Exam -2 Chapter-7 Production And Costs Flashcards
Businesses combine what to create goods
Factors of production land, labor, and capital.
Firms seek to maximize profits
Which means that they will want to maximize revenue and minimize cost, with the understanding that there is often a relationship between the amount spent to create the good and the revenue it can produce.
Fixed inputs
Create fixed cost
Variable inputs
Create variable cost
A business has
Fixed inputs and variable inputs
Total cost
Are the sum of fixed cost and variable costs
Fixed costs
Are those that don’t vary with output
Variable cost
Are those that vary with the level of output produced
Short run
Is defined as a time period with both fixed and variable costs
The long run exists
When there are only variable costs
In the short run, business is subject
To diminishing returns
Diminishing returns
Means that as it adds variable resources such as labor ti it’s fixed resources such as capital, the marginal output created by each additional unit of variable input will decline
Marginal cost
Is the additional cost of producing one more good
Sunk costs
Are those costs which are already paid out. They should not be considered in decision making
A business should operate so long as
The loss it incurs from operating is smaller than its fixed costs. If the loss from operating is greater than fixed costs, the business should shut down
When do economies of scale occur
When average cost declines as output grows.
When do diseconomies of scale occur
When the average cost increases as output grows
Minimum efficient scale
Is the smallest size a business can be and profitably operate.
What 2 things form the foundation of the profit equation
Cost
Supply of goods and services
Each factor of production has
Explicit ( money cost). These costs are not constant, but vary over time.
How to make profit
Profit comes from the relationship between revenue and costs.
If the firm produces a good that consumers think is cheap
Then the selling price will be lower than if the good is considered to be of good quality
Inputs create
Output
Inputs have a
Cost
Outputs generate
Revenue
What should a firm do to create profits
Minimize its cost and maximize its revenue
An increase in cost may allow for
An increase in price and revenue
How can a firm have an incentive to be efficient
By getting the maximum output from the inputs it chooses to buy
Outsourcing
Some of the production is actually done by another company
Advantages of outsourcing
Domestic companies can provide a wider range of products
And produce at a lower cost.
Consumers will have more choice at lower prices.
It forces entrepreneurs to be more creative and aggressive
The inputs used by the business [land, labor, capital] maybe either
Fixed or variable
Fixed input
Does not vary as the amount of output produced changes. Example factories where cars Are made
Variable inputs
Change as the amount of output changes. Example labor
Fixed cost
The cost of fixed inputs
Variable costs
The cost of variable inputs
Total cost
Is the sum of fixed and variable cost
How do you economists divide time
Economists divide time into 2 periods
Short run
Long run
In the short run
The business has both fixed and variable costs and fixed and variable inputs
In the long run
The business has only variable costs
How does the long run in a business appear
The long run appears in short burst. For example when its lease expires, the brief period (perhaps just a few minutes )until the business signs a new one, moves or shuts down
Average cost
Is the cost per unit
When is the ability of a business to adapt to changing market conditions greater
When more of the cost and inputs are variable , which means that they are more able to adjust the longer the amount of time available to them
Diminishing returns
Diminishing returns occurs when the addition of units of one input results in decreasing amount of additional output being produced
What is the best way for a business to control costs
To add more of all the factors of production when it wants to expand. ( labor, capital, and natural resources)
Marginal productivity
How much more output is added with one more worker
Marginal physical productivity MPP
Additional output produced by an additional unit of labor which equals the change in total output divided by the change in labor
What is the problem with workers and their MPP marginal physical productivity
As we add labor without adding capital, the marginal productivity of the new workers will decline
Marginal cost MC
Is the additional cost of producing one more unit of good
What is the key to determining the most profitable quantity of a good that a firm can produce
Marginal cost
Average cost
Average cost= total cost divided by the total number of goods produced
Marginal cost
Is the additional cost of the last product produced which includes only those factors that vary :labor and natural resources
The marginal cost will either be
Higher or lower than the average cost
Marginal cost comes entirely from
Variable cost
There is no relationship between fixed cost and
Marginal cost
Marginal cost will tell us whether
Each unit of production adds to our profit or not.
Why is average cost needed
Average cost is needed to discover whether or not the entire business is profitable, since average cost include fixed cost
The independent nature of marginal cost and fixed cost also tells us that
Businesses with the same total cost may act differently if their fixed variable costs are not the same
How to calculate average fixed cost
Average fixed cost equals fixed cost divided by the quantity we produce
How to calculate average total cost ATC or total cost per unit?
Total cost divided by the quantity produced
Because of diminishing returns, average total cost will
Decline at first, but eventually it will cost us more and more to produce more and more because the new workers we hire are not as productive as our existing workers
Similarly because of diminishing returns, our marginal cost (cost of producing one more)
Declines initially, but eventually turns and heads up as diminishing returns sets in
Why does the marginal cost always pass through the lowest point on the average total cost
Because the average total cost follows what the marginal cost tells it to do.
When the marginal cost is below the average total cost, average total cost falls [heads towards marginal cost )
When marginal cost is above the average total cost, average total cost rises [heads towards marginal cost]
Where the average total cost switches from falling to rising, therefore, must be where marginal cost is not above, nor below, average total cost, which means they are equal
Sunk cost
Sunk cost are on the cost that we have already paid out. They could have been fixed or variable cost originally, but in either case ,they are gone
Variable costs once paid
Cannot be reclaimed
If a business is losing money, the decision to shut down is best based on
The comparison between the loss it incurs by operating and the loss it would incur if it shut down
If a business operates
It has revenue, fixed cost and variable cost
Loss of a operating business is equal to
It’s revenue minus the sum of its fixed and variable costs
The loss of a closed business is equal to
It’s fixed cost, since it has no revenue and zero variable cost
Should some businesses be able to operate forever at a loss
No, in the long run, there are only variable cost. So a business must be profitable in the long run or it will have to shut down.
-businesses can operate at a loss for a short period, but eventually the value of its fixed costs diminishes to the point that shutting down is the most sensible decision
The long run
Is the point when all costs are variable
The long run shows up in
Spurts: when the lease expires, when we decide to open a new store, or when we make any decision that changes all the factors of production at the same time
Long run decisions mean
Flexibility in all facets of operation.
Short run decisions
Are constrained by fixed inputs and costs
The short run and a long run happen
At the same time. Because we are running our business today in the short run, while planning and implementing changes for the future, in the long run
Optimal business size
The optimal or best size for the business is a long run decision
Economies of scale
Occurs when the cost of production decline with an increase in the size of the firm
Diseconomies of scale
Occurs when the cost of production increases with the size of the firm.
Businesses that have significant economies of scale will tend to
Grow larger
Businesses with significant diseconomies of scale will
Remain small
Technically, economies of scale exist when
The average total cost of production of a good declines as the quantity produced of the good increases. For example: economies of scale are likely to occur in the production of mass produced goods such as cars, electricity and airplanes
Diseconomies of scale exist when
The average total cost of production rises as the quantity produced of the goods increases.
Diseconomies of scale are most often linked to
Difficulties in managing a large enterprise. The larger of the company, the more difficult it is to manage
Constant returns to scale
Some businesses neither become more efficient nor less efficient as they grow. When this occurs, it is referred to as constant returns to scale.
Many companies in the real world have constant returns to scale in their operations because
They most often achieve these by replication. That is they expand by duplicating existing plants or stores, and contract by eliminating them.
For example McDonald’s does not expand by adding seats to each restaurant, but it builds or replicates new restaurants
Minimum efficient scale
For every business there is a minimum size that will be profitable for the company to operate, called the minimum efficient scale.
Minimum efficient scale is the
Smallest size at which the business can operate efficiently
