Lesson 1.4 Flashcards
explain opportunity cost
revenue a manager could have received if she had used her resources to produce the next best alternative product or service. That is, opportunity costs are the revenues forgone if resources (inputs) are not optimally used
do you minimize/maximize opportunity cost by using resources as efficiently as possible?
minimize
explain economic cost
cost of a product is equal to sum of production costs (explicit costs) and opportunity costs (implicit costs)
opportunity cost doctrine
the inputs’ values (when used in their most productive way) together with production costs (the accounting costs of producing a product) determine the economic cost of production
define explicit cost
ordinary items accountants include as firm expenses
define historical cost
money that managers actually paid for an input
explain sunk cost
resources that have already been spent and cannot be recovered
what should managers do with sunk costs?
ignore them when making decisions about future actions, they are irrelevant to financial decisions
what do cost functions show?
relationship between input costs and output
how is cost structure of a firm determined?
production function and the input prices it faces
what can cost functions and production functions be?
short run and long run
define short run
period of time between the situation in which the quantity of no input is variable and the situation where all quantities of inputs are variable; where quantity of at least 1 input is fixed
what is a more restrictive definition of short run
time interval so brief that managers cannot change the quantities of plant or equipment employed in production
what are fixed inputs?
inputs that cannot be changed in short run
what do fixed inputs determine?
the scale (size) of the plant
what is total fixed cost
cost per period of time spent on fixed inputs
what kind of value is TFC
constant, does not vary with level of output produced
explain total variable cost
cost spent on variable inputs
what happens to TVC as output increases?
increases since greater output requires more inputs
what rule does total variable cost follow?
law of diminishing marginal returns
what is total cost TC?
TFC + TVC
what do cost functions predict?
how costs change with the level of output
formula for ATC
AFC + AVC
x axis and y axis graph of MC, AVC, AFC, ATC
y axis is cost per unit of output, x axis is unit of output
explain graph of MC
decreases for a little and then increases (checkmark)
explain graph of ATC
higher than AVC and ATC, U shape with only slight increase, minimum where ATC = MC
explain graph of AFC
decreases in an increasing way; passes through the intersection of AVC and
MC
explain graph of AVC
U shape, starts in middle of MC and AFC curve; minimum where AVC = AFC = MC; hits minimum before ATC; inverse of AP curve
formula for AVC
TVC / Q = (PX)/Q = P(1/AP)
what is MC
incremental cost of producing one more unit of output
formula for MC for continuous units
dTC/dQ = dTVC / dQ = P(dX/dQ) = P(1/MP) (forgone)
formula for MC for discrete units (whole numbers only)
change in TC / change in Q = change in TVC / change in Q
final formula for MC between Q and Q - 1
where C(Q) is the total cost of producing Q units of output, it is C(Q) - C(Q-1)
what does long run average cost function LAC show
minimum cost per unit of output for any size of plant
how is LAC related to short run cost functions?
for each level of output, the point on the lowest short run cost function for that level of output will also lie on the LAC curve
what is LRTC
long run total cost function: shows the relationship between long run total cost and output
formula for LRTC
Q*L(Q)
LAC formula
L(Q)
explain long run marginal cost function
function representing how varying output affects the cost of producing the last unit if the manager has chosen the most efficient input bundle
long run marginal cost function
M(Q) = dLRTC / dQ = L(Q) + Q[dL(Q) / dQ]
how does M(Q) relate to LAC = L(Q) curve?
similar shape; M(Q) < LAC when LAC curve is decreasing. M(Q) = LAC when LAC is minimized. M(Q) > LAC when LAC is increasing
what happens to long run marginal cost function if the manager has chosen optimal scale of plant
M(Q) = short run MC at that level of output
define economies of scale
when a firm’s avg unit cost decreases as output increases
how can we tell if a firm has economies of scale from LAC curve
if it is decreases as output increases (downward sloping)
define diseconomies of scale
when avg cost per unit of output increases as output increases
explain economies of scope
exist when cost of jointly producing 2 or more products is cheaper than producing each of the products separately
formula for if economies of scope is possible
if S = C(Q1) + C(Q2) - C(Q1 + Q2) / C(Q1 + Q2) is positive, then there is economies of scope
what is break even
what level of output equates revenue and costs; output level that must be reached if managers are to avoid losses
formula for break even level of output QB
QB = TFC / (P - AVC)
define profit contribution analysis
break even analysis to understand relationship between price and profit
formula to figure out what level of sales would earn a specific profit
Q = TFC + profit target / profit contribution per unit
formula for profit contribution
total revenue - TVC or on a per unit basis: Price - AVC
formula for economic profit
accounting profit - opportunity cost
when is AP=MP
when AP is maximized
what can economies of scale result from
larger plant size and/or increase in # of plants
how can economies of scale by exploited?
by changes in production, distribution, raising capital, advertising and other business processes
what does S measure in economies of scope formula?
the percentage of saving that results from producing jointly over individually
LAC graph
U with x - quantity of output, y - average cost
