Chapter 13-14
When a small firm expands the scale of its operation, why does it usually first experience increasing returns to scale? When the same firm grows to be extremely large, why might a further expansion of the scale of operation generate decreasing returns to sale?
As a small firm expands the scale of operation, the higher production level allows for greater specialization of the workers and long-run average total costs fall. As an enormous firm continues to expand, it will likely develop coordination problems and long-run average total costs begin to increase.
Explain the shape of each curve: AFC, AVC, ATC, and MC.
Average Fixed Cost declines as the quantity goes up because a fixed cost is spread across a greater number of units. Marginal Cost declines for the first four units due to an increasing marginal product of the variable input. It then rises thereafter due to decreasing marginal product. Average Variable Cost is U-shaped for the same reason as MC. Average Total Cost declines due to falling AFC and increasing marginal product. It then rises at higher levels of production due to decreasing marginal product.
How do you find the efficient scale?
Efficient scale is the output that minimizes ATC. It is also the place where MC crosses the average-total-cost curve.
T or F: If marginal cost exceeds marginal revenue at a firm's current level of output, the firm can increase profit if it increases its level of output.
False
T or F: If the production function for a firm exhibits diminishing marginal product, the corresponding total-cost curve for the firm will become flatter as the quantity of output expands.
False
T or F: In the short run, if the price a firm receives for a good is above its average variable costs but below its average total costs of production, the firm will temporarily shut down.
False
If a firm is operating in the area of constant returns to scale, what will happen to average total costs in the short run if the firm expands production? Why? What will happen to average total costs in the long run? Why?
In the short run, the size of the production facility is fixed so the firm will experience diminishing returns and increasing average total costs when adding additional workers. In the long run, the firm will expand the size of the factory and the number of workers together, and if the firm experiences constant returns to scale, average total costs will remain fixed at the minimum.
Is the salary of management in a firm a fixed cost or a variable cost? Why?
It is a fixed cost because the salary paid to management doesn't vary with the quantity produced.
What is the shape of the marginal-cost curve in the typical firm? Why?
Its typically U-shaped. The firm often experiences increasing marginal product at very small levels of output as workers are allowed to specialize in their activities. Thus, marginal cost falls. At some point, the firm will experience diminishing marginal product and the marginal-cost curve will begin to rise.
the increase in output that arises from an additional unit of input.
marginal product
T or F: all costs are variable in the long run
True
Explain the relationship between ATC and MC.
When MC is below ATC, ATC must be declining. When MC is above ATC, ATC must be rising. Therefor they cross at the minimum of ATC.
the property whereby long-run average total cost stays the same as the quantity of output changes
constant returns to scale
the property whereby the marginal product of an input declines as the quantity of the input increases
diminishing marginal product
the property whereby long-run average total cost rises as the quantity of output increases
diseconomics of scale
Equation for Profit
(P-ATC)Q
Describe the slope of the short-run supply curve for the market for baseballs. Describe the slope of the long-run supply curve in the market for baseballs.
The slope of the short-run supply curve is positive because when P=$2, quantity supplied is one or two units per firm and when P=$3, quantity supplied is two or three units per firm. In the long run, supply is horizontal (perfectly elastic) at P=$2 because any price above $2 causes firms to enter and drives the price back to $2.
Explain the relationship between the production function and the total-cost curve.
The total-cost curve reflects the production function. When an input exhibits diminishing marginal product, the production function gets flatter because additional increments of inputs increase output by ever smaller amounts. Correspondingly, the total-cost curve gets steeper as the amount produced rises.
You go to your campus bookstore and see a coffee mug emblazoned with your university's shield. It costs $5 and you value it at $8, so you buy it. On the way to your car, you drop it and it breaks into pieces. Should you buy another one or should you go home because the total expenditure of $10 now exceeds the $8 value that you place on it? Why?
buy another one, the original mug is a sunk cost and is now irrelevant
the property whereby long-run average total cost falls as the quantity of output increases
economics of scale
the quantity of output that minimizes average total cost
efficient scale
Which of the following is a variable cost in the short run? -payment on the lease for factory equipment -rent on the factory -salaries paid to upper management -wages paid to factory labor -interest payments on borrowed financial capital
wages paid to factory labor