Production Decisions

Question 1

What is comparative advantage?

Answer 1

The idea that workers differ not only in their absolute ability to do things but also their relative ability to do things. Also applies to trade i.e. countries having relative ability to produce goods

Question 2

What does an isoquant line show? What does it look like on a diagram?

Answer 2

Shows all possible combinations of inputs that can produce a given efficient level of output. Different points on the isoquant represent different techniques.

An isoquant diagram has capital (x-axis) and labour (y-axis). The isoquant is downward sloping and curved (sort of like an l but less pronounced)

Question 3

What does the isocost line show? What does it look like on the diagram?

Answer 3

Shows different input combinations with the same total cost.

X-axis = capital, Y-axis=labour, the isocost is downward sloping, and the close to the origin the lower the total cost for the firm

Question 4

What is the equation for the isocost line? What is the slope?

Answer 4

Total cost = (wage ratelabour) + (price of capitalcapital)

Slope = -r / w, where r = p of capital, w = wage rate

Question 5

How does the firm choose a production technique? i.e. the cost-minimizing production technique

Answer 5

Where the isoquant is tangent to the lowest possible isocost

Question 6

What would be the result of an increase in the relative price of capital?

Answer 6

The slope of the isocost will increase, making less capital intensive techniques more attractive

Question 7

What is the marginal rate of technical substitution (MRTS)?

Answer 7

MRTS = the amount by which the quantity of one input has to be reduced when on extra unit of another input is used, so that output remains constant

Question 8

What does the short-run average variable (and total) cost curve look like? (X= Output, Y=Cost)

Answer 8

U-shaped curve

Question 9

What does the short-run average fixed cost curve look like? (X=Output, Y=Cost)

Answer 9

Loose L shape

Question 10

Define constant returns to scale?

Answer 10

An equal or proportionate increase in all inputs gives the same proportionate increase in output

Question 11

Define decreasing returns to scale?

Answer 11

An equal proportionate increase in all inputs gives a smaller proportionate increase in output

Question 12

Define increasing returns to scale?

Answer 12

An equal proportionate increase in all inputs gives a larger proportionate increase in output

Question 13

What will the long-run total cost curves look like for different returns to scale? (X=output, Y=cost)

Answer 13

Constant = straight upward sloping diagonal line
Increasing = sort of lower case r
Decreasing = mirror of increasing

Question 14

What does the marginal (both short and long run) cost curve look like?

Answer 14

similar to a nike tick

Question 15

What does the marginal cost curve represent?

Answer 15

The increase in total cost if output increases by one unit

Question 16

What are the 2 key points on the relationship between marginal and average cost curves

Answer 16

1) When marginal cost is below (above) average cost, average costs must be falling (rising)
2) Marginal cost curve always intersects the average cost curve at it’s minimum point