quiz 2 - production costs, profit maximization Flashcards
what three considerations must firms make?
1 - what is the lowest cost method of producing good
2 - given the costs for producing each possible good, what should they produce
3 - how much of that good should they produce?
what are the three types of costs
accounting costs
economic costs
opportunity costs
accounting cost
Actual expenses plus depreciation charges for capital equipment
economic costs
Cost to a firm of utilizing economic resources in production, including opportunity cost
opportunity costs
Cost associated with opportunities that are forgone when a firm’s resources are not put to their best alternative use.
total costs
Total economic cost of production, consisting of fixed + variable costs
fixed costs
Cost that does not vary with the level of output and that can be eliminated only by shutting down
Examples include overhead costs like paying the electricity bill in an office, or paying back office staff like accountants
In the long-run, no costs are fixed because if production increased enough, you would need more offices and more accountants
A fixed cost can be avoided in the long run (but not in the short run) – you can shut down your operation and stop paying the cost
variable cost
aka marginal costs
Cost that varies as output varies.
variable cost = sum of all marginal costs
sunk cost
Cost that has already been incurred and cannot be recovered (even if you shut down)
is a warehouse a sunk cost?
no, if you have a warehouse, it is a fixed cost. However, it is not sunk, because you can sell the warehouse – it has an alternative use
is a market study a sunk cost?
yes, it is a fixed cost, but it is also sunk because you cannot sell it – it has no alternative use
is tuition a sunk cost
yes
how do costs change over time
in the very short run, all costs are fixed
in the very long run, all costs are variable
average total cost
firm’s total cost divided by output
AC(Q) = C(Q)/Q
note that total cost includes fixed and variable costs
marginal cost
Increase in cost resulting from the production of one extra unit of output.
MC = dTC/dQ
what is the relationship between MC and AC
If MCAC, AC is increasing
MC=AC at minimum AC
what is the relationship between MC and supply curve
they’re the same
total variable cost
is often just called variable cost
describe shape of marginal cost curve
marginal cost initially declines, then increases
why do they decrease? 2 reasons:
1 - The initial decrease is caused by improvements in productivity from specialization. At low levels of output, inputs (labor) cannot specialize. As more output is made, more inputs are hired and they can specialize.
2 - fixed costs per unit become smaller as more units are produced
why do they later increase? because of decreasing marginal gains = firm becomes bigger, costs become greater because inputs become scarce
where do MC and ATC intersect?
at the minimum of the ATC curve
the same relationship holds for average variable cost curve (MC intersects AVC at AVC’s minimum)
describe shape of average fixed cost curve
always declining - as you make more units, the fixed costs are spread over a greater number of units; since fixed costs don’t change and Q is increasing, average fixed cost is decreasing
economies of scale
as Q increases, ATC decreases; this is because larger scale allows specialization, optimized use of inputs and buying power to negotiate prices
but at some point, Q increases enough that ATC starts to increase; this is because very large firms become more complex and harder to manage; they have exhausted their efficient inputs and have to rely on increasingly inefficient ones that drive costs up; you get diminishing returns to your inputs (called diseconomies of scale)
what does it mean if a firm has a total cost curve that is declining
this means that each unit of output produced drives costs down indefinitely; this is only possible if the firm has very high fixed costs relative to marginal costs
this is a natural monopoly - most efficient outcome is if this one firm produces all of the output
good example of natural monopolies is a utility company - extremely high fixed costs (the power line distribution) but running electricity through those lines has very low marginal cost
what is the slope of a firm’s production possibilities frontier?
its marginal cost
supply is based on ____
profit is based on _____
marginal cost
average cost
