econ 1021 mid 2 Flashcards
1
Q
Market price
A
Allocates resources by setting a market price. The “choose not to pay” section generally consists of those who can afford to pay and choose not to, and those who cannot afford to pay. Most essential items are not allocated by market price for this reason.
2
Q
Command
A
A command system has someone with authority allocating resources. In Canada this system is used inside firms and government departments (allocation of labour for example). The command system works badly in an economy because it is too large to be controlled.
3
Q
Majority rule
A
Allocated how the majority sees fit. Many government services as well as taxes are decided this way.
4
Q
Lottery
A
Allocate resources to those who win a draw or type of game that revolves around luck. Many airports, marathons, and wireless service providers use this system to award services.
4
Q
Contest
A
Allocates resources to a winner or group of winners.
5
Q
First-come, first-served
A
Allocates resources to those who are first in line. Highways use this method to fill up lanes (cars come on the on ramp in an order). Restaurants that don’t accept reservations also use this method to fill their tables.
6
Q
Personal characteristics
A
People with the “right” characteristics get the resources.
7
Q
Force
A
Using force plays a crucial role in allocating resources. A good example of this is during war. Small-scale and large-scale crime also allocate billions of dollars in scarce goods annually. Also allows for the state to allocate wealth between rich and poor
8
Q
Price
A
What we pay.
8
Q
Value
A
What we get
9
Q
Marginal benefit
A
Value of one more unit of a good or service.
10
Q
A demand curve
A
is a marginal benefit curve because we measure marginal benefit by willingness to pay.
11
Q
Market demand curve
A
The demand of the ENTIRE market is found by adding the quantities demanded of all individuals at each price.
Also known as the marginal social benefit curve (social meaning the entire market)
12
Q
Consumer surplus
A
Excess benefit received from a good over the amount paid for it.
13
Q
individual demand
A
The relationship between the price of a good and the quantity demanded by one person
14
Q
market demand
A
The relationship between the price of a good and the quantity demanded by all buyers in the market
15
Q
We can calculate consumer surplus
A
as the marginal benefit (or value) of a good minus its price, summed over the quantity bought.
It is measured by the area under the demand curve and above the price paid, up to the quantity bought.
16
Q
Cost
A
What a firm gives up to produce a good or service.
17
Q
Price
A
What a firm receives when they sell a good or service.
18
Q
Marginal cost
A
The cost of producing one more unit of a good or service.
Thus, this is the minimum price that producers must receive to induce them to offer one more unit of a good or service
19
Q
A supply curve
A
is a marginal cost curve because the minimum supply price determines supply.
20
Q
Market supply curve
A
The quantity supplied by the ENTIRE market is found by adding the quantities supplied of all firms at each price.
Also known as the marginal social cost curve (social meaning the entire market)
21
Q
Producer surplus
A
The excess of the amount received from the sale of a good or service over the cost of producing it.
22
Q
individual supply
A
The relationship between the price of a good and the quantity supplied by one producer
23
market supply
The relationship between the price of a good and the quantity supplied by all producers in the market
24
ALLOCATIVE EFFICIENCY
Since the marginal social cost and benefit curves are supply and demand curves, ALLOCATIVE EFFICIENCY is achieved when the two curves reach equilibrium.
25
Equilibrium
means that a good or service is worth exactly what it costs to consumers.
26
Total surplus
The SUM of the producer and consumer surplus. This value is maximized at equilibrium.
27
Market failure
When a market is inefficient.
In this scenario, either too little or too much of a good or service is being produced
28
Deadweight loss
The decrease in total surplus that results from an inefficient level of production.
29
When production is …
less than the equilibrium quantity, MSB > MSC.
greater than the equilibrium quantity, MSC > MSB.
equal to the equilibrium quantity, MSC = MSB.
30
The Invisible Hand
Adam Smith’s “invisible hand” idea in the Wealth of Nations implied that competitive markets send resources to their highest valued use in society.
Consumers and producers pursue their own self-interest and interact in markets.
Market transactions generate an efficient—highest valued—use of resources.
31
Price and quantity regulations
Price caps and price floors block the market from adjusting prices in order to fix inefficiencies and return to equilibrium. Regulating the amount a firm can produce can also lead to underproduction.
32
Taxes and subsidies
Taxes increase the amount paid by buyers, lower the amount received by sellers, and thus lead to underproduction. Subsidies decrease the prices paid by buyers, increase the prices received by sellers, and lead to overproduction.
33
Externalities
External costs are additional costs not considered which lead to overproduction. External benefits are additional benefits not considered when originally planning that lead to underproduction.
34
Public goods and common resources
These public goods are goods or services that everyone benefits from. A competitive market would underproduce these resources because everyone would try to free ride on everyone else. Common resources are owned by everyone to be used by everyone. As a result of this, they are overused.
35
Monopoly
This is a firm that is a sole provider of a good or service. Since these companies do not compete and work in their self-interest, they underproduce because they produce too little and charge too much.
36
High transactions costs
These costs are additional costs incurred with a purchase. Buying a house will include transactions costs for lawyers and realtors, for example. Some markets are too costly to be in that transactions costs are useless, and some markets might underproduce when transactions costs are high.
37
Alternatives to allocate resources
more efficiently include, majority rule, command systems, and first-come first-served.
38
On the issue of fairness
all economists agree that the size of the economic pie should be maximized and produced at the lowest possible cost.
38
Ideas about fairness can be divided into two groups
It’s not fair if the result isn’t fair.
It’s not fair if the rules aren’t fair.
39
Big tradeoff
Tradeoff between efficiency and fairness. It is based on the following facts: Income can only be transferred from high to low incomes by means of taxation. Taxing people’s income makes them work less, which results in quantity of labour being less than the efficient quantity. Additionally, taxing people’s capital results in a less than efficient quantity of capital. Thus, the quantity of goods and services are less than the efficient quantity.
The economic pie SHRINKS from this
Thus, the greater amount of taxation the less efficient the economy
Another inefficiency is the fact that taking a dollar from a rich person does not give a dollar to a poor person. The amount diminishes in value as government agencies and taxation services take their cut from the tax amount
Also states that poorer people could be worse off too, as more taxes could lead to entrepreneurs shutting down businesses that employ people of lower incomes
AS A RESULT, no economist today believes that the pie should be divided evenly because of the risks described within the big tradeoff
40
Utilitarianism
is the principle that states that we should strive to achieve “the greatest happiness for the greatest number
41
It’s not fair if the RESULT isn’t fair (thought one)
General idea is that it’s unfair if people’s incomes are too unequal.
Economists in the nineteenth century thought that for the market to be fair then there needed to be equality of incomes. This idea turned out to be wrong.
These thinkers believed in UTILITARIANISM – the idea that we must bring the greatest amount of happiness to the greatest number of people.
They believed that to achieve this, income must be transferred from the rich to the poor
Reasoned that the marginal benefit is greater for a thousandth dollar for a poor person compared to a millionth dollar for a rich person
42
A new theory in response to this was proposed by philosopher John Rawls in a 1971 book titled A Theory of Justice.
Rawls said that the fairest distribution of the economic pie is the distribution that makes the poorest as well off as possible
Thus, taxes should be set so that they are not high enough to massively hinder on efficiency, but enough to ensure the pie is large and poor people are benefiting from the wealth generated from it
This ratio will most likely not be an equal share
43
It’s not fair if the RULES aren’t fair (thought two)
This idea is based off of the SYMMETRY PRINCIPLE – the idea that individuals in similar situations should be treated similarly
“Behave toward other people in a way you expect them to behave toward you”
In economics, this principle translates into equality of opportunity
44
Philosopher Robert Nozick reinforced this view in economics in his 1974 book Anarchy, State, and Utopia
He says that fairness mustn’t be based on the outcome or result, but rather on the rules. He suggests that fairness obeys two rules:
The state must enforce laws that establish and protect private property – theft must be prevented
Private property can only be transferred from one individual to another by voluntary exchange
If these two rules are followed, it does not matter how unequal the economic pie is.
Economists have theorized that if these principle rules are followed, the economy will function efficiently, as resource allocation will be efficient
According to Nozick, no matter how unequal the resulting wealth distribution is, it will be equal
Scarcity prevents everyone from being well off
45
Price ceiling/cap
Government regulation that makes it illegal to charge a price higher than a specified level.
Price ceiling above equilibrium has no affect on the market
A price ceiling below the equilibrium will have large effects and create a shortage (QS is less than QD)
46
rent ceiling
When a price ceiling is applied to a housing market it
If the rent ceiling is set above the equilibrium rent, it has no effect. The market works as if there were no ceiling.
But a rent ceiling set below the equilibrium rent creates
A housing shortage
Increased search activity
An illicit market
47
A rent ceiling set below equilibrium rents creates
A housing shortage
Increased search activity
Search activity is the time spent looking for someone with whom to do business
Opportunity cost of housing is equal to the rent (a regulated price) plus the time and other resources spent searching for the restricted quantity available
This could make the cost of housing higher than what it would be without the rent ceiling
A black market
With loose enforcement this rent is close to the unregulated rent, but with strict enforcement it is equal to the maximum price that a renter is willing to pay
48
Rent ceilings set below the equilibrium
result in MSB exceeding MSC and creating a deadweight loss that restricts both consumer and producer surplus.
Potential loss from housing search (all borne by consumers) + deadweight loss + overall loss
49
Increased Search Activity
When a price is regulated and there is a shortage, search activity increases.
Search activity is costly and the opportunity cost of housing equals its rent (regulated) plus the opportunity cost of the search activity (unregulated).
Because the quantity of housing is less than the quantity in an unregulated market, the opportunity cost of housing exceeds the unregulated rent
50
search activity
The time spent looking for someone with whom to do business
51
illicit market
is an illegal market that operates alongside a legal market in which a price ceiling or other restriction has been imposed.
A shortage of housing creates an illicit market in housing.
Illegal arrangements are made between renters and landlords at rents above the rent ceiling—and generally above what the rent would have been in an unregulated market.
52
A rent ceiling decreases the quantity of housing supplied to less than the efficient quantity.
A deadweight loss arises.
Consumer surplus shrinks.
Producer surplus shrinks.
There is a potential loss from increased search activity
53
Mechanisms for allocating regulated rents
Lottery
First-come, first-served
Discrimination
54
Price floor
A government regulation that makes it illegal to charge a price lower than a specified level
Price floor set below equilibrium has no effect on the market
A price floor set above the equilibrium creates a surplus of jobs (QD is less than QS)
55
A price floor applied to the labour market
is called a minimum wage.
A minimum wage set above equilibrium creates unemployment
If the minimum wage is set below the equilibrium wage rate, it has no effect. The market works as if there were no minimum wage.
If the minimum wage is set above the equilibrium wage rate, it has powerful effects
56
Unregulated labour market is efficient because MSC and MSB are at equilibrium
When regulated MSB exceeds MSC and results in a deadweight loss, shrinking the firms’ and workers’ surplus
Results in unemployment and increased job search
57
The ELASTICIES of demand and supply
determines who pays what portion of the tax.
57
When a transaction is taxed, there are two prices
The price that includes the tax and the price that excludes the tax
Buyers respond to the price that includes the tax while sellers respond to the price that excludes the tax
58
Tax incidence
Division of the burden of a tax between buyers and sellers.
59
A tax on sellers decreases supply
because it is equivalent to a rise in their cost.
60
If demand is perfectly INELASTIC, then the buyers pay all of the tax.
This situation also results in no underproduction and no deadweight loss
61
Tax results in inefficient underproduction because it drives a wedge between the price buyers pay and the price that sellers receive.
Taxes result in MSB exceeding MSC, thus creating a deadweight loss
Also shrinks consumer and producer surplus – some of this goes to the government in tax revenue while the other ends up being a deadweight loss
62
If the demand is perfectly ELASTIC, then the sellers pay the entire tax and the quantity supplied decreases.
Since the equilibrium quantity decreases, there is underproduction and a deadweight loss occurs
Therefore, the more inelastic the demand the greater tax amount paid by the sellers.
63
When supply is perfectly INELASTIC, then the sellers pay the entire tax.
Since the equilibrium quantity does not change there is no underproduction or deadweight loss incurred
64
Perfectly Inelastic Supply
The supply of this good is perfectly inelastic—the supply curve is vertical.
65
When supply is ELASTIC, then the buyers pay the entire tax.
Since the equilibrium quantity decreases there is underproduction and a deadweight loss is created
66
Benefits principle
Proposition that people should pay taxes equal to the benefits they receive from the services provided by the government.
Those who benefit the most pay the most taxes
Makes the system similar to that of a private company
67
Perfectly Elastic Supply
The supply of this good is perfectly elastic—the supply curve is horizontal.
68
The ability-to-pay principle
Proposition that people should pay taxes according to how easily they can bear the burden of the tax.
Justifies taxes on high incomes
In the market for illegal drugs, the larger the penalties and the better the policing, the higher the costs.
69
A production quota
is an upper limit to the quantity of a good that may be produced during a specified period.
70
A subsidy
is a payment made by the government to a producer
71
Inefficiency
At the quantity produced
Marginal social benefit equals the market price, which has increased.
Marginal social cost has decreased.
Production is inefficient and producers have an incentive to cheat
72
Inefficient Overproduction
At the quantity produced
Marginal social benefit equals the market price, which has fallen.
Marginal social cost (on the supply curve) has risen.
Marginal social cost exceeds marginal social benefit.
73
Penalties on the sellers bring a decrease in supply
a leftward shift in the supply curve
74
Penalties for drug possession on buyers results in a decrease in demand
a leftward shift in the demand curve.
75
If penalties are imposed on BOTH the buyers and the sellers of an illegal good
demand and supply decrease.
The larger the penalties and the greater the enforcement, the larger is the decrease in demand and supply
76
Legalizing and taxing these drugs
will result in a decrease in supply and raise the price while the government would generate large amounts of revenue
An illegal good can be legalized and taxed.
A high enough tax rate would decrease supply, raise the price, and achieve the same decrease in consumption that occurs when trade is illegal.
Arguments that extend beyond economics surround this choice
77
Penalties on Sellers
If the penalty on the seller is the amount HK, then the quantity supplied at a market price of PC is QP.
Supply of the drug decreases to S + CBL.
The new equilibrium is at point F. The price rises and the quantity decreases.
78
Penalties on Buyers
If the penalty on the buyer is the amount JH, the quantity demanded at a market price of PC is QP.
Demand for the drug decreases to D – CBL.
The new equilibrium is at point G. The market price falls and the quantity decreases.
But the opportunity cost of buying this illegal good rises above PC because …
the buyer pays the market price plus the cost of breaking the law
79
Penalties on Both Sellers and Buyers
With both sellers and buyers penalized for trading in the illegal drug, …
both the demand for the drug and the supply of the drug decrease.
The new equilibrium is at point H.
The quantity decreases to QP.
The market price is PC.
The buyer pays PB and the seller receives PS.
80
Time frame for the supply decision – We can distinguish three time frames of supply
Momentary supply, Short-run supply, Long-run supply
81
Momentary supply
When the price changes, the momentary supply is the immediate response to a change in supply of that good (Ex. some fruits and vegetables have a perfectly inelastic momentary supply because immediate changes in price cannot change their predetermined outputs)
82
Short-run supply
The response of the quantity supplied to a price change when only some of the possible adjustments to production can be made. This is generally inelastic because most firms cannot make drastic changes to their production capabilities
83
Long-run supply
The response of the quantity supplied to a price change after all technologically possible ways of adjusting supply have been exploited. For most goods, long-run supply is either elastic or perfectly elastic
84
An indifference curve
is a line that shows combinations of goods among which a consumer is indifferent.
84
A Change in Income
An change in money income brings a parallel shift of the budget line.
The slope of the budget line doesn’t change because the relative price doesn’t change.
84
The budget line
describes the limits to the household’s consumption choices
if two goods are X and Y, and the available income is I, write the budget equation:
PY + PX = I
Y = I/Py - (Px/Py)X
The budget line represents a constraint on an individual’s choices – what is affordable and what is unaffordable.
85
Marginal Rate of Substitution
The marginal rate of substitution, (MRS) measures the rate at which a person is willing to give up good y to get an additional unit of good x while at the same time remain indifferent (remain on the same indifference curve).
The magnitude of the slope of the indifference curve measures the marginal rate of substitution
86
Preferences and Indifference Curves
If the indifference curve is relatively steep, the MRS is high.
In this case, the person is willing to give up a large quantity of y to get a bit more x.
If the indifference curve is relatively flat, the MRS is low.
In this case, the person is willing to give up a small quantity of y to get more x.
87
diminishing marginal rate of substitution
is a general tendency for a person to be willing to give up less of good y to get one more unit of good x, while at the same time remaining indifferent as the quantity of good x increases.
88
The shape of the indifference curves
The shape of the indifference curves reveals the degree of substitutability between two goods.
89
Best Affordable Choice
The consumer’s best affordable choice is
On the budget line
On the highest attainable indifference curve
Has a marginal rate of substitution between the two goods equal to the relative price of the two goods
90
price effect.
The effect of a change in the price of a good on the quantity of the good consumed
91
The effect of a change in price
The effect of a change in income on the quantity of a good consumed
92
Indivisible goods
Cannot be divided into smaller parts.
93
Divisible goods
Can be bought in any quantity desired.
Examples: Gasoline and electricity
Makes up the budget line
94
Real income
The quantity of goods that the household can afford to buy.
95
Relative price
Price of one good divided by the price of another good
96
When prices change, so does the budget line
The lower the price of a good on the x-axis, the flatter the budget line
The higher the price of a good measured on the x-axis, the steeper is the budget line
A change in money income shifts the budget line but the slope remains the same. Therefore, it changes the real income but does not change the relative price
97
Indifference curve
Shows combinations of goods among which a consumer is indifferent.
98
Preference map
A series of indifference curves that resemble the contour lines on a map.
99
Indifference curve steep
Marginal rate of substitution is high – a person is willing to give up a large quantity of good y to get an additional unit of good x while remaining indifferent.
100
Indifference curve is flat
Marginal rate of substitution is low – a person is willing to give up a small amount of good y to get an additional unit of good x while remaining indifferent.
101
Income effect
The effect of a change in income on buying plans
102
Substitution effect
The effect of a change in price on the quantity bought when the consumer (hypothetically) remains indifferent between the original situation and the new one.
The direction of the substitution effect never varies, it always goes to the right
103
Inferior good
Demand increases when income decreases.
For an inferior good the income effect is negative, which means that a lower price does not inevitably lead to an increase in the quantity demanded
The substitution effect of a fall in the price increases the quantity demanded, but the negative income effect works in the opposite direction and offsets the substitution effect to some degree
If negative income effect = positive substitution effect, a fall in price leaves the quantity bought the same
This makes demand perfectly inelastic
If the negative income effect is smaller than the positive substitution effect, a fall in price increases the quantity bought and the demand curve still slopes downward like that for a normal good
The demand curve for this inferior good might be less elastic than that of a normal good though
If the negative income effect exceeds the positive substitution effect, a fall in the price decreases the quantity bought and the demand curve slopes upward
This does not occur in the real world because demand does not slope upward
104
A firm
is an institution that hires factors of production and organizes them to produce and sell goods and services.
105
The Firm’s Goal
A firm’s goal is to maximize profit.
If the firm fails to maximize its profit, the firm is either eliminated or taken over by another firm that seeks to maximize profit.
106
Accounting Profit
Accountants measure a firm’s profit to ensure that the firm pays the correct amount of tax and to show it investors how their funds are being used.
Profit equals total revenue minus total cost.
Accountants use Revenue Canada rules based on standards established by the accounting profession
107
Economic Accounting
Economists measure a firm’s profit to enable them to predict the firm’s decisions, and the goal of these decisions is to maximize economic profit.
108
Economic profit
is equal to total revenue minus total cost, with total cost measured as the opportunity cost of production.
109
A Firm’s Opportunity Cost of Production
A firm's opportunity cost of production includes the value of the resources it uses, comprising costs from resources bought in the market, resources owned by the firm, and resources supplied by the firm's owner.
110
Resources Bought in the Market
Resources Bought in the Market
111
The implicit rental rate of capital is made up of
Economic depreciation
Interest forgone
112
Resources Owned by the Firm
When a firm utilizes its owned capital for production, it faces an opportunity cost as it could have alternatively sold or rented out the capital. This implicit cost is termed the implicit rental rate of capital, reflecting the foregone rental income the firm could have earned from its capital assets.
113
Economic depreciation
is the change in the market value of capital over a given period.
Interest forgone is the return on the funds used to acquire the capital.
114
Resources Supplied by the Firm’s Owner
The owner's contribution can involve both entrepreneurship and labor. Entrepreneurship yields profit, with normal profit representing the average profit an entrepreneur anticipates. This normal profit serves as the cost of entrepreneurship, constituting an opportunity cost of production.
115
normal profit
The profit that an entrepreneur can expect to receive on average
116
The Short Run
In the short run, a firm operates with fixed quantities of certain resources, like its capital or plant, while other resources, such as labor, raw materials, and energy, can be adjusted. Short-run decisions are typically reversible and focus on managing variable inputs to optimize operations.
117
Economic Accounting: A Summary
Economic profit equals a firm’s total revenue minus its total opportunity cost of production.
118
Decision Time Frames
The firm aims to maximize profit and makes various decisions toward this goal. Some decisions are vital for the firm's survival or entail significant irreversible costs. Others are easily reversible but still impact profit. These decisions are categorized into the short run and the long run time frames.
119
Short-Run Technology Constraint
To increase output in the short run, a firm must increase the amount of labour employed.
Three concepts describe the relationship between output and the quantity of labour employed:
Total product
Marginal product
Average product
120
The Long Run
In the long run, a firm can adjust all of its resources, including the size of its plant or capital. Decisions made in the long run are typically more permanent and irreversible compared to those made in the short run. Sunk costs, which are incurred and cannot be recovered, are irrelevant to a firm's current decisions because they cannot be changed or recovered.
121
Product Schedules
Total product= is the total output produced in a given period.
The marginal product= of labour is the change in total product that results from a one-unit increase in the quantity of labour employed, with all other inputs remaining the same.
The average product =of labour is equal to total product divided by the quantity of labour employed.
122
Product Curves
Product curves show how the firm’s total product, marginal product, and average product change as the firm varies the quantity of labour employed
123
Diminishing returns
Increasing marginal returns stem from heightened specialization and the division of labor. Conversely, diminishing marginal returns occur due to reduced access to capital and workspace for each additional worker. The law of diminishing returns, considered almost universal, asserts that as a firm increases its utilization of a variable input alongside fixed inputs, the marginal product of the variable input will eventually decline.
124
Total Cost
A firm’s total cost (TC) is the cost of all resources used.
Total fixed cost (TFC) is the cost of the firm’s fixed inputs. Fixed costs do not change with output.
Total variable cost (TVC) is the cost of the firm’s variable inputs. Variable costs do change with output.
Total cost equals total fixed cost plus total variable cost. That is:
TC = TFC + TVC
125
Marginal Cost
Marginal cost (MC) is the increase in total cost that results from a one-unit increase in total product.
Over the output range with increasing marginal returns, marginal cost falls as output increases.
Over the output range with diminishing marginal returns, marginal cost rises as output increases.
126
Average Product Curve
When marginal product exceeds average product, average product increases.
When marginal product is below average product, average product decreases.
When marginal product equals average product, average product is at its maximum.
127
Short-Run Cost
To produce more output in the short run, the firm must employ more labour, which means that it must increase its costs.
Three cost concepts and three types of cost curves are
Total cost
Marginal cost
Average cost
128
Average Cost
Average cost measures can be derived from each of the total cost measures:
Average fixed cost (AFC) is total fixed cost per unit of output.
Average variable cost (AVC) is total variable cost per unit of output.
Average total cost (ATC) is total cost per unit of output.
ATC = AFC + AVC.
129
Why the Average Total Cost Curve Is U-Shaped
The U-shape of the ATC curve comes from two factors: spreading fixed costs over more output (AFC decreases as output increases), and diminishing returns (AVC increases faster than AFC decreases).
130
Average and Marginal Product and Cost
A firm's cost curves are influenced by its technology:
MC is lowest where MP is highest.
When MP rises, MC falls.
AVC is lowest where AP is highest.
When AP rises, AVC falls.
131
Shifts in the Cost Curves
The position of a firm’s cost curves depend on two factors:
Technology
Prices of factors of production
132
Technology
Technological advancements impact both product and cost curves:
Increased productivity raises product curves and lowers cost curves.
Shifting towards more capital and less labor increases fixed costs but decreases variable costs.
Consequently, average total cost rises at low output levels but falls at high output levels.
133
Prices of Factors of Production
A rise in factor prices escalates costs and alters cost curves:
Increased fixed costs shift the TC and ATC curves upward but leave the MC curve unchanged.
Elevated variable costs shift all curves—TC, ATC, and MC—upward.
134
The Production Function
The behavior of long-run cost depends upon the firm’s production function.
The firm’s production function is the relationship between the maximum output attainable and the quantities of both capital and labour.
135
Diminishing Marginal Product of Capital
Diminishing marginal returns affect both labor and capital inputs in production:
The marginal product of capital reflects the additional output gained from increasing capital while keeping labor constant.
Diminishing marginal returns to both labor and capital lead to U-shaped cost curves for MC, AVC, and ATC in the short run for each plant.
136
Short-Run Cost and Long-Run Cost
The firm's average total cost (ATC) depends on its plant size:
Larger plants typically achieve lower ATC, reaching a minimum at higher output levels.
The firm operates four plants, each with its own short-run ATC curve.
By comparing the ATC for each output across different plants, the firm can assess cost efficiency
137
Long-Run Average Cost Curve
The long-run average cost (LRAC) curve shows the lowest average total cost possible across various output levels when the firm can adjust both its plant and labor. It helps firms plan by indicating the most cost-efficient plant size for different output ranges. Once a plant is chosen, costs align with the average total cost (ATC) curve linked to that plant.
138
Economies and Diseconomies of Scale
Economies of scale cause long-run average costs to decrease as output increases, while diseconomies of scale result in rising long-run average costs with increased output. Constant returns to scale maintain a consistent long-run average cost as output changes.
139
Minimum Efficient Scale
A firm typically encounters economies of scale until reaching a certain output level. Beyond this point, it may face constant returns to scale or even diseconomies of scale. The minimum efficient scale represents the lowest output level at which long-run average costs are minimized. In a U-shaped long-run average cost curve, this point identifies the minimum efficient scale output level.
