The Short- Run and Long Run Theory of Production

Question 1

The law of diminishing marginal returns

Answer 1

When increasing amounts of a variable factor and there is a given fixed factor eventually each additional unit of the variable factor will produce less output than the previous.

Question 2

TPP

Answer 2

Total Physical product- It is the total output of a product per period of time that is obtained from a given amount of inputs.

Question 3

APP

Answer 3

Average Physical Product is the total output per unit of the variable factor in question TPP/Q

Question 4

MPP

Answer 4

Marginal Physical Product is the extra output gained by the employment of one more unit of the variable factor. (Change in TPP/ Change in Q or first derivative of TPP)

Question 5

What is the total cost?

Answer 5

TFC +TVC

Question 6

Equation of the average cost

Answer 6

TC/Q

Question 7

Equation of the marginal cost

Answer 7

Change in Total cost divided by Change in quantity (or first derivative of TC)

Question 8

Why is the MC curve negatively sloped at first and then reaches a minimum point and becomes positively sloped?

Answer 8

At low levels of the variable factor relative to the fixed increasing this factor (for example labour) lowers the cost of each additional unit of output as these new workers can make use of unutilised land and capital and the workers can specialize in their areas of expertise rather than a small number of workers having to take on all areas of the production.
This means once the new workers join the cost that was spent for each additional unit of output they produce is lower than previously.
However, once the variable cost has been increased past a certain amount, the returns from this variable cost decrease and increasing this factor raises marginal cost as there is not enough of the fixed factor for each worker so productivity decreases.

Question 9

What is the shape of the Marginal Physical Product curve?

Answer 9

It is a mirror reflection of the marginal cost curve, increasing when the variable factor is first increased but becoming negatively sloped once MPP hits the maximum point due to diminishing marginal returns of the variable factor when the fixed factor is kept constant.

Question 10

How can the shape of the average cost curve be explained in terms of the marginal cost curve?

Answer 10

If additional units of output are being produced more cheaply than the average, their production pulls down the average cost.
However, when additional units are produced more expensively the marginal cost pushes up the average cost.
If MCAC , Ac is positively sloped
MC=AC where AC is stationary (minimum point)

Question 11

What is the difference between the short run and the long run?

Answer 11

In the short run at least one of the factors of production are fixed but in the long run all can be varied.

Question 12

What is the difference between diminishing marginal returns and decreasing returns to scale?

Answer 12

Diminishing marginal returns is in the short term where only one variable factor increases relative to a fixed factor of production.
Decreasing returns to scale is when a given increase in inputs (all of which are variable) leads to a smaller increase in output.

Question 13

Economies of scale

Answer 13

When increasing the scale of production lowers the cost per unit of output

Question 14

Increasing returns to scale

Answer 14

In the long run, as inputs are increased, output increases by a larger proportion.

Question 15

How can increasing returns to scale result in a firm experiencing economies of scale?

Answer 15

If a firm is able to increase output by a proportion higher than the increase in the factors of production the higher their output is the smaller amount of factors of production used for each unit is on average meaning it will be producing at a lower average cost.

Question 16

How can specialisation and division of labour lead to economies of scale?

Answer 16

Hiring more workers allows the different jobs to be split between them so they can specialise in an area and become highly efficient in their particular job (causing marginal product of labour to increase)

Question 17

How can the use of large machines lead to economies of scale?

Answer 17

Larger machines tend to be more efficient as more output can be gained from the same amount of input e.g. it only takes one person to operate a machine, whether big or small.

Question 18

How can multi-stage production lead to economies of scale?

Answer 18

A large factory may be able to take a product through several stages of the production process rather than having to spend an extra amount of money on moving a semi- finished product to different firms

Question 19

What are plant-economies of scale?

Answer 19

Economies of scale that arise due to the large size of a factory (rather than the firm in itself) e.g. specialisation, use of large machines, multi-stage production

Question 20

Organisational economies of scale

Answer 20

When a firm is large there can be a centralised administration of the firm, often after a merger savings can be made through rationalising activites.

Question 21

Rationalisation

Answer 21

The reorganizing of production to cut out waste and duplication and to cut costs (often after a merger).

Question 22

Financial economies

Answer 22

Large firms are often able to obtain lower interest rates as they are seen by banks as having lower risk.

They may be able to lower AC by buting certain inputs in bulk.

Question 23

Economies of scope

Answer 23

If a firm produces a range of products the firm often can reduce overhead costs by sharing them amongst the products.