Exam 2

cost output elasticity:

% change in the cost of production resulting from a 1% increase in output: E(c) = (change in C/change in q)(C/q) OR MC / AC

to find an increase in production from increasing, decreasing, constant returns to scale

((beta+% ^)-1)q / q

Recipe for Firm's Optimization under Perfect Competition

- P = MC to find optimal output - If asked to find profit: use TR - TC - To check if a firm will continue to operate, if P > AVC. If so, firm operates at P = MC, if not, shuts down. - You should be able to identify what is fixed cost and variable cost from a cost curve

follow 3 steps to get from expansion path to a cost curve

1. Choose an output level, then find the point of tangency of that isoquant with an isocost line 2. from the chosen isocost line, determine the minimum cost of producing the ouput level that has been selected 3. graph the output-cost combination

A long-run competitive equilibrium occurs when 3 conditions occur:

1. all firms are maximizing profit 2. No firm has an incentive to enter or exit the industry because all are earning 0 economic profit. 3. the Price of the product is such that the Q(s) = Q(d)

Suppose that the price of labor (PL) is $10 and the price of capital (PK) is $20. What is the equation of the isocost line corresponding to a total cost of $100?

10L+20K = $100

marginal cost =

1st derivative of TC function

The total cost (TC) of producing computuer software diskettes (Q) is given as: TC = 200+5Q. What's the average total cost?

200/Q +5

A perfectly competitive hardware manufacturer has total revenue of $85 million, total variable cost of $45 million, and fixed costs of $10 million. What is the firm's producer surplus?

40 million

The total cost (TC) of producing computer software diskettes (Q) is given as: TC = 200 + 5Q. What is the variable cost?

5Q

the point where MP(L) = AP(L),

AP(L) is at its maximum

Calculate if the firm should shut down in the SR if they're incurring a loss

ATC > P > AVC

LMC intersects the LAC where

LAC is at its minimum

The long-run output of a profit-maximizing competitive firm is the point at which

LMC = P

the cost-output elasticity can be written and calculated as

MC / AC

If E(c) < 1

MC < AC, so there's economies of scale because costs increase less than proportionately with output)

When average cost is at a minimum,

MC = AC

If E(c) = 1

MC = AC. Costs increase proportionately with output. Neither economies or diseconomies

A firm maximizes profit by operating at the level of output where

MC = MR (= P)

The firm chooses its output so that

MC = P as long as the firm covers its AVC in SR

If E(c) > 1

MC > AC, so diseconomies of scale

perfectly competitve firm should choose its output so that

MC(q) = MR = P

the point where total production is maximized...

MP = 0

If AP(L) is decreasing....

MP(L) < AP(L)

If AP(L) is increasing...

MP(L) > AP(L)

Steeper the tangent, higher the _______. Steeper the secant, higher the ________

MP(L), AP(L)

MRTS formula with Marginal Product

MP(L)/MP(K) = - change in K/ change in L

cost minimization condition

MP(L)/w = MP(K)/r

the firm's condition for cost minimization requires

MP_L/MP_K = w/r

MRTS =

MP_l / MP_K

The slope of the isoquant at any point measures the ______

MRTS - the ability of the firm to replace capital with labor while maintaining the same level of output.

The rate at which one input can be reduced per additional unit of the other input, while holding output constant, is measured by the

MRTS, marginal rate of substitution

Because of the relationship between a perfectly competitive firm's demand curve and its marginal revenue curve, the profit maximization condition for the firm can be written as

P = MC

Calculate if the firm should shut down or not

P > ATC

Producer Surplus

PS = R - VC

Producer surplus =

PS = R -VC

Profit =

R - VC - FC

a production function assumes a given _______

Technology

Firm A has a cost output elasticity of 0.7

There are economies of scale.

total firms competing at equilibrium price =

Total production (Q)/ production for a certain month(q)

In a market with entry and exit,

a firm enters when it can earn a positive long-run profit and exits when it faces the prospect of a long-run loss.

To model the input decisions for a production system, we plot labor on the horizontal axis and capital on the vertical axis. In the short run, labor is a variable input and capital is fixed. The short-run expansion path for this produciton system is

a horizontal line

If the law of diminishing returns applies to labor then

after some level of employment, the marginal product of labor must fall

accounting cost

all explicit costs

Long Run

all inputs are variable

MRTS

amount by which the quantity of one input can be reduced when one extra unit of another input is used, so that output remains constant. MRTS = - change in K/ change in L

If we take the production function and hold the level of output constant, allowing the amounts of capital and labor to vary, the curve that is traced out is called:

an isoquant

In a supply-and-demand graph, producer surplus can be pictured as the

area between the equilibrium price line and the supply curve to the left of equilibrium output.

Relation between diminishing marginal returns and marginal cost

as you hire more labor as ouput increases, MP(L) falls, resulting in increasing marginal cost.

In a short-run production process, the marginal cost is rising and the average total cost is falling as output is increased. Thus, marginal cost is

below average total cost

PS for a market is the area

below the demand curve(market price) and above the market supply curve

The following production function q = K + L exhibits

constant returns to scale

opportunity cost

cost associated with opportunities foregone when a firm's resources are not put to their best alternative use.

Given their _______ ________, firms use the existing ________ ________ to make ______ _______ in a way that minimizes their costs

cost constraints, production technology, input choices

Expansion path

curve passing through points of tengency between a firm's isocost lines and its isoquants

LR average cost curve

curve relating average cost of production to output when all inputs, including capital, are variable.

SR average cost curve

curve relating average cost of production to output when level of capital is fixed

Production with 2 variable inputs labor: Isoquants

curve showing all possible combinations of K & L that yield the same output

LR marginal cost

curve showing the change in the long-run total cost as output is increased incrementally by 1 unit.

Assume that a firm's production process is subject to increasing returns to scale over a broad range of outputs. Long-run average costs over this output will tend to

decrease/decline

In a production process, all inputs are increased by 10%, but ouput increases less than 10%. This means that the firm experiences

decreasing returns to scale

Isoquants are

downward sloping and convex

Which of the following is a key assumption of a perfectly competitive market?

each seller has a very small share of the market

LAC exhibits

economies of scale initially but eventually exhibits diseconomies of scale at higher output levels

LAC

envelope of the short-run average cost curves

Sunk Cost

expenditure that cannot be recovered. It shouldn't influence a firm's decisions

When MC of production increases for a firm, the level of output that maximizes profit

falls

P > ATC

firm makes a profit, produces where P=MC

Average total cost

firm's total cost divided by it's level of output ATC= TC / q

total cost =

fixed cost + variable cost

Production Function

function showing the highest output that a firm can produce for every specified combination of inputs Ex: q = f(K,L) i.e output is a function of capital and labor

Isoquant map

graph combining a number of isoquants, used to describe a production function

isocost line

graph showing all possible combinations of labor and capital that can be purchased for a given total cost C = wL + rK Slope = change in K/change in L= -w/r

The long-run supply curve in a constant-cost industry is linear and

horizontal

Industry's long run supply curve: The long-run supply curve for a constant-cost industry

horizontal line at a price equal to the minimum average cost of production

Theory of a firm states

how a firm makes cost-minimizing production decisions and how its costs varies with its output

Zero Economic Profit

implies a firm is earning a normal return on its investment (its doing as well as it could by investing its money elsewhere.

Marginal cost:

increase in cost resulting from the production of one extra unit of output MC = change in VC/change in q OR change in TC/ change in q

An isocost line reveals the

input combinations that can be purchased with a given outlay of funds

Factors of production

inputs into the production process (labor, capital, materials)

prospective sunk cost

investment

When the average product is decreasing, marginal product

is less than average product

Production with one variable output (SR): Marginal Product

is the additional output produced as an input increased by one unit. MP = change in q/change in L = derivative of q in respect to L

Fixed cost

is the cost that does not vary with output levels & can only be eliminated by shutting down

Production with one variable output (SR): Average Product of Labor -

is the output per unit of labor AP(L) = q/L

At the profit-maximizing level of output, marginal profit

is zero

Along the same isoquant, the output is held constant. further the isoquant from the origin, higher the associated output

isoquant map

The supply curve for a competitive firm is

its MC curve above the minimum point of the AVC curve.

the demand curve facing an individual firm in a competitive market is both

its average revenue curve which is equal to the market price

Higher-cost firms have _____ ps, and lower cost firms have ______ps

less, more

A decreasing-cost industry has a downward-sloping

long-run industry supply curve

The slope of the total product curve is the

marginal product

Economic Cost =

opportunity cost

economic cost

opportunity cost + explicit costs

When an isocost line is just tangent to an isoquant, we know that

output is being produced at a minimum cost

SR Supply Curve of Competitive Firm & Industry: the firm's SR supply curve is the..

portion of marginal cost curve for which MC > AVC

Law of Diminishing Marginal Return

principle that as the use of an input increases with other inputs fixed, the resulting additions to output will eventually decrease. (applies to a given technology)

In the short run, when fixed cost is positive,

producer surplus is greater than profit

A production function is drawn for a _________ _____________

production technology

Joe owns a small coffee shop, and his production function is q = 3KL where q is total output in cups per hour, K is the number of coffee machines (capital) and L is the number of employees hired per hour (labor). If Joe's capital is currently fixed at K = 3 machines, what is his short run production function?

q=9L

Total Product Curve

shows the output produced for different amounts of labor output

diseconomies of scale:

situation in which a doubling of output requires more than a doubling of cost

Economies of scale

situation where output can be doubled for less than a doubling of cost.

Marginal Product (in respect to total product curve)

slope of a tangent to the total product at a given point.

when a firm is producing at an output at which LAC is falling,

the LMC < LAC.

If LAC is rising,

the LMC will lie above it.

whenever marginal cost lies below average cost,

the average cost curve falls

whenever marginal cost lies above average cost,

the average cost curve rises.

When labor usage is at 12 units, output is 36 units. From this we may infer that

the average product of labor is 3

Producer surplus in a perfectly competitive industry is

the difference between revenue and variable cost. (PS = R-VC)

ATC>P>AVC

the firm operates to minimize loss and produces at P = MC since it can still cover its variable cost and part of its fixed cost as well

AVC > P

the firm will temporarily shut down

the amount of output that a firm decides to sell has no effect on the market price in a competitive industry because

the firm's output is a small fraction of the entire industry's output.

IN an increasing-cost industry

the long-run industry supply curve is downward sloping

In an increasing-cost industry

the long-run industry supply curve is upward sloping.

The difference between the economic and accounting costs of a firm are

the opportunity costs of the factors of production that the firm owns.

the firm's cost minimizing input combination is given by

the point where the isocost is tangent to the firm's isoquant

If a competitive firm has a U-shaped marginal cost curve then

the profit maximizing output is found where MC = MR and MC is increasing

marginal cost crosses the average variable cost and average total cost curves at....

their minimum points

A few sellers may behave as if they operate in a perfectly competitive market if the market demand is:

very elastic

Marginal cost =

w / MP(L)

equation of the isocost line. (used to find optimal quantities of labor and capital)

wL + rK = budget (C)

Suppose capital and labor are perfect substitutes in a long-run production process. If labor costs $15 per hour and the rental rate of capital is $20 per hour, what can we say about the profit maximizing choice of labor and capital inputs?

we will only use labor in the production process

Short Run

will always have at least one fixed input (production factor that cannot be varied)

A straight-line isoquant

would indicate that capital and labor are perfect substitutes in production

Know the difference between accounting and economic profit

zero-economic profit = using all the capital for investments to reach a profit of 0.