Economics Review-Costs of production Flashcards
What is fixed cost?
The cost that doesn’t change as output changes
What is variable cost?
The cost that changes as output changes
What is total cost?
It is the total minimal cost that needs to be paid by the firm to produce an output. So VC+ FC=TC
What does the total cost curve look like?
It is Up-ward sloping
Why is the total cost curve upward sloping?
Since fixed cost stays fixed, there will be a gap between the x-axis and the curve. It is upward sloping since variable cost is subject to change as output increases, or decreases.
What is average cost?
It is sometimes called average cost per unit which is found by TC/Q.
What does the average cost curve look like?
It is U shaped
Why is the average cost curve U-shaped?
It is U shaped because of fixed cost. In the beginning if a small amount of output is produced, then it is hard to share the fixed cost among the revenue firms get from the output. As output increases, the fixed cost amount is easily divided among the output sold and therefore decreases. If output is increased anymore however, then scarce resources may become a problem, where producing more output requires more effort and thus more costs.
What is marginal cost?
- The extra cost of producing one extra unit
- The increase in Total Cost from producing one more unit
If the marginal cost is the extra cost of producing one extra unit, How do you find the MC?
On a chart, at quantity 0, indicates what the fixed cost is. Once you know that, take the known total cost and subtract it by the fixed cost. You will get your vairbale cost(just in case you need this)
But if you really want to find marginal cost, simply take the change in total cost and divide by the change in quantity. Change in Total Cost/Change in Q=MC
What does the marginal cost curve look like?
It increases just like the total cost curve, except more flatter.
The marginal cost(“extra cost” of producing one extra unit of output) increases because it is more costly to produce one extra unit. Perhaps, a worker needs to work extra hours to create the product or more workers need to be hired(the factors of production become scarcer and therefore need to be increased.)
What is the production function?
The production function depicts the relationship between
the quantity of input used to produce the good and the quantity of output, of that good.
Think of farmer jack. The y-axis is the quantity of output, which is dependant on the x-axis, or the no. of workers. As workers increase, Q of output also increases. However, as there are too many workers, the quantity of output starts to decrease(since there might not be enough resources for the workers to work with)
Implicit vs. Explicit costs
Implicit-accounts for the opportunity cost of firms(money is not given out to others, it is more of a theoretical cost)
Explicit costs-on the other hand, are the costs which firms must pay others for their costs of production ex.fixed and variable costs.
Accounting vs. Economic profit
Accounting profit-only accounts for the the explicit costs. So TR - TC(which is also FC+VC).
Economic profit- on the other hand, includes both implicit and explicit costs: TR - TC(implicit + explicit(FC+VC)))
What is marginal product?
What is the marginal product of labour?
Essentially a trick question:
the marginal product of any input is:
the increase in output that occurs when you add one more unit of that input, holding all other inputs constant.
So when farmer Jack hires an extra worker, his costs rise by the MPL(or the wage he pays the worker). His output also rises by the MPL
-So if we were to calculate the number of workers who input their labour, we would not include the increase of raw materials.
What is the formula for MPL(Marginal product of Labour)?
change in Q/ change in L or labour(# of workers)
What is the simplest and key thing to think about to understanding the decision a firm makes about how many workers to hire and how much output to produce? (from chapter 1)
Rational people think at the margin.
Back to MPL(Marginal product of labour), why does it diminish?
MPL due to resource scarcity. As a firm increases their quantity of input, say the workers, then the workers have less to work with. Ex. If farmer Jack hired more workers, he would be short of other factors of production such as tractors, farm animals etc and vice versa as well.
How does MPL diminish?
MPL diminishes as labour increases, whether the land or capital(equipment, machines, etc).
Diminishing marginal product?
The marginal product of input falls as the quantity of input rises.
- A diminishing marginal product is a very steep total cost curve
- if you think about it, the x axis is the quantity of output while the y-axis is the costs of producing at each output. The steep curve represents how the cost increases more significantly than the quantity produced. Which explains why increasing input(in this case, costs to make the good)does not increase output at the same rate.
while increasing one input and keeping other inputs constant may initially increase output, further increases in that input will have a limited effect, and eventually no effect or a negative effect, on output. The law of diminishing marginal productivity helps explain why increasing production is not always the best way to increase profitability.
let’s consider a pizza restaurant that wants to increase profitability. Increasing the amount of cheese (the input) that goes on each pizza can create a more delicious product and sell more pizzas. But at some point, the pizza reaches an optimal cheese level. The amount of cheese must be balanced with the crust thickness, amount of sauce and other pizza toppings, if any. If the restaurant continues to add more cheese to the pizza beyond the optimal level, its sales will decline because customers will not enjoy pizzas that leave them with a mouthful of cheese and little else.
So think of marginal product as the whole good while input being one singular part that makes the good. Ex. To create a computer, you need workers. Increasing workers increases profit. You only increase workers and nothing else lets say. As you increase workers, the marginal product of input starts to fall(since there are more workers than there are computers). So workers are the input while computers are the marginal product of input that falls.
Remember that rational people think at the margin. If this is the case, then come up with two scenarios where Farmer Jack would increase/decrease production.
Jack like any sensible person, wants to get as much profit as he can. So if MC is less than revenue, Jack will produce more of his good.
If MC is greater than revenue, Jack will produce less of his good.
What does an average fixed cost curve look like?
Hint: Use some logic-as in what happens to fixed cost as you increase quantity of output
The average fixed cost curve starts out very high, but begins to decrease. Here you also have to think about the equation of how to get AFC: FC/Q
This is due to the dispersion of the fixed cost after output increases. Remember that fixed cost doesn’t change as output changes. It stays the same. Ex. fixed cost of land is $100. So as output increases, each unit of output takes on a portion of the fixed cost, which makes paying for fixed cost easier.
Using logic as well, what does the average variable cost curve take the shape of?
It is U-shaped, just like average cost since if you increase more workers, their production is less efficient(materials needed to create goods is more scarce)
How do you calculate average total cost?
ATC= TC/Q or ATC= AFC + AVG
