Production Theory Flashcards

Question

Isocost line

Answer 1

combinations of labor and capital that can produce an output at the same cost C = w*L + r*K Analogous to a budget constraint

Answer 2

The LRAC is the lower envelope of the SRAC for different plant sizes. The LR cost of production is lower than the SR cost of production

Answer 3

``` Many small buyers and sellers Identical products Symmetric information No transactions costs Free exit and entry in the long run ```

Answer 4

No, the residual demand (or the demand curve a firm faces) is much more elastic than the overall demand curve of the market

Answer 5

pi = R(q) - C(q) where R(q) is the total revenues the firm receives from selling output "q" and C(q) is the cost

Answer 6

Set MR = MC or dR(q)/dq = dC(q)/dq & produce outputs at this point

Answer 7

Competitive firms face a perfectly elastic demand curve, MR = P, hence for a perfectly competitive firm P = MC

Answer 8

In the short run, firms shut down if P < min AVC To find this, we can derive individual firm supply curve using P = MC and Q = 0 (shut down) for P < min AVC

Answer 9

the horizontal sum of individual firm SR supply curves

Answer 10

Can be either positive or negative

Answer 11

In LR, free entry and exit drives economic profits to 0, i.e. P = MC = AC. Hence, LR industry supply curve is perfectly elastic at P = min AC and each firm produces at q = min AC

Answer 12

SR supply less elastic than LR supply with barriers to entry LR supply w/ barriers to entry is less elastic than LR supply curves with free entry

Answer 13

Could lead to an upward sloping LR supply curve, even with free entry

Answer 14

In the SR and LR, demand for labor will be its marginal revenue product MRPL = MR * MPL MR = marginal revenue from an additional unit of output (MR = p if competitive output market); however MPL in LR will take into account optimal capital adjustmnets

Answer 15

LR labor demand is more elastic than SR labor demand

Answer 16

Capital is fixed in the SR, and variable in the LR

Answer 17

When average costs are falling, they must be below the marginal costs When they rising, they must be above the marginal cost If the average cost > marginal cost, you can always drive average cost down by producing more (left of the intersection) If the average cost < marginal cost, the more you produce, the more the average costs go up (right of intersection)

Answer 18

In the short run, a firm should shut down when total variable cost exceeds total revenue, which is also when average variable cost exceeds price. Fixed costs cannot be avoided in the short run, so they are irrelevant to the shutdown decision. You only shut down if: "pq" < VC "p" < AVC

Answer 19

Key difference is the shutdown rule For SR competition: Firm will shutdown when price is less than AVC (fixed costs can't be changed) For LR competition: Firms will shutdown when price is less than Average Costs (fixed and variable together)

Answer 20

We're going to argue that this decision will be a function of the profits being made in that market Enter if profits being made; exit if money is being lost In a perfectly competitive market, firms will enter & exit in the long run until profits are zero Entry & exit drives profit to zero (in the LR)

Answer 21

All the firms will be producing at marginal cost equals minimum average cost Long run supply, with identical firms, are free entry and exit, will be perfectly elastic at minimum average cost. Competition leads to cost minimization.

Answer 22

The market supply curve becomes increasingly elastic with firm entry. It does not ever become perfectly inelastic. Firms enter until average cost equals price (=MC), which is the point at which profits are driven to zero. This is also the point at which average cost is minimized, which is by definition the point at which the firm is operating at greatest efficiency.

Answer 23

Barriers to entry and exit, such as large sunk costs, mean that there is no longer free entry and exit. This makes entry difficult even for firms for which it would be profitable to produce in the long run. If firms are not identical — if some firms can produce at a lower minimum average cost — then they can stay in the market and make profits. However they might not out-compete all other firms because they cannot supply the market quantity demanded; that is, they are capacity-constrained. Input costs that rise with output, such as wages, increase the minimum average cost of higher quantities of output. This creates an upward-sloping output supply curve. Input prices are not driven to zero by competition. Firms do minimize the cost of their inputs, but this does not explain why input prices are not fixed. With non-identical firms, with costly entry and exit, or with rising input costs, not all of these results are necessarily true. But with identical firms, free entry and exit, and fixed input costs, all these results are true. Market price will be equal to the long-run minimum average cost of each firm in the market, driving their profits to zero, and squeezing out every firm that charges above or below that price.

Answer 24

They're forgone no matter what you produce at any level of production

Answer 25

price – average cost * number of units (level)

Answer 26

decreasing

Answer 27

increasing

Answer 28

is at its minimum

Answer 29

1. Write down the production function. 2. Solve for the optimum by setting MRTS = w/r; solve for either K or L 3. Rewrite the production function, substituting solved K or L 4. Solve for the other L/K 5. Plug L/K back into the production function to solve for K/L 6. Write cost function = C = rK +w L 7. Then put those numbers back into the cost function, as a function of the quantity