Production, Cost and the Perfect Competition Model Flashcards
Why do firms face costs and what are these costs called?
Firms face costs because the resources they need, have alternative uses that other firms compete for. Therefore, the economic cost is the payment that must be made to obtain or retain a resource
What is an opportunity cost?
The cost of the foregone, next-best alternative
What do all resources have associated with them?
All resources have an opportunity cost.
Ex. An oak tree can be sold as lumber or can be bought as raw material to be made into a table
What is the difference between explicit and implicit costs?
- Explicit - a firm’s monetary payment for a resource it doesn’t have
Ex. Purchasing new assets, hiring workers, purchasing raw materials
- Implicit - the opportunity cost for using resources that it already has
Ex. Giving workers a day off
How is accounting profit found and what are its disadvantages?
Accounting profit = Total Cost- Revenue
Accounting profit does not account for implicit costs and therefore is an idealized summary
What is normal profit
- Normal profit takes into account both explicit and implicit costs
- Normal profit is a condition that exists when a company or industry’s economic profit is equal to zero.
How is economic profit different from accounting profit?
Economic profit factors in implicit costs and directs how resources are allocated in the economy
Economic profit = Revenue - Explicit - Implicit
What can a firm conclude if it breaks even?
Allows entreprenuers to conclude that they are doing exactly as well as they could expect to in an alternative business venture
How do resources flow when positive economic profits are achieved?
Resources will move toward producing with higher net benefits
What is plant capacity?
- The size of the factory building, the amount of machinery and equipment, and other capital resources
- The bigger the organization, the harder it becomes to change plant capacity
What is the difference between short (fixed plant) and long run (variable plant)
Short run - period too brief for a firm to alter its plant capacity, yet long enough to permit a change in the degree to which the plant’s capacity is used
Long run - period long enough for a firm to adjust the quantities of all resources that it employs, including plant capacity
What is total product (TP)?
The total quantity, or total output, of a particular good or service produced
What is marginal product (MP)?
The extra output or added product associate with adding a unit of a variable resource to the production process
MP = change in TP/change in labor input
What is average product (AP)?
Alternatively called “labor productivity”, AP is output per unit of labor input
AP = TP/units of labor
What is the law of diminishing returns?
- Law that assumes that technology is fixed and thus techniques of prodction do not change
- As sucessive units of a variable resource (labor) are added to a fixed resource (capital or land), beyond some point the benefit will increase at a decreasing rate
Ex. A farm or a shirt factory
What does a total production curve look like?
- Rises initially at an increasing rate
- Increases but at a diminishing rate
- After reaching a maximum point it declines
What does a marginal product curve look like
- MP is the slope of the total product curve because it measures the change in total producted with each succeeding unit of labor
What is the relationship between an MP and TP curve?
- When TP is increasing at an increasing rate, MP is rising
- When TP is increasing at a decreasing rate, MP is positive but falling
- When TP is at maximum, MP is at 0
- When TP declines, MP becomes negative
What is the relationship between an MP and AP curve?
- When MP exceeds AP, AP rises
- When MP is less than AP, AP declines
- MP intersects AP where AP is at its maximum
What are fixed costs?
- Costs that do not vary with changes in output
- Fixed costs are beyond a business manager’s current control; they are incurred in the short run and must be paid regardless of output level
Ex. rental payments, interest on firm’s debts, insurance premiums
What are variable costs?
- Costs that change with the level of output however it increases by increasing amounts due to the law of diminishing returns
- Variable costs can be controlled or altered in the short run by changing production levels
Ex. payments for materials, fuel, power, transportation services, and labor
What is total cost (TC)?
The sum of fixed cost and variable costs at each level of output which is measured vertically on a graph
TC = TFC + TVC
What is average fixed cost (AFC)?
- Because TFC is the same regardless of oupute, AFC must declien as output increases.
- As output rises, the TFC is spread over a larger and larger output AKA “spreading the overhead”
- AFC is a continually declining curve as total ouput increases
AFC = TFC/Q
What is average variable cost (AVC)?
- Due to increasing and then diminishing returns, AVC declines initially, reaches a minimum, and then increases again.
- AVC is a U-shaped curve because production is relativel tin
AVC = TVC/Q
What are the characteristics of a perfectly competitive market?
- Many buyers and sellers in the market
- The goods offered are about the same
- Firms can freely enter or exit the market (if they feel they can make or lose a profit)
What is an example of a perfectly competitive market?
Agriculture before social programs of the New Deal
What are the outcomes of a perfectly competitive market?
- Individual firm produces a small portion of the total market output
- The firm cannot have influence over the price it charges (the customer will either leave or cause the customer to go bankrupt)
In a perfectly competitive market, what is the individual firm considered?
Price taker who takes the price determined by the market as the price that it will receive for its output
