Production and Cost Flashcards
What is a firm?
an institution that hires factors of production and organizes them to produce and sell goods and services.
What is the goal of a firm?
A firm’s goal is to maximize profit.
If the firm fails to maximize its profit, the firm is either eliminated or taken over by another firm that seeks to maximize profit.
Accounting profit vs economic profit:
Accountants measure a firm’s profit to ensure that the firm pays the correct amount of tax and to show it investors how their funds are being used.
Profit equals total revenue minus total cost.
vs
Economists measure a firm’s profit to enable them to predict the firm’s decisions, and the goal of these decisions is to maximize economic profit.
Economic profit is equal to total revenue minus total cost, with total cost measured as the opportunity cost of production.
What five choices must a firm make to maximize economic profit?
- What to produce and the quantity
- What production techniques to use
- How much to pay workers
- How to market and price the product
- What to produce themselves and what to buy from other firms
What are the three features of its environment that limit the maximum profit a firm can make
- Technology constraints
- Information constrains
- Market constraints
Technical efficiency vs economic efficiency
Technical efficiency means that the fewest possible inputs are used to produce a given output.
Technical efficiency is efficiency that does not consider costs of production.
The economically efficient method of production is the method that produces a given level of output at the lowest possible cost.
Principle agent problem:
the problem of devising compensation rules that induce an agent to act in the best interest of the principal.
The two types of decision times frames are:
Short run and long run
Important things about the short run time frame:
- The short run is a time frame in which the quantity of at least one input is fixed and the quantities of the other inputs can be varied.
- In the short run, a firm’s plant is fixed. To increase output, it must increase the quantity of variable inputs it uses, typically labor.
Short-run decisions are easily reversed.
Important things about the long run time frame:
- The long run is a time frame in which the quantities of all inputs can be varied.
- In the long run, a firm can increase output by varying plant as well as the quantity of variable inputs it uses.
-Long-run decisions are not easily reversed.
Past costs of buying a new plant are sunk costs. A sunk cost is irrelevant to the firm’s decisions.
Total product vs marginal product vs Average Product
Tp= Total product produced
Mp= increase in total product that result from a one-unit increase in an input.
Ap=total product divided by the quantity of inputs.
Marginal product curves two features=
increasing marginal returns initially
occurs when the marginal product of an additional worker exceeds the marginal product of the previous worker.
diminishing marginal returns eventually
Law of diminishing returns:
As a firm uses more of a variable input, with a given quantity of fixed inputs, the marginal product of the variable input eventually diminishes
Tc= Tfc + tvc
Total cost= total fixed cost + total variable costs
To produce more output in the short run, the firm must employ more labour, which increases its costs. There are three cost concepts:
Total cost
Marginal cost
Average cost
