Production theory

Question 1

What is the short run

Answer 1

Only one factor of production is variable others are fixed

Question 2

What is the long run?

Answer 2

All factors of production are variable

Question 3

What is short run proudction subject to?

Answer 3

Short-run production is subject to the law of diminishing returns

Question 4

What do we assume firms aim to do?

Answer 4

Profit max

Question 5

What is a firms profit?

Answer 5

Total revenue- Total cost

Question 6

What is opportunity cost?

Answer 6

the cost of something is what you give up to receive it

Question 7

What does a firms opportunity cost include?

Answer 7

A firm’s costs include opportunity costs: the value of the next best alternative

Question 8

What do explicit costs require?

Answer 8

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

Question 9

What do implicit costs not require?

Answer 9

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

Question 10

What is accounting profit?

Answer 10

Accounting profit = total revenue – explicit costs

Question 11

What si economic profit?

Answer 11

Economic profit = total revenue – explicit costs – implicit costs

Question 12

How does output change?

Answer 12

With labout and capital

Question 13

In the short run what is the only FoP which can vary?

Answer 13

Labour

Question 14

What is total phsycial product of labour?

Answer 14

Total physical product of labour (TPPL)

This is total output that is produced by the units of labour, for a given capital

Question 15

What is average physcial product of labour?

Answer 15

Average physical product of labour (APPL)

This is the average output produced by the units of labour, for a given capital

APPL = TPPL/L

Question 16

What is marginal physical product of labour?

Answer 16

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

Question 17

What is the law of dimishing returns?

Answer 17

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

Question 18

Why will TPP fall in the short run?

Answer 18

In the short-run, it is just impossible that increasing the hire of variable factor can increase output indefinitely…

Question 19

Explain the shape of the TPP curve?

Answer 19

Indicated by the change in the labour hired leading to the change in

D TPP / D L = MPP

Question 20

Diagram to show TPP and MPP

Answer 20

Question 21

Diagram to show the relation between TPP and MPP

Answer 21

Question 22

Relationship between MPP and APP

Answer 22

Question 23

Diagrams to plot TPP, APP and MPP

Answer 23

Question 24

Relationship between costs and production in the SR

Answer 24

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

Question 25

Total costs equation

Answer 25

Total costs (TC) = total fixed costs (TFC) + total variable costs (TVC)

Question 26

What are total fixed costs?

Answer 26

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

Question 27

What are total variable costs?

Answer 27

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

Question 28

What is average total cost?

Answer 28

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

Question 29

What is marginal cost?

Answer 29

This is the extra cost of producing one more unit of output (Recall that ∆ means change) MC = ∆TC/∆Q = TC(Q+1) –TC(Q)

Question 30

Diagram to show total cost curves

Answer 30

Question 31

Diagram to show average and marginal cost curves

Answer 31

Question 32

Methods to derive the shape of the average and marginal cost curves

Answer 32

1. 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 2. 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

Question 33

How the shapes of average and marginal cost curves are dervied

Answer 33

Question 34

Shape of MC explained

Answer 34

Marginal costs This is related to the marginal product of the variable factor Falling MC = increasing returns Rising MC = diminishing returns

Question 35

Shape of Average cost curves explained

Answer 35

Question 36

Diagram showing MC, ATC and AVC

Answer 36

Question 37

Summary notes for short run production and costs

Answer 37

Question 38

When is a seller a price taker?

Answer 38

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

Question 39

What is market price elastciity of deamnd?

Answer 39

price elasticity of demand (PED) = – % change in quantity demanded/ % change in price

Question 40

When is a buyer a price taker?

Answer 40

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

Question 41

When is a seller a price maker?

Answer 41

A seller is a price maker if the amount it sells affects the market price

Question 42

When is a buyer a price maker?

Answer 42

A buyer is a price maker if the amount it buys affects the market price

Question 43

Normal profit?

Answer 43

Firm breaks even

Question 44

Supernormal profit?

Answer 44

Firms total revenue is greater than its total costs

Question 45

Diagram to show a firms revenue, costs and profit

Answer 45

Question 46

What is average revenue?

Answer 46

1) Average revenue (AR) This is the amount that the firm earns per unit of output sold AR = TR/Q

Question 47

What is marginal revenue?

Answer 47

2) Marginal revenue (MR) This is the extra revenue of selling one more unit of output MR = ∆TR/∆Q = TR(Q+1) –TR(Q)

Question 48

Show the demand curve of a price taking firm and explain why

Answer 48

Question 49

Profit equation

Answer 49

Profit = total revenue – total fixed costs – total variable costs

Question 50

Short run shut down rule

Answer 50

Question 51

Long run shutdown rule

Answer 51

Question 52

Supernormal profit in SR diagram

Answer 52

Question 53

Diagram to show a loss of a firm

Answer 53

Question 54

Diagram to show loss in the short run

Answer 54

Question 55

When should a firm not shutdown?

Answer 55

Question 56

When should a firm shutdown?

Answer 56

Question 57

If a firm does not shut down, at what level should it produce and why?

Answer 57

Question 58

What is the marginal output rule?

Answer 58

Question 59

Where a profits maxed in the SR?

Answer 59

Where MC=MR

Question 60

Diagram to show profit max in the short run

Answer 60

Question 61

When are loss minimised?

Answer 61

At a point where MR=MC

Question 62

Diagram to show loss minimisation in the short run

Answer 62

Question 63

Why does the supply curve slope upwards?

Answer 63

As price increases, the quanityt supplied by the firm increases

Question 64

Diagram to show upwards sloping supply curve

Answer 64

Question 65

Summary notes of revenue and profit max

Answer 65