test 2

Question 1

short-run

Answer 1

period of time during which at least one of a firm’s inputs is fixed

Question 2

long-run

Answer 2

firm can vary all of its inputs, adopt new technology, and increase or decrease the size of its physical plant

Question 3

variable costs

Answer 3

costs that change as output changes

Question 4

fixed costs

Answer 4

costs that remain constant as output changes

Question 5

law of diminishing marginal returns

Answer 5

adding more of a variable input, such as labor, to the same amount of a fixed input, such as capital, will eventually cause the marginal product of the variable input to decline
- what TP curve is based on

Question 6

Assumptions for law of diminishing marginal returns

Answer 6

• short run (fixed factors variable)
• fixed factors do not change
• technology is given
• all the workers are of the same quality

Question 7

TFC curve

Answer 7

• horizontal line
• does not change as output changes
• is zero when Q is zero

Question 8

TVC curve

Answer 8

cost of variable inputs

• when Q is zero, TVC is zero
• increases at a diminishing rate at the beginning
• increases at an increasing rate in later stage
• shape of TVC depends on law of DMU
• mirror image of TP curve

Question 9

TC curve

Answer 9

cost of all the inputs a firm uses in production
TC= TFC + TVC
- TC is parallel to TVC
- TFC is distance between TVC and TC

Question 10

AFC curve

Answer 10

AFC = TFC / Q

Continuously downward sloping curve

Question 11

AVC curve

Answer 11

AVC = TVC / Q

U-shaped

Question 12

AC curve

Answer 12

AC = AFC + AVC
Difference between 2 successive TVC
- U-shaped smaller than AVC
- Law of DMU

Question 13

MC

Answer 13

MC= change in TC / change in Q
Cuts AC curve at its lowest point
- If M < A, then A must be falling
- If M > A, then A must be rising

Question 14

Long-run AC curve

Answer 14

Shows the lowest cost at which a firm is able to produce a given quantity of output in the long run, when no inputs are fixed
U-shaped because of economies and diseconomies of scale

Question 15

Economies of scale

Answer 15

the firms LRAC falls as it increases the quantity of output it produces
LAC ↓ as Q ↑ 
Advantages of growing bigger: 
- volume discounts
- better utilization of fixed factors
"increasing returns to scale"

Question 16

Diseconomies of scale

Answer 16

the firms LRAC increases as it increases the q of output it produces after MES
LAC ↑ as Q ↑
Disadvantages of growing too big:
- supervision and management become costly
“Decreasing returns to scale”

Question 17

Increasing returns to scale

Answer 17

If inputs ($ costs) are doubled, output more than doubles
AC will fall ↓
because output increased proportionately more than cost

Question 18

Decreasing returns to scale

Answer 18

If inputs ($costs) are doubled, output less than doubles
AC ↑

Question 19

Constant returns to scale

Answer 19

If inputs are doubled, outputs are also doubled
AC remains constant
special case

Question 20

Minimum efficient scale (MES)

Answer 20

the level of output at which all economies of scale are exhausted

• lowest cost
• AC
• most efficient

Question 21

Perfect competition characteristics

Answer 21

• large number of small sellers
• identical/ homogeneous products (perfect subs)
• D is horizontal line (elasticity is infinite)
• No control over p (“price takers”)
• Free entry and free exit (no barriers)

Question 22

Condition for short-run equilibrium

Answer 22

MR = MC

total profits are maximized

Question 23

Supernormal profits

Answer 23

P > AC
Profits are over and above the minimum
Total Profits = TR - TC

Question 24

Long-run adjustments for supernormal profits

Answer 24

• more firms will enter the industry
• S ↑
• EQp ↓
• Profits ↓
• entry of new firms will continue until all the firms just get the normal profits

Question 25

Loss

Answer 25

P < AC

Firms cant raise P because they are price takers

Question 26

Why are firms price takers?

Answer 26

P is industry determined
D is horizontal
Market share is tiny
Products are identical to competitors

Question 27

Long-run adjustments for loss

Answer 27

• existing firms leave the industry (free exit)
• industry S ↓
• EQp ↑
• Losses ↓
• process continues until all the remaining firms get only normal profits

Question 28

normal profits

Answer 28

1. P = AC, AR = AC
2. Included in AC
3. Bare minimum profits a firm expects to get
4. if a firm does not get normal profits, it will leave the industry

Question 29

What happens in the long run?

Answer 29

always end up with normal profits

Question 30

Why do firms get only the normal profits?

Answer 30

under perfect competition, in the long-run, firms get only normal profits because of free entry and free exit