Inputs and Costs and Perfect Competition

Question 1

total product curve - how does it look? what does it represent?

Answer 1

hows how the quantity of output depends on the quantity of the variable input, for a given quantity of the fixed input.

Question 2

long run vs. short run

Answer 2

The long run is the time period in which all inputs can be varied.

The short run is the time period in which at least one input is fixed.

Question 3

fixed vs. variable input

Answer 3

A fixed input is an input whose quantity is fixed for a period of time and cannot be varied. E.g. land

A variable input is an input whose quantity the firm can vary at any time. E.g. labour

Question 4

production function

Answer 4

the relationship between the quantity of inputs a firm uses and the quantity of output it produces.

Question 5

marginal product

Answer 5

the additional quantity of output that is produced by using one more unit of that input.

Question 6

diminishing returns to an input

Answer 6

when an increase in the quantity of that input, holding the levels of all other inputs fixed, leads to a decline in the marginal product of that input.

But each additional worker is working with a smaller share of the 10 acres—the fixed input—than the previous worker. As a result, the additional worker cannot produce as much output as the previous worker.

Question 7

fixed cost vs. variable cost vs. total cost

Answer 7

A fixed cost is a cost that does not depend on the quantity of output produced. It is the cost of the fixed input.

A variable cost is a cost that depends on the quantity of output produced. It is the cost of the variable input. E.g. wages

The total cost of producing a given quantity of output is the sum of the fixed cost and the variable cost of producing that quantity of output.

Question 8

total cost curve

Answer 8

6-4 shows how total cost depends on the quantity of output.But unlike the total product curve, which gets flatter as employment rises, the total cost curve gets steeper

Question 9

marginal cost

Answer 9

the additional cost incurred by producing one more unit of that good or service. Marginal cost, meanwhile, tells the producer how much one more unit of output costs to produce.

Question 10

Why does the marginal cost curve slope upward?

Answer 10

Because there are diminishing returns to inputs in this example. As output increases, the marginal product of the variable input declines. This implies that more and more of the variable input must be used to produce each additional unit of output as the amount of output already produced rises. And since each unit of the variable input must be paid for, the additional cost per additional unit of output also rises.

Question 11

Average total cost

Answer 11

often referred to simply as average cost, is total cost divided by quantity of output produced. Average total cost is important because it tells the producer how much the average or typical unit of output costs to produce.

Question 12

Average total vs. average fixed vs. average variable cost

Answer 12

A U-shaped average total cost curve falls at low levels of output, then rises at higher levels. as more output is produced, the fixed cost is spread over more units of output; the end result is that the fixed cost per unit of output—the average fixed cost—falls. You can see this effect: average fixed cost drops continuously as output increases. Average variable cost, however, rises as output increases. As we’ve seen, this reflects diminishing returns to the variable input: each additional unit of output incurs more variable cost to produce than the previous unit. So variable cost rises at a faster rate than the quantity of output increases.

Average fixed cost is the fixed cost per unit of output.

Average variable cost is the variable cost per unit of output.

Question 13

increasing output has two opposing effects on average total cost

Answer 13

(1) The spreading effect. The larger the output, the greater the quantity of output over which fixed cost is spread, leading to lower average fixed cost.
(2) The diminishing returns effect. The larger the output, the greater the amount of variable input required to produce additional units, leading to higher average variable cost.

At low levels of output, the spreading effect is very powerful because even small increases in output cause large reductions in average fixed cost. So at low levels of output, the spreading effect dominates the diminishing returns effect and causes the average total cost curve to slope downward. But when output is large, average fixed cost is already quite small, so increasing output further has only a very small spreading effect. Diminishing returns, however, usually grow increasingly important as output rises. As a result, when output is large, the diminishing returns effect dominates the spreading effect, causing the average total cost curve to slope upward.

Question 14

minimum - cost output

Answer 14

the quantity of output at which average total cost is lowest—the bottom of the U-shaped average total cost curve.

At the minimum - cost output, average total cost is equal to marginal cost. At output less than the minimum - cost output, marginal cost is less than average total cost and average total cost is falling. At output greater than the minimum - cost output, marginal cost is greater than average total cost and average total cost is rising.

When average total cost is U-shaped, the bottom of the U is the level of output at which average total cost is minimized, the point of minimum - cost output. This is also the point at which the marginal cost curve crosses the average total cost curve from below. Due to gains from specialization, the marginal cost curve may slope downward initially before sloping upward, giving it a “swoosh” shape.

Question 15

The relationship between ATC and MC curves:

Answer 15

6-9

The marginal cost curve goes through the minimum of the average total cost curve.​

Question 16

profit

Answer 16

total revenue (TR) minus total cost (TC):​

Question 17

how to maximize profit?

Answer 17

MC=MR

Question 18

ATC/AFC/AVC

Answer 18

ATC = AFC + AVC

when Q is small, AFC is large and AVC is small​

as Q increases, AFC decreases and AVC increases​

AFC drives ATC down, AVC drives ATC up​

Question 19

calculating profit

Answer 19

(slides 13-15)
If P > ATC, profits are positive.​

Profit = (P − ATC)Q​

f P < ATC, profits are negative.

Question 20

When Should a Firm Enter or Exit an Industry?

Answer 20

If P > ATC, profits can be made when entering​

If P < ATC, firms make losses and may exit​

however, it does not always make sense to exit or enter an industry immediately​

there are entry and exit costs​
^large entry and exit costs: for example for some type of businesses there are huge fixed costs at the beginning that need to be paid

Question 21

Long-Run Industry Supply

Answer 21

18th slide

^1)increase in price and production and profit 2)other producers also see this increase in demand, so they also choose to enter the market – the supply curve shifts

^increasing cost industry – every additional supplier has an increasing cost of entering the market

Question 22

perfectly competitive market

Answer 22

a market in which all market participants are price - takers. That is, neither consumption decisions by individual consumers nor production decisions by individual producers affect the market price of the good.

Question 23

market share

Answer 23

A producer’s market share is the fraction of the total industry output accounted for by that producer’s output. There are thousands of wheat farmers, none of whom accounts for more than a tiny fraction of total wheat sales.

Question 24

standardized product

Answer 24

also known as a commodity, when consumers regard the products of different producers as the same good.

Question 25

marginal benefit

Answer 25

the additional benefit derived from producing one more unit of that good or service.

Question 26

The principle of marginal analysis

Optimal output rule

Answer 26

says that the optimal amount of an activity is the quantity at which marginal benefit equals marginal cost

According to the optimal output rule, profit is maximized by producing the quantity of output at which the marginal revenue of the last unit produced is equal to its marginal cost. Profit is maximized by producing the quantity at which the marginal revenue of the last unit produced is equal to its marginal cost. That is, MR = MC at the optimal quantity of output.

Question 27

Marginal revenue

Answer 27

the change in total revenue generated by an additional unit of output.

Question 28

economic vs. accounting profit

Answer 28

Economic profit is equal to revenue minus the opportunity cost of resources used.

Accounting profit is equal to revenue minus explicit cost. It is usually larger than economic profit.

It’s important to understand clearly that a firm’s decision to produce or not, to stay in business or to close down permanently, should be based on economic profit, not accounting profit.

Question 29

The break - even price

Answer 29

taking firm is the market price at which it earns zero profit.

So the rule for determining whether a producer of a good is profitable depends on a comparison of the market price of the good to the producer’s breakeven price—its minimum average total cost:
• Whenever the market price exceeds minimum average total cost, the producer is profitable.
• Whenever the market price equals minimum average total cost, the producer breaks even.
• Whenever the market price is less than minimum average total cost, the producer is unprofitable.

Question 30

shut - down price

Answer 30

A firm will cease production in the short run if the market price falls below the shut - down price, which is equal to minimum average variable cost.

Question 31

A sunk cost

Answer 31

is a cost that has already been incurred and is nonrecoverable. A sunk cost should be ignored in decisions about future actions.

Question 32

profit maximizing rule

Answer 32

continue to produce as long as the marginal revenue of the last unit produced is greater or equal to the marginal cost

Question 33

law of diminishing marginal returns

Answer 33

ass you add variable resources to a set number of fixed resources the additional output generated from each additional worker will eventually decrease