output
what’s the formula to get average fixed, variable and total cost from the total fixed, variable and total cost?
TC/Q = ATC
TFC/Q = AFC
TVC/Q = AVC
ATC = AFC + AVC
describe the curves of the AFC, AVC, and ATC
AFC curve = gradually decreases with more output
ATC curve = u-shaped
AVC curve - U-shaped
vertical distance between AVC and ATC = AFC
when does the marginal cost curve intersect with the average total cost curve at?
at their minimum points
what’s the relationship between marginal cost and average cost/ATC/AVC
when marginal cost is less than average cost, the average cost is decreases
when the marginal cost exceeds average cost, average cost is increasing
why is the ATC curve U-shaped?
- spreading total fixed cost over a larger output
- when the firm increases its output, its total fixed costs is spread over a larger out, so AFC decreases + AFC curve slopes downwards - diminishing returns - as output increases, AVC decrease initially then eventually increases
ATC slopes down then up from AVC increasing more quickly than AFC decreasing
what’s the relationship between total product and total variable cost
variable cost is proportional to labour
curve has a positive slope that becomes less steep
what’s the relationship between the average + marginal product and cost?
as output increases, MP + AP rise, while MC and AVC fall
at the maximum of marginal product, marginal cost is at it’s minimum, then with more output, MP lowers and MC rises while AP rises and AVC falls
at the maximum of average product, AVC is at it’s minimum, then as labourr increases further, out increases and AP diminishes and AVC increases.
what are the factors that shift the short-run cost curves?
- technology
- prices of factors of production
how does technology shift the short-run cost curves?
a technological change that increases productivity increases the marginal product + average product of labour
technological advances lowers the cost of product + shifts cost curves downward.
how does the prices of factors of production affect the short-run cost curves?
generally, an increase in the price of a factor of production increases the firm’s cost and shifts the cost curves
increase in fixed costs, shifts the TFC and AFC curves upward and shifts the TC curve upward but leaves the AVC and TVC curves, and MC curve unchanged.
increase in variable cost shifts the TVC and AVC curves upward and shifts MC curve upward but leaves AFC and TFC curves unchanged.
what happens to the firm’s costs in the long-run?
all the costs become variable
what does the behaviour of long-run costs depend on?
the firm’s production function
define the production function
the relationship between the maximum output attainable and the quantities of both labour and capital
what occurs in a long-run cost?
- diminishing returns
- diminishing marginal product of capital
define the marginal product of capital
the change in total product divided by the change in capital when the quantity of labour is constant
AKA the change in output resulting from a one-unit increases in the quantity of capital
why does the minimum ATC for a larger plant occurs at a greater output than it does for a smaller plant?
larger plant has a higher total fixed, therefore at any given output, a higher AFC
what’s the economically efficient plant for producing a given output?
the one that has the lowest average total cost.
in the long-run, firms chooses the plant that ______ average total cost
minimizes
when a firm is producing a given output at the least possible cost, it is operating on its _____
long-run average cost curve
define the long-run average cost curve
the relationship between the lowest attainable average total cost and output when the firm can change both the plant it uses and quantity of labour it employs
what is a characteristic of the long-run average cost curve?
it’s a planning curve - tells the firm the plant and the quantity of labour to use at each output to minimize average cost
once the firm chooses a plant, the firm operates on the short-run cost curves that apply to that plant
define economies of scale
features of a firm’s technology that make average total cost fall as output increases
LRAC curve slopes downwards
what is the source of economies of scale
- greater specialization of labour + capital
define diseconomies of scale
features or a firm’s technology that make average total cost rise as output increases
LRAC slope curves upwards
define constant returns to scale
features of a firm’s technology that keep average total cost constant as output increases
LRAC curve is horizontal
define a firm’s minimum efficient scale
the smallest output at which a long-run average cost reaches its lowest level
what’s the role of minimum efficient scale in the market structure?
in a market where minimum efficient scale is small relative to market demand, the market has room for many firms and the market is too competitive
in a market where minimum efficient scale is large relative to market demand, only a small number of firms (maybe only 1 firm), can make a profit and the market is either an oligopoly or monopoly
