Production theory Flashcards
What is the short run
Only one factor of production is variable others are fixed
What is the long run?
All factors of production are variable
What is short run proudction subject to?
Short-run production is subject to the law of diminishing returns
What do we assume firms aim to do?
Profit max
What is a firms profit?
Total revenue- Total cost
What is opportunity cost?
the cost of something is what you give up to receive it
What does a firms opportunity cost include?
A firm’s costs include opportunity costs: the value of the next best alternative
What do explicit costs require?
Explicit costs: require a cash flow from the firm
● when £1000 is used to pay workers, that £1000 can’t be used for something else
What do implicit costs not require?
Implicit costs: do not require a cash to flow out of the firm
● running business is costly: owner could do something else with time & money
What is accounting profit?
Accounting profit = total revenue – explicit costs
What si economic profit?
Economic profit = total revenue – explicit costs – implicit costs
How does output change?
With labout and capital
In the short run what is the only FoP which can vary?
Labour
What is total phsycial product of labour?
Total physical product of labour (TPPL)
This is total output that is produced by the units of labour, for a given capital
What is average physcial product of labour?
Average physical product of labour (APPL)
This is the average output produced by the units of labour, for a given capital
APPL = TPPL/L
What is marginal physical product of labour?
Marginal physical product of labour (MPPL)
This is the extra output of producing one more unit of labour, for a given capital MPPL = ∆TPPL/∆L = TPPL+1 – TPPL
What is the law of dimishing returns?
LAW OF DIMINISHING RETURNS:
When some factors are fixed in the short run, employing another unit of a
variable factor eventually results in smaller and smaller increases in output This means to increase production, larger amounts of variable factors must be used
Why will TPP fall in the short run?
In the short-run, it is just impossible that increasing the hire of variable factor can increase output indefinitely…
Explain the shape of the TPP curve?
Indicated by the change in the labour hired leading to the change in
D TPP / D L = MPP
Diagram to show TPP and MPP
Diagram to show the relation between TPP and MPP
Relationship between MPP and APP
Diagrams to plot TPP, APP and MPP
Relationship between costs and production in the SR
Firms incur costs when they buy factors of production: more inputs, higher costs
Variable factor usually labour: easier to increase labour quickly than capital
EXAMPLE:
Consider a small farm that produces wheat
To produce wheat it requires just two factors of production: workers and tractors
In the short-run - number of tractors is constant, more workers can be employed
Total costs equation
Total costs (TC) = total fixed costs (TFC) + total variable costs (TVC)
What are total fixed costs?
Total fixed (economic) costs (TFC)
Fixed costs are not related to the amount of output produced
● They are incurred even if nothing is produced
● They can change but not as a result of affecting output
These relate to “costs for tractors” in our previous example
What are total variable costs?
Total variable (economic) costs (TVC)
Variable costs are related to the amount of output produced
● They are not incurred if nothing is produced ● They increase as more is produced
These relate to “costs of workers” in our previous example
What is average total cost?
1) Average total cost (ATC) = average variable cost (AVC) + average fixed cost (AFC)
This is the average cost per unit of output
ATC =TC/Q=(TVC+TFC)/Q
= TVC/Q + TFC/Q = AVC + AFC
What is marginal cost?
This is the extra cost of producing one more unit of output (Recall that ∆ means change)
MC = ∆TC/∆Q = TC(Q+1) –TC(Q)
Diagram to show total cost curves
Diagram to show average and marginal cost curves
Methods to derive the shape of the average and marginal cost curves
- Method 1:
The numerical example we just saw
This method helps us to draw the curves and understand the relationships among ATC, AVC and MC
- Method 2:
The one we will be looking at
Using the link between the “physical product of labour” and the “cost” Physical product of labour includes: MPP, APP and TPP
Costs include: Marginal cost, average cost, and total cost
How the shapes of average and marginal cost curves are dervied
Shape of MC explained
Marginal costs
This is related to the marginal product of the variable factor Falling MC = increasing returns
Rising MC = diminishing returns
Shape of Average cost curves explained
Diagram showing MC, ATC and AVC
Summary notes for short run production and costs
When is a seller a price taker?
Price takers
● A seller is a price taker if it can sell as much as it wants at a given price Price takers are small compared to the size of the market
What is market price elastciity of deamnd?
price elasticity of demand (PED) = –
% change in quantity demanded/ % change in price
When is a buyer a price taker?
A buyer is a price taker if the individual can buy as much as the individual wants at a given price without affecting the price
When is a seller a price maker?
A seller is a price maker if the amount it sells affects the market price
When is a buyer a price maker?
A buyer is a price maker if the amount it buys affects the market price
Normal profit?
Firm breaks even
Supernormal profit?
Firms total revenue is greater than its total costs
Diagram to show a firms revenue, costs and profit
What is average revenue?
1) Average revenue (AR)
This is the amount that the firm earns per unit of output sold AR = TR/Q
What is marginal revenue?
2) Marginal revenue (MR)
This is the extra revenue of selling one more unit of output MR = ∆TR/∆Q = TR(Q+1) –TR(Q)
Show the demand curve of a price taking firm and explain why
Profit equation
Profit = total revenue – total fixed costs – total variable costs
Short run shut down rule
Long run shutdown rule
Supernormal profit in SR diagram
Diagram to show a loss of a firm
Diagram to show loss in the short run
When should a firm not shutdown?
When should a firm shutdown?
If a firm does not shut down, at what level should it produce and why?
What is the marginal output rule?
Where a profits maxed in the SR?
Where MC=MR
Diagram to show profit max in the short run
When are loss minimised?
At a point where MR=MC
Diagram to show loss minimisation in the short run
Why does the supply curve slope upwards?
As price increases, the quanityt supplied by the firm increases
Diagram to show upwards sloping supply curve
Summary notes of revenue and profit max
