Lesson 12 Costs of Production Flashcards
Industrial organization
study of how firms’ decisions about price/quantities depend on market conditions
Goal of firms
1) maximize profit
Profit
1) Total revenue - Total cost
Types of costs
1) explicit - paying worker wages or price for ingredients
2) implicit - do not require cash outlay (instead of baking cookies Chloe could earn 100 an hour being a programmer)
Cost of Capital is a ____ cost
1) opportunity
2) instead of spending $300K to buy factory –> could’ve put it in savings account at 5% interest, or 15K a year –> Opportunity cost is 15K
Economic profit vs accounting profit
1) economic profit –> Total rev - implicit costs - explicit costs
2) accounting profit –> total rev - explicit costs
Why is economic profit important
1) Firm with positive economic profit –> stays in business (has enough to cover all its opp. costs + has revenue leftover to give owners)
2) Firm with economic losses –> will eventually go out of business
Marginal product
1) change in quantity of output from one additional unit of input
2) ex: when # workers go from 1 to 2, cookie production goes from 50 to 90 SO marginal product is 40 cookies
What happens to marginal product as # workers increase
1) marginal product declines
2) DIMINISHING MARGINAL PRODUCT –> as more workers hired, they have to share more kitchen equipment –> each one contributes less to overall production
Total Cost Curve
1) relationship btwn quantity produced (x) + total cost (y)
2) exponential (concave up, increasing)
Production function curve
1) relationship btwn workers hired (x) + quantity output (y)
2) flattens out (concave down, increasing)
Diminishing marginal product explains why, as output increases
the production function gets flatter, and the total-cost curve gets steeper
Farmer Greene faces diminishing marginal product. If she plants no seeds on her farm, she gets no harvest. If she plants 1 bag of seeds, she gets 3 bushels of wheat. If she plants 2 bags, she gets 5 bushels. If she plants 3 bags, she gets
6 bushells
Fixed vs variable costs
1) Fixed cost = do not vary with quantity of output produced
2) example = rent, bookkeeper’s salary
3) Variable cost = changes with quantity of output produced
4) cost of coffee beans, milk, sugar (inputs for product)
Average cost
1) total cost divided by quantity of output
2) Subdivide into average fixed and average variable cost
Marginal cost
1) amount total cost rises when firm increases production by one unit
2) change TC / change Q
Graph Analysis
1) Rising marginal cost –> upward slope of MC –> diminishing marginal product
2) U shaped average total cost –> U shaped since at first ATC falls bc fixed cost is spread over greater output BUT then variable cost increases with more production
*vertex/bottom of U shaped total cost –> represents most efficient point where minimize total cost
Relationship btwn marginal cost + average total cost
1) When MC less than ATC –> ATC falling
2) When MC greater ATC –> ATC rising
3) MC curve crosses ATC at minimum
A firm is producing 20 units with an average total cost of $25 and a marginal cost of $15. If it increases production to 21 units, which of the following must occur?
ATC decreases
The government imposes a $1,000 per year license fee on all pizza restaurants. As a result, which cost curves shift?
average total cost and average fixed cost
Relationship btwn short run (SR) + long run curves (LR)
1) LR ATC much flatter U shape than SR
2) SR curves on or above LR –> over LR firms have more flexibility
Why do firms have more flexibility in long run
1) in SR –> no choice but to hire more workers –> diminishing marginal product
2) in LR –> can build more factories
Economics of scale vs diseconomies of scale vs constant returns to scale
1) Economies of scale = when LR ATC declines as output increases
2) Diseconomies of scale = when LR ATC rises as output increases
3) Constant returns to scale = LR ATC doesn’t vary with output
What causes economies/diseconomies of scale
1) Economy of scale –> higher production levels –> more specialization amongst workers –> better at specific tasks
2) Diseconomies of scale –> coordination problems arise –> more production could stretch management team
