Chapter 5 - MBA ECON

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Long-run average cost curve

A curve that defines the minimum average cost of producing alternative levels of output allowing for optimal selection of both fixed and variable factors of production

Irrelevance of Sunk Costs

A decision maker should ignore sunk costs to maximize profits or minimize loses

average product

total product divided by the quantity used of the input

Profit-Maximization input usage

-To maximize profits, use input levels at which marginal benefit equals marginal cost -When the cost of each additional unit of labor is w, the manager should continue to employ labor up to the point where VMPL = w in the range of diminishing marginal product.

Fixed costs

Cost that does not change with output

Sunk cost

Cost that is forever lost after it has been paid

Economies of scale

Declining portion of the long-run average cost curve as output increase.

Cost complementarity

Exist when the marginal cost of producing one type of output decreases when the output of another good is increased

Economies of scope

Exist when the total cost of producing Q1 and Q2 together is less than the total cost of producing each of the type of output separately

The Leontief production function implies

L-shaped isoquants.

The production function

Mathematical function that defines the maximum amount of output that can be produced with a given set of inputs. Q= F(K,L)

The Cost Function

Mathematical relationship that relates cost to the cost-minimizing output associated with an isoquant

Constant returns to scale

Portion of the long-run average cost curve that remains constant as output increases

Cost-minimizing input rule

Produce at a given level of output where the marginal product per dollar spent is equal for all inputs; a firm should employ inputs such that the marginal rate of technical substitution equals the ratio of input prices

Cost minimization

Producing at the lowest possible cost.

Diseconomies of scale

Rising portion of the long-run average cost curve as output increases

law of diminishing returns

The marginal product of an additional unit of output will at some point be lower than the marginal product of the previous unit

Marginal rate of technical substitutions (MRTS)

The rate at which a producer can substitute between two inputs and maintain the same level of output.

Optimal Input Substitution

To minimize the cost of producing a given level of output, the firm should use less of an input and more of other inputs when that input's price rises

Measures of productivity

Total Product Average Product Marginal Product

Which curve(s) does the marginal cost curve intersect at the (their) minimum point?

average total cost curve and average variable cost curve

What is implied when the total cost of producing Q1 and Q2 together is less than the total cost of producing Q1 and Q2 separately?

economies of scope

It is profitable to hire units of labor as long as the value of marginal product

exceeds wage.

in the short run, some of production factors are

fixed

in the production function K is

is the quantity of capital input

The change in total output attributable to the last unit of an input is the

marginal product.

The absolute value of the slope of the isoquant is the

marginal rate of technical substitution.

Variable factors of production are the inputs that a manager

may adjust in order to alter production.

negative marginal product

means that the last unit of the input reduced the total product (too many workers to be efficient)

If the last unit of input increases total product, we know that the marginal product is

positive.

The Role of the Manager in the Production Process is to

produce output on the production function; Aligning incentives to induce maximum worker effort. Use the right mix of inputs to maximize profits; To maximize profits when labor or capital vary in the short run, the manager will hire labor until VMPl = wage rate and capital until VMPk = rental rate

average product of capital is

quantity divided by capital

average product of labor

quantity divided by labor

Changes in the price of an input cause

slope changes in the isocost line.

Costs that are forever lost after they have been paid are

sunk costs.

Isocost lines

the Combination of inputs that yield the same cost. For given input prices, isocosts farther from the origin are associated with higher costs. Changes in input prices change the slopes of isocost lines

marginal product

the change in total output attributable to the last unit of an input marginal product of capital = change in total output/change in capital marginal product of = change in total output/ by change in labor

'long run' is

the horizon over which the manager can adjust all factors of production

in the production function Q is

the level of output

total product

the maximum quantity of output that can be produced with the given combination of inputs

in the production function L is

the quantity of labor input

'short run' is

the time frame in which there are fixed factors of production

inputs that can be adjusted in the short run are

variable factors of production


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