Exam 4 chapters 6-7 Flashcards
Theory of the firm
explanation of how a firm makes cost-minimizing production decisions and how its cost varies with its output
Three steps of production decisions
- Production technology
- Cost constraints
- Input choices
Production technology
practical way of transforming inputs into outputs
Cost constraints
take into account the prices of labor, capital(invested), and other inputs- cost of production
Input choices
firm must choose how much of each input to using when producing the output
factors of production
inputs into the production process
production function
function showing the highest output that a firm can produce for every specified combination of inputs
short run
period of time in which quantities of one or more production factors cannot be changed; at least one factor that cannot be varied
fixed input
production factor that cannot be varied
long run
amount of time needed to make all production inputs variable
average product
output per unit of a particular input
marginal product
additional output produced as an input is increase by one unit
average product of labor=
output/labor input= q/L
marginal product of labor=
change in output/ change in labor input= q/L
average product of labor is given by
the slope of the line drawn from the orgin to the corresponding point on the total product curve
marginal product of labor at a point is given by
the slope of the total product at that point
law of diminishing marginal returns
principle that as the use of an input increases with other inputs fixed, the resulting additions to output will eventually decrease
labor productivity
average product of labor for an entire industry or for the economy as a whole
stock of capital
total amount of capital available for use in production
technological change
development of new technologies allowing factors of production to be used more effectively
isoquants
curve showing all possible combinations of inputs that yield the same output
isoquant map
graph combining a number of isoquants, used to describe a production function
Isoquants show the flexibility that firms have when making production
decisions:
They can usually obtain a particular output by substituting one input
for another. It is important for managers to understand the nature of this
flexibility.
marginal rate of technical substitution (MRTS)
Amount by
which the quantity of one input can be reduced when one extra unit of another
input is used, so that output remains constant.
fixed-proportions production function
Production function with L-shaped
isoquants, so that only one combination of labor and capital can be used to
produce each level of output
The fixed-proportions production function describes situations in which
methods of production are limited
returns to scale
Rate at which output increases as inputs are increased proportionately
increasing returns to scale
Situation in which output more than doubles when all inputs are doubled
constant returns to scale
Situation in which output doubles when all
inputs are doubled
decreasing returns to scale
Situation in which output less than doubles
when all inputs are doubled
accounting cost
Actual expenses plus depreciation charges for capital equipment
economic cost
Cost to a firm of utilizing economic resources in production
opportunity cost
Cost associated with opportunities forgone when a firm’s resources are not put to their best alternative use
The concept of opportunity cost is particularly useful in situations where
alternatives that are forgone do not reflect monetary outlays
economic cost=
opportunity cost
sunk cost
Expenditure that has been made and cannot be recovered
Because a sunk cost cannot be recovered,
it should not influence the firm’s decisions
total cost
Total economic cost of production, consisting
of fixed and variable costs
fixed cost
Cost that does not vary with the level of output and that
can be eliminated only by shutting down
variable cost
Cost that varies as output varies
amortization
Policy of treating a one-time expenditure as an annual cost
spread out over some number of years
marginal cost
Increase in cost resulting from the production of one
extra unit of output
average total cost
Firm’s total cost divided by its level of output
average variable cost
Variable cost divided by the level of output
average fixed cost
Fixed cost divided by the level of output
user cost of capital
annual cost of owning and using a capital asset equal to economic depreciation plus foregone interest
rental rate
cost per year of renting one unit of capital
isocost line
graph showing all possible combinations of labor and capital that can be purchased for a given total cost
expansion path
curve passing through points of tangency between a firm’s isocost lines and its isoquants
long-run average cost curve (LAC)
Curve relating average cost of
production to output when all inputs, including capital, are variable
short-run average cost curve (SAC)
Curve relating average cost of
production to output when level of capital is fixed
long-run marginal cost curve (LMC)
Curve showing the change in longrun total cost as output is increased incrementally by 1 unit
economies of scale
Situation in which output can be doubled for less than a doubling of cost
diseconomies of scale
Situation in which a doubling of output requires more than a doubling of cost
product transformation curve
Curve showing the various combinations of two different outputs (products) that can be produced with a given set of inputs
economies of scope
Situation in which joint output of a single firm is greater than output that could be achieved by two different firms when each produces a single product
diseconomies of scope
Situation in which joint output of a single firm is less than could be achieved by separate firms when each produces a single product
degree of economies of scope (SC)
Percentage of cost savings resulting when two or more products are produced jointly rather than Individually.
