Unit 3 - Cost of production and pure competition

Question 1

Law of diminishing marginal returns

Answer 1

The principle that as successive units of a variable resource are added to a fixed resource, the marginal product of the variable resource will eventually decline.

Question 2

Short run cost curve

Answer 2

ATC hits the MC at ATC minimum
MC goes down and up because of as you hire more workers, they specialize. Additional costs are gonna fall. But as you hire more people they will produce less and less stuff.

Question 3

Long run cost curve

Answer 3

In the long run, all resources are variable. Law of diminishing marginal reutrns does not apply.

Economies of scale: Mass production means AC goes down
Constant returns to scale: Can’t use more mass production tech and costs level.
Diseconomies of scale: Costs go back up in the long run.

Question 4

Pure/perfect competition characteristics

Answer 4

• Many small sellers
• Standardized/Substitute product
• “Price takers” - firms have no pricing power
• Low barriers of entry and exit
• Perfectly elastic demand/horizontal demand - cant choose price so they only choose amount to produce.

Long run equilibrium. If ATC below demand - profit.

Question 5

Profit maximization rule

Answer 5

Produce amount where MC = MR. If MC is less

Question 6

What is the shut down rule?

Answer 6

If the price falls below AVC, the firm should shut down. This is the only rule that trumfs MR = MC

Question 7

Accounting vs economic profit

Answer 7

Accounting profit only looks at explicit costs while economic profit looks at explicit and implicit cost (opportunity costs)

Question 8

Productive efficiency and allocative efficiency

Answer 8

Productive efficiency is the production of a good in the least costly way. Graphically where price equals minimum ATC.

Allocative efficiency is the production of the right mix of goods and services. Graphically where price equals MC

Question 9

Economies of scale

Answer 9

Refers to the idea that, for a time, larger plant sizes will lead to lower unit costs. An increase in inputs where there are economies of scale will lead to a more than proportionate increase in output.

• Labor specialization
• Managerial specialization:
• Efficient capital: high-volume production-warrants the expensive large scale equipment.
• Other factors lead to economies of scale because costs such as design, development, and advertising are spread out over larger quantities

Question 10

Diseconomies of scale

Answer 10

Diseconomies of scale may occur if a firm becomes too large, as illustrated by the rising part of the long-run ATC curve. As the firm expands over time, the expansion may lead to higher average total costs. With diseconomies of scale, an increase in inputs will cause a less-than-proportionate increase in output.
Reasons that diseconomies of scale may occur:

• (1) it is difficult in controlling and coordinate large-scale operations
• (2) a large bureaucracy leads to communication problems
• (3) workers may feel alienated and therefore may not work efficiently
• (4) shirking, or work avoidance, may be easier in a larger firm.