HL - Theory of the Firm Flashcards
What’s the difference between the short run and the long run? Give an example
In the short run fixed factors of production exist (but you can still have variable factors as well).
In the long run all factors of production are variable
E.g a lease that may last for 12 months.
Definition of total product (TP)
Total output
Definition of average product (AP)
It means the total product/ variable factor (e.g workers).
What does marginal product mean?
The extra output produced by employing one extra variable factor of production. E.g employing one more worker
What’s the formula for calculating MP?
Change in output/ change in variable factor
What happens to MP when TP is at its maximum?
MP must be equal to zero
Why do negative marginal returns eventually set in?
Because there’s always a fixed factor e.g if you have a field to grow grain and you keep employing people, at one point there will be too many people and they will start to tread on the grain, which is inefficient.
Why does MP cut AP at its highest point?
If you’re creating a new average by adding numbers that is higher than the existing average, then it must be rising. If you are creating a new average by adding values lower than the existing average then the new average must be falling.
What is the law of diminishing returns?
As more units of variable factor get added to a fixed factor, although increasing returns may initially apply (due to divisor of labour), diminishing returns will eventually set in. This can only happen in the short run because it’s only in the short run that we have fixed factors.
What are the benefits and negative aspects of the division of labour, and what is it?
It’s the separation of talks involved in that labour.
Benefits:
More efficient sit to time saving and specialisation. Create more output
Negatives:
Boring for the working
What happens to the rate of increase according to the law of diminishing returns?
At first the rebate of increase slows down (decreases) but then it becomes disadvantageous and total output decreases.
What are economic costs?
It’s the opportunity cost of all resources employed by the firm. It’s the sum of explicit and implicit costs. Including profit for the entrepreneur.
What are the explicit and implicit costs in economic costs?
Explicit - payments the firms makes to buy resources from external suppliers
Implicit - the sacrificed income the firm loses when it uses its own resources. E.g The firm using its own money rather than borrowing, it could have been earning interest in the bank.
What happens to fixed costs and variable costs as output changes?
Nothing happens to the fixed costs
Variable costs change
What’s the relationship between Total costs and variable costs in the long run?
TC = VC
What’s the equation for TC?
TC = TVC + TFC
What’s the equation for Average Fixed Costs and Average Variable Costs?
AFC = TFC / Q AVC = TVC / Q
What’s the equation for Average Total Costs?
ATC = TC / Q
What’s the equation for Marginal costs?
It’s the extra cost of producing one more unit of output.
Change in TC / change in output
What does the Average Total Cost curve show in the long term?
Shows the lowest possible total costs. It’s made up of the points of tangency of an infinite number of SRATC curves, which show all the different possible scales of operation.
What are increasing, constant and decreasing returns to scale?
Increasing returns - increase in inputs leads to a bigger than proportionate amount of output.
Constant returns - increase in inputs is exactly matched by increase in output
Decreasing returns - increase in input leads to a proportionately smaller increase in output.
When do economies of scale occur?
When average costs of production are falling as output increases. (increasing returns)
What are the reasons for economies of scale? (1)
Specialisation - the division of labour
Efficiency - larger firms can use capital equipment that can have lower costs per unit. E.g doubling the dimensions of a container makes the capacity increase more than proportional. So transportation per unit and storage per unit are cheaper for larger firms.
What are the reasons for economies of scale? (2)
Marketing - cost per unit of marketing is cheaper for larger firms
Indivisibilities - equipment might not be used to maximum efficiency in a small firm. E.g a photocopier