test 2 Flashcards
short-run
period of time during which at least one of a firm’s inputs is fixed
long-run
firm can vary all of its inputs, adopt new technology, and increase or decrease the size of its physical plant
variable costs
costs that change as output changes
fixed costs
costs that remain constant as output changes
law of diminishing marginal returns
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
Assumptions for law of diminishing marginal returns
- short run (fixed factors variable)
- fixed factors do not change
- technology is given
- all the workers are of the same quality
TFC curve
- horizontal line
- does not change as output changes
- is zero when Q is zero
TVC curve
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
TC curve
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
AFC curve
AFC = TFC / Q
Continuously downward sloping curve
AVC curve
AVC = TVC / Q
U-shaped
AC curve
AC = AFC + AVC
Difference between 2 successive TVC
- U-shaped smaller than AVC
- Law of DMU
MC
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
Long-run AC curve
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
Economies of scale
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"
Diseconomies of scale
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”
Increasing returns to scale
If inputs ($ costs) are doubled, output more than doubles
AC will fall ↓
because output increased proportionately more than cost
Decreasing returns to scale
If inputs ($costs) are doubled, output less than doubles AC ↑
Constant returns to scale
If inputs are doubled, outputs are also doubled
AC remains constant
special case
Minimum efficient scale (MES)
the level of output at which all economies of scale are exhausted
- lowest cost
- AC
- most efficient
Perfect competition characteristics
- 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)
Condition for short-run equilibrium
MR = MC
total profits are maximized
Supernormal profits
P > AC
Profits are over and above the minimum
Total Profits = TR - TC
Long-run adjustments for supernormal profits
- more firms will enter the industry
- S ↑
- EQp ↓
- Profits ↓
- entry of new firms will continue until all the firms just get the normal profits
Loss
P < AC
Firms cant raise P because they are price takers
Why are firms price takers?
P is industry determined
D is horizontal
Market share is tiny
Products are identical to competitors
Long-run adjustments for loss
- existing firms leave the industry (free exit)
- industry S ↓
- EQp ↑
- Losses ↓
- process continues until all the remaining firms get only normal profits
normal profits
- P = AC, AR = AC
- Included in AC
- Bare minimum profits a firm expects to get
- if a firm does not get normal profits, it will leave the industry
What happens in the long run?
always end up with normal profits
Why do firms get only the normal profits?
under perfect competition, in the long-run, firms get only normal profits because of free entry and free exit
