Week 5 - costs of production Flashcards
explain total revenue, total costs and profit
Total revenue is the total amount (in $) a firm receives for the sale of its output.
• Total cost is the total amount (in $) a firm pays to purchase the inputs into production.
• Profit is the firm’s total revenue minus its total cost.
Profit = total revenue − total cost
define marginal product
Increase in output that arises from additional units of input
Define marginal cost
Increase in total cost that arises from an extra unit of input
Marginal cost helps answer the following question:
• How much does it cost to produce an additional unit of
output?
Marginal costs = Change in total costs / change in total quantity
difference between accountant and economist
economist includes all opportunity costs when allaying a firm where as accountant measure only explicit costs, therefore eco profit is smaller than accounting profit
Explicit costs are input costs that require a direct outlay of money by the firm.
• Implicit costs are input costs that do not require an outlay of money by the firm
When total revenue exceeds both explicit and implicit costs, the firm earns economic profit.
Explain difference between short term and long run
Long run = the period of time needed for all the factors of production to become variable
Short term = A period of time during which at least one factor of production is fixed
For many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered.
– In the short run, many costs are fixed.
– In the long run, fixed costs become variable costs.
Businesses have to make 2 key decisions
• How much to produce
• What do I charge
Define diminishing marginal product
The property whereby the marginal product of an input declines as the quantity of the input increases
• Example: As more and more workers are hired at a firm, each additional worker contributes less and less to production because the firm has a limited amount of equipment.
Define production function
relationship between quantity of inputs used and the quantity of output of that good
The slope of the production function measures the
marginal product of an input, such as a worker.
– When the marginal product declines, the production function becomes flatter.
– Lower the cost the better due to scarcity
– Competition forces firms to compete at the lowest point
Costs of production can be divided into 2 types:
– Fixed = costs that do not vary with the quantity of output produced (sunk costs) e.g. uni fees, rent
– Variable = Costs that vary with the quantity of output produced
Define average total costs
Average total costs = Total cost divided by the quantity of output
Define average fixed costs
Average fixed costs = fixed costs divided by the quantity of output
define average variable costs
Average variable costs = variable costs divided by the quantity of output
Define marginal costs
Marginal costs = The increase (difference) in total costs that arises from an extra unit of production
3 important properties of cost curves
– Marginal cost eventually rises with the quantity of output.
– The average-total-cost curve is U-shaped.
– The marginal-cost curve crosses the average-total-cost curve at the minimum of average total cost.
Define economies of scale
– Economies of scale refer to the property whereby long-run average total cost falls as the quantity of output increases.
Explain diseconomies of scale
Diseconomies of scale refer to the property whereby long-run average total cost rises as the quantity of output increases.
– (opposite to diseconomies of scale?)
Define constant rate to scale
Constant returns to scale refers to the property whereby long-run average total cost stays the same as the quantity of output changes.
Returns to scale measures the effect on average costs as scale is changed
• Scale refers to the proportionate change in all inputs
• For example, CRTS means a 10% increase in ALL inputs increases average costs by 10%: costs rise the same % as inputs.
Increasing returns of scale:
Scale refers to the proportionate change in inputs
• For example, IRTS means a 10% increase in ALL inputs increases average costs by only 5%: costs rise less than the increase in scale
Distinguish between short and long term
The short run refers to a period of time when at least one factor is fixed, not to a specific calendar time. It can vary in length of time, depending on the industry. For example, the building on a new factory cannot be achieved overnight if you wished to establish a steel manufacturing plant, whereas a dog walking service can be established almost overnight. The long run refers to a period of time in which the quantities of all inputs can be varied.
e.g. the input that cannot be changed in the short term is the factory itself where as the long run period of time needed for all factors of production to become variable
What is your aunt’s opportunity cost of running a hardware store for a year?
If your aunt thought she could sell $510,000 worth of merchandise in a year, should she open the store? Explain.
The opportunity cost of running the hardware store is $550,000, consisting of $500,000 to rent the store and buy the stock and a $50,000 opportunity cost, since your aunt would quit her job as an accountant to run the store. Since the total opportunity cost of $550,000 exceeds revenue of $510,000, your aunt shouldn’t open the store, as her profit would be negative. She would lose money
Marginal Product is the increase in output that arises from an additional unit of input. Marginal product rises at first, then declines because of diminishing returns (diminishing marginal product)
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