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ECON 101 > Week 8: Output and Costs > Flashcards

Week 8: Output and Costs Flashcards

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1
Q

What is a firm’s goal?

A

To maximize profit

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2
Q

What is the formula for economic profit?

A

Total revenue - total cost (measured as the opportunity cost of production)

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3
Q

What is depreciation?

A

The fall in the value of a firm’s capital calculated as a percentage of the price paid for them using formulas that are unrelated to the change in the market value of capital

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4
Q

Why do accountants measure a firm’s profit?

A

To ensure that the firm pays the right amount of income tax and to show its investors how their funds are being used

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5
Q

Why do economist’s measure a firm’s profit?

A

To enable themselves to predict the firm’s decisions with the goal of maximising economic profit

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6
Q

What is a firms’s opportunity cost of production?

A

The value of the best alternative use of the resources the firm uses for production or the value of real alternatives forgone (money units)

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7
Q

A firm’s opportunity cost of production is the sum of the cost of using resources…

A

Bought in the market, owned by the firm, and supplied by the firms owner

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8
Q

Why does a firm incur an opportunity cost when it buys resources in the market?

A

The firm could have used the amount spent on these resources to buy different resources to produce some other good or service

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9
Q

Why does a firm incur an opportunity cost when it uses its own capital?

A

The firm could sell the capital it owns and rent capital from another firm

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10
Q

What is a firm’s opportunity cost of using the capital it owns called?

A

Implicit rental rate of capital since a firm implicitly rents from itself when it uses its own capital

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11
Q

What are the two components of the implicit rental rate of capital?

A
  1. Economic depreciation- fall in the market value of a firm’s capital over a given period (initial market price of capital - final market price of capital)
  2. Forgone interest- next best use of the funds used to buy the capital would have earned interest
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12
Q

What are the factors of production supplied by the firm’s owner that incurs an opportunity cost?

A
  1. Entrepreneurship- amount of the normal profit (profit earned on average) is the cost of entrepreneurship and the opportunity cost of production
  2. Owner’s labour services- opportunity cost is the wage income forgone by not taking the best alternative job
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13
Q

What five decisions must a firm make in order to achieve maximum economic profit?

A

What to produce and in what quantities, how to produce, how to organise and compensate its managers and workers, how to market and price its products, what to produce itself and buy from others

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14
Q

What is the biggest decision that an entrepreneur makes?

A

What industry to establish a firm

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15
Q

What do decisions about the quantity to produce, price to charge, and how to produce depend on?

A

The quantity to produce and the price to charge depends on the type of market in which the firm operates while all types of firms and all types of markets make similar decisions on how to produce.

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16
Q

What do firm’s actions that influence the relationship between output and cost depend on?

A

Depends on how soon the firm wants to act, an earlier change in output rate has fewer options

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17
Q

What decision timeframes are used to study the relationship between a firm’s output decision and its costs?

A

The short run and the long run

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18
Q

What is the short run?

A

Timeframe in which the quantity of at least one factor of production is fixed, which is called the firm’s plant

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19
Q

How can you increase output in the short run?

A

A firm must increase the quantity of a variable factor of production, which is usually labour.

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20
Q

Why are short-run decisions easily reversed?

A

The firm can increase or decrease its output in the short run by changing the amount of labour it hires.

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21
Q

What is the long run?

A

Timeframe in which quantities of all factors of production can be varied, meaning the firm can change its plant

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22
Q

How can you increase output in the long run?

A

A firm can change its plant as well as the quantity of labour it hires.

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23
Q

Why are long-run decisions not easily reversed?

A

Once the plant decision is made, the firm usually must live with it for some time.

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24
Q

What is a sunk cost?

A

Past expenditure on a plant that has no resale value

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25
Q

Are sunk costs relevant to the firm’s current decisions?

A

No, the short-run cost of changing its labour inputs and the long-run cost of changing its plant are the only costs than influence its current decisions.

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26
Q

What three related concepts can be used to describe the relationship between output in the short run and the quantity of labour employed?

A

Total product, marginal product, and average product

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27
Q

What does the data in product schedules tell us?

A

How the quantity of goods produced increases as more workers are employed and the productivity of the labour that a firm employs

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28
Q

What is the total product and its relationship with the quantity of labour employed?

A

Maximum output that a given quantity of labour can produce. Each increase in employment increases total product.

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29
Q

What is the marginal product?

A

Increase in total product that results from a one-unit increase in the quantity of labour employed (additional worker), ceteris paribus.

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30
Q

What is the average product?

A

Tells us how productive the workers are on average and is equal to total product divided by the quantity of labour employed

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31
Q

What are product curves?

A

Graphs that show the relationships between employment and the three product concepts or how the product concepts change as employment changes

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32
Q

How is the total product curve similar to the production possibilities frontier?

A

It separates the attainable output levels from those that are unattainable. Only points on the total product curve are technologically efficient.

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33
Q

Describe the shape of the total product curve.

A

As employment increases, the total product curve gets steeper till a certain point, then becomes less steep.

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34
Q

How can you determine marginal product from the total product curve?

A

Measured by the slope of the total product curve and the height of the segment of the curve for each additional unit of labour. The steeper the slope of TP, the larger is MP.

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35
Q

What does the height of the marginal product curve measure?

A

Slope of the total product curve at a point

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36
Q

How can you determine the marginal product from the marginal product curve?

A

Value on the y-axis of the point plotted between (midpoint) A and B workers (quantities of labour)

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37
Q

What two features of almost every production process make the shapes of the product curves similar?

A

Increasing marginal returns initially and diminishing marginal returns eventually (increases to a maximum then declines)

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38
Q

When do increasing marginal returns occur?

A

When the marginal product of an additional worker exceeds the marginal product of the previous worker

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39
Q

How do increasing marginal returns arise?

A

Increased specialization and division of labour in the production process

40
Q

When do diminishing marginal returns occur?

A

When the marginal product of an additional worker is less than the marginal product of the previous worker

41
Q

How do diminishing marginal returns arise?

A

More and more workers are using the same capital and working in the same space. As more workers are added, there is less for additional workers to do that is productive. Gains from specialization and division of labour have been exhausted.

42
Q

What does the law of diminishing returns state?

A

As a firm uses more of a variable factor of production with a given quantity of the fixed factor of production, the marginal product of the variable factor eventually diminishes.

43
Q

What does it mean when marginal returns are diminishing?

A

Hiring more and more workers continues to increase output but by successively smaller amounts.

44
Q

Describe the average product curve.

A

Average product increases until it reaches its maximum value then decreases as yet more workers are employed.

45
Q

When is average product largest?

A

When average product and marginal product are equal, marginal product curve cuts average product curve at the point of maximum average product

46
Q

What is the relationship between the average product and marginal product?

A

For the number of workers at which marginal product exceeds average product, average product is increasing. For the number of workers at which marginal product is less than average product, average product is decreasing.

47
Q

What three cost concepts are used to describe the relationship between output and cost in the short run?

A

Total cost, marginal cost, and average cost

48
Q

What is a firm’s total cost?

A

Cost of all the factors of production it uses, sum of total fixed cost and total variable cost

49
Q

What is total fixed cost?

A

Cost of the firm’s fixed factors, remains the same at all outputs since quantities of fixed factors don’t change as output changes

50
Q

What is total variable cost?

A

Cost of the firm’s variable factors, changes as output changes (number of workers x wage)

51
Q

Describe the total fixed cost curve, total variable cost curve, and total cost curve.

A

TFC curve is horizontal, TVC curve and TC curve slope upward (increase output, more labour employed, increased cost). TFC is equal to the vertical distance between TVC and TC curves.

52
Q

What is a firm’s marginal cost?

A

increase in total cost that results from a one unit increase in total output, calculated as the increase in total cost divided by increase in output

53
Q

Why is the marginal cost curve u-shaped?

A

At small outputs, marginal cost decreases as output increases because of greater specialization and division of labour. As outputs increase further, marginal cost increases because of the law of diminishing returns.

54
Q

What are the three average costs of production?

A

Average fixed cost, average variable cost, and average total cost

55
Q

What are average fixed cost, average variable cost, and average total cost?

A

AFC is the total fixed cost per unit of output, AVC is the total variable cost per unit of output, and ATC is the total cost per unit of output

56
Q

How do you calculate for the average cost concepts?

A

Divide each total cost term (TC=TFC+TVC) by the quantity produced Q to get ATC=AFC+AVC

57
Q

What is the shape of the average fixed cost curve?

A

AFC curve slopes downward and becomes less steep as output increases. As output increases, the same constant total fixed cost is spread over a larger output.

58
Q

What is the shape of average total cost curve and the average variable cost curve?

A

ATC curve and AVC curve are u-shaped. Vertical distance between the two curves is equal to the average fixed cost, which shrinks as output increases.

59
Q

Where does the marginal cost curve intersect the average total cost curve and average variable cost curve?

A

At their minimum points

60
Q

What is the relationship between marginal cost and average cost?

A

When marginal cost is less than average cost, average cost is decreasing. When marginal cost exceeds average cost, average cost is increasing. This is shown in both the ATC curve and the AVC curve.

61
Q

What two opposing forces influence the U shape of the ATC curve?

A

Spreading total fixed cost over a larger output and eventually diminishing returns (AVC eventually increases)

62
Q

Where are a firm’s cost curves derived from?

A

Directly from its product curves. The technology a firm uses determines its costs.

63
Q

What is the relationship between a firm’s total product curve and total variable cost curve?

A

Graphing output against labour gives the TP curve and graphing output against variable cost gives the TVC curve. Since variable cost is proportional to labour, both variable cost and labour are measured on the x axis while output is on the y axis.

64
Q

What is the relationship between a firm’s marginal product curve and its marginal cost curve?

A

A firm’s MP curve is linked to its MC curve. As labour increases, MP rises and MC falls. At maximum MP, MC is at minimum. As labour increases further, MP diminishes and MC rises.

65
Q

What is the relationship between a firms average product curve and average variable cost curve?

A

A firm’s AP curve is linked to its AVC curve. As labour increases, AP rises and AVC falls. At maximum AP, AVC is at minimum. As labour increases further, AP diminishes and AVC rises.

66
Q

What two factors do a firm’s short-run cost curves depend on?

A

Technology and prices of factors of production

67
Q

How does technology affect a firm’s short-run cost curves?

A

Technological changes that increases productivity increases the marginal product and average product of labour. It lowers the costs of production and shifts the cost curves downward since the same factors of production can produce more output.

68
Q

Which of a firm’s factors of production does a technological change end up affecting?

A

Firm uses more capital and less labour, which decreases total cost and variable cost but increases fixed costs. At small outputs, average total cost might increase, while at large outputs, average total cost decreases.

69
Q

How do prices of factors of production affect a firm’s short-run cost curves?

A

An increase in the price of a factor of production increases the firm’s costs and shifts the cost curves depending on which factor price changes.

70
Q

What shifts result from an increase in rent or some other component of fixed cost?

A

TFC and AFC curves shift upwards, TC curve shifts upward, but AVC and TVC curves remain unchanged

71
Q

What shifts result from an increase in wages, gasoline, or another component of variable cost?

A

TVC and AVC curves shift upwards, MC shifts upward, but AFC and TFC curves remain unchanged

72
Q

What does the behaviour of a firm’s long-run cost depend on?

A

The firm’s production function, which is the relationship between the maximum output attainable and the quantities of both labour and capital

73
Q

How is a firm’s production function expressed?

A

A table that lists total product schedules for different quantities of capital or plant sizes. Each column can be graphed as a total product curve for each plant.

74
Q

When does diminishing marginal product of labour occur in the production function?

A

With each plant size, as the firm increases the quantity of labour employed, marginal product of labour eventually diminishes.

75
Q

When does diminishing marginal product of capital occur in the production function?

A

With each quantity of labour, as the firm increases the quantity of capital, marginal product of capital eventually diminishes.

76
Q

Why are the short-run ATC curves for each plant size U-shaped?

A

Because as the quantity of labour increases, its marginal product initially increases then diminishes

77
Q

Why does the minimum ATC occur at a greater output than it does for a smaller plant?

A

The larger plant has a higher total fixed cost and thus has a higher average fixed cost for any output

78
Q

Which short-run ATC curve does a firm operate on?

A

Depends on the plant it has. In the long run, the firm chooses the plant that enables it to produce its planned output for the lowest average total cost.

79
Q

When is a firm operating on its long-run average cost curve?

A

When a firm is producing a given output at the least possible cost

80
Q

What is the long-run average cost curve?

A

The relationship between the lowest attainable average total cost and output when the firm can change both the plant it uses and the quantity of labour it employs

81
Q

Why is the long-run average cost curve a planning curve?

A

It tells the firm the plant and quantity of labour to use at each output to minimize average cost

82
Q

What does the long-run average cost curve consist of?

A

Piece of each ATC curve of every plant size with the lowest average total cost, scallop-shaped

83
Q

What are economies of scale?

A

Features of a firm’s technology that make average total cost fall as output increases

84
Q

What happens to the LRAC curve when economies of scale are present?

A

LRAC curve slopes downward

85
Q

What is the main source of economies of scale?

A

Greater specialization of both labour and capital

86
Q

What are diseconomies of scale?

A

Features of a firm’s technology that make average total cost rise as output increases

87
Q

What happens to the LRAC curve when diseconomies of scale are present?

A

LRAC curve slopes upward

88
Q

What is the main source of diseconomies of scale?

A

The challenge of managing a large enterprise

89
Q

What are constant returns to scale?

A

Features of a firm’s technology that keep average total cost constant as output increases

90
Q

What happens to the LRAC curve when constant returns to scale are present?

A

LRAC curve is horizontal

91
Q

What is a firm’s minimum efficient scale?

A

The smallest output at which long-run average total cost reaches its lowest level or is minimized

92
Q

How does minimum efficient scale play a role in determining market structure?

A

If the minimum efficient scale is small relative to market demand, the market has room for many firms and is competitive. If the minimum efficient scale is large relative to market demand, only a small number of firms or possibly only one can make a profit and the market is an oligopoly or monopoly.

93
Q

What is an intermediate good?

A

An output of one firm used as an input by another another firm

94
Q

What happens to firms that do not seek to maximize profit?

A

Will either be driven out of business by its competitors or taken over by another firm that does seek to maximize profit

95
Q

What are explicit and implicit costs?

A

Explicit costs are from using inputs that are purchased and implicit costs are from using inputs that are not purchased, but still have an opportunity cost

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