Production

Question 1

SR vs LR vs VLR

Answer 1

SR - at least one FOP is fixed, but usually only labour is variable

LR - all FOP are variable

VLR - all FOP are variable including state of technology and govt legislation

Question 2

production function

Answer 2

max possible output from a given set of factor inputs

in the SR, is upward sloping until it tapers off due to DMR

Question 3

average product

Answer 3

total output/total workers

one measure of productivity

Question 4

explain the shape of the SR ATC curve

Answer 4

• ATC = AFC+AVC
• AFC curve continues to be downward sloping as output increases since FC are constant
• AVC rises as output increases due to DMR
• ## eventually the increase in AVC outweighs the fall in AFC, causing the ATC curve to take a U shape

Question 5

normal profit

Answer 5

minimum return needed by a firm to remain in business

Question 6

supernormal profit

Answer 6

that earned above NP

Question 7

subnormal profit

Answer 7

that earned below normal profit

Question 8

explain the law of DMR

Answer 8

short run concept

capital is fixed in the SR so as labour is continually added to a fixed capacity, the marginal product of labour will initially rise

this is due to** productivity and efficiency** gains from specialisation and division of labour - capacity better utilised

but then MP begins to fall due to inefficiencies in the production process - over-utilisation of capacity

every worker begins adding more to costs than to output

Question 9

accounting VS implicit costs

Answer 9

payments of money made for business expenses like raw materials VS the opportunity cost of using a factor of production like rent that could have been earned from a factory space

Question 10

economic profit VS accounting profit

Answer 10

TR - economic costs where EC = accounting plus implicit costs

TR - accounting costs

Question 11

relationship between MC and VC in the SR

Answer 11

MC is the change in variable costs which is the change in total costs

since fixed costs cannot change in the SR

Question 12

explain the shape of the AVC curve

Answer 12

• initially downward sloping due to productivity gains
• then when DMR sets in, MP falls and MC rise, which means average variable costs must have risen
• remember MC = change in VC

Question 13

explain the shape of the AFC

Answer 13

is continuously downward sloping as output increases

fixed costs are constant in the short run meaning that a constant numerator with a rising denominator leads to a smaller average figure

Question 14

why do all costs become variable in the LR?

Answer 14

size of the production facility or other capital intensive means of production may not be easily expanded in short run due to financial or space constraints, for e.g. so a firm facing a higher demand for its good is unable to significantly expand production in the SR

However, in a long run, it is easier for the firm to purchase more capital thus making these factors variable in a long run.

Question 15

increasing VS decreasing VS constant returns to scale

Answer 15

LR concept:

Increasing: a percentage increase in inputs leads to a greater percentage increase in outputs

Decreasing: opposite

Constant: % increase in inputs leads to same % increase in output

Question 16

what causes increasing RTS?

Answer 16

as the firm expands its inputs and production, it is able to make efficiency gains - this is the idea of economies of scale! Give an example an EOS to support this explanation

Question 17

explain the shape of the LRAC curve

Answer 17

the LRAC curve is made of the lowest possible AC for each level of fixed factor capacity

it is a flatter u shape due to falling costs over time

each SRAC curve corresponds to a different fixed level of capital - in the SR, if it wanted to increase output due to higher demand, firm would have to move along the current SRAC curve to produce the output at a higher cost

however in the LR as FOP are variable and firm increases level of capital, moving to a new, lower SRAC curve, can produce that same higher level of output at a lower cost

in the LR, the rational firm chooses to produce a given level of output at the level of capital that results in the lowest average cost

shape of the curve is explained by RTS and EOS - increasing your level of capital will result in efficiency gains and a lower SATC until you reach the MES, and past this, increasing the level of capital you have will result in DEOS

Question 18

MES

Answer 18

lowest level of output for which LRAC are minimised

Question 19

EOS and DEOS

Answer 19

LRAC fall/rises as the scale of production increases due to increasing/decreasing RTS

Question 20

examples of EOS

Answer 20

Really Fun Mums Try Making Pies

Risk bearing
Financial
Managerial
Technical
Marketing
Purchasing

Question 21

risk bearing EOS

Answer 21

spreads business risk over larger range of output

if demand for one product range falls, has the other one to rely on for sales and revenues

Question 22

managerial EOS

Answer 22

large firm employ specialist managers instead of generalists, which can contribute their expertise to boost workforce productivity

Question 23

technical EOS

Answer 23

• afford to employ specialist machinery that boosts productivity
• firm utilitises their factory capacity more effectively as they produce more
• employ more workers then use division of labour and specialisation that increases productivity

Question 24

purchasing EOS

Answer 24

purchasing in bulk allows for negotiating discounts

Question 25

marketing EOS

Answer 25

company can bulk buying advertising resources - e.g. billboards, TV air time - which lets them negotiate lower unit costs

Question 26

financial EOS

Answer 26

larger firms are more reputable and successful so banks perceive them as being less risky and so are willing to lend at lower IR

Question 27

the KEY way to analyse the impact of EOS

Answer 27

as a firm grows larger and carries out the specific activity that leads to the EOS, for e.g. buying specialist machinery, total costs WILL rise, but productivity and output rises much faster than costs and so AVERAGE costs fall

costs rise but not as fast as output

Question 28

external EOS

Answer 28

cost savings enjoyed by all firms in an industry as that industry grows larger

Question 29

examples of external EOS

Answer 29

• better transport links increase efficiency and lower costs of transporting inputs and finished goods
• concentration of skilled labour - specialists will boost productivity
• R&D facilities move closer to firms - better tech will increase efficiency - e.g. biotech and electronics firms and Cambridge
• suppliers move closer to firms - lower transport costs

e.g. Silicon Valley, e.g. biotech and electronics firms that have R&D links with Cambridge Uni

Question 30

KEY analysis for external EOS

Answer 30

total costs fall regardless of the level of output you are producing - even if Q is constant, TC falls, resuling in lower LRAC

represented by downward shift of LRAC curve

Question 31

internal DEOS

Answer 31

3 Cs and an M

Control
Coordination
Communication
Motivation

Question 32

KEY analysis for internal DEOS

Answer 32

problems leading to DEOS will reduce productivity, and increase total costs much faster than output

Question 33

control as a DEOS

Answer 33

more workers so harder for managers to supervise all, giving workers the incentive to ‘slack off’

Question 34

communication as a DEOS

Answer 34

harder to pass messages through the business - either from top or bottom - or leads to miscommunication - this wastes time and effort which reduces productivity

Question 35

coordination as a DEOS

Answer 35

harder for larger departments to work alongside each other and work towards the same goal, reducing productivity

Question 36

motivation as a DEOS

Answer 36

more workers means that each individual workers feels more alienated and dispensable, reducing morale and productivity

Question 37

examples of external DEOS

Answer 37

• traffic congestion increases transport time and costs
• land shortages increases fixed costs
• shortages of skilled labour increases variable costs

all INCREASE TC at every level of output, upward shift of LRAC curve

Question 38

implications of the LR and productivity

Answer 38

because all FOP can be varied, the firm can alter its mix of FOP to ensure the most efficient production possible - for e.g. improvements in capital relative to labour could increase capital intensivity, or obtain the capital for a new production process

Question 39

rule for maximising efficiency with your mix of FOP

Answer 39

marginal product factor A/price of factor A = MP of factor B/price of factor B and so on

Question 40

how to arrive at the best combo of labour and capital using isoquants and isocosts

Answer 40

the point where the isocost is tangential to an isoquant

Question 41

significance of making subnormal profit - firm may withdraw from market in LR