Theory of the Firm: Production

Question 1

Theory of the Firm

Answer 1

Firms offer coordination to the market
- Theory of the Firm: explains how firms make cost minimizing production decisions and how cost varies with its output
Understood through:
- Production Technology
- Cost Constraints
- Input Choices

Question 2

Factors of Production

Answer 2

Inputs into the production process e.g. labour, material and capital

Question 3

Production Function

Answer 3

Relationship where inputs are put together to provide outputs
- Capital (K)
- Labour (L)
Q = f(K,L)

Question 4

Production Short-run

Answer 4

Period of time when only some of a firm’s inputs can be varied
- Variable factors: inputs that can be changed in the short-run
- Fixed factor: inputs that can’t be changed in the short run

Question 5

Production Long-run

Answer 5

Period of time when a firm can change any input

Question 6

Production Function Slope

Answer 6

(change in Q/ change in L) = 2K0

Question 7

The Law of Diminishing Return

Answer 7

If other inputs are fixed factors, the increase in output from an increase in variable factor inputs much eventually decline.

Question 8

Total Product Curve

Answer 8

Curve that shows the amount of output as a function of the amount of variable output.
(graph)

Question 9

Marginal Product

Answer 9

The change in total product due to a 1-unit change in the variable input.
MP = (change Q/ change L)

Question 10

Average Product

Answer 10

Of a variable input:
Total product / Q of that input
AP = Q/L

Question 11

MPC and APC

Answer 11

• If MPC lies above APC: APC is rising
• If MPC lies below APC: APC is falling
  ^ the two curves intersect at the max value of the APC

Question 12

Isoquant

Answer 12

The combination of variable inputs that yields a given level of output
(graph)

Question 13

Marginal Rate of Technical Substitution (MRTS)

Answer 13

The rate at which one input can be exchanged for another without altering the output
- Assume this is diminishing as isoquant is convex
- Productivity for any 1 input is limited: more labour added in place of capital, productivity will decrease
Between two points, MRTS = ratio of the marginal products of the inputs

Question 14

Perfect Substitution in Isoquants

Answer 14

If inputs are perfect substitution for one another, MRTS is constant at all points of the isoquant
(graph)

Question 15

Perfect Complements in Isoquants

Answer 15

If there’s perfect complements, its impossible to make substitutions among inputs
(graph)

Question 16

Returns to Scale

Answer 16

Describes the relationship between scale and efficiency (is a long-run concept as all factor inputs are variable)

Question 17

Increasing Returns to Scale

Answer 17

Production function for any given proportional change in all inputs leads to proportional change in output

Question 18

Constant Returns to Scale

Answer 18

Production function for any given proportional change in all inputs causes output to change by the same proportion

Question 19

Decreasing Returns to Scale

Answer 19

Production function for any given proportional change in all inputs causes less than proportionate change in output

Question 20

Different Production Functions

Answer 20

1. Cobb-Douglas (most used)
   - Q = mK^α ×L^β
   (graph)
2. Leontief (Simplest)
   - Q = min(a/K, b/L)
   ​(graph)