Unit 3 - The Theory of the Firm
Beth makes gourmet dog treats and wants to increase her output. It takes her 1 hour to acquire more peanut butter, 1 day to acquire more cooking molds, 1 week to hire more workers, 2 weeks to get a new oven, and 4 months to find a new building for a larger bakery. Assume Beth can also sell off these inputs in the same amount of time it takes to obtain them. - How long is the long run for Beth?
4 months
The marginal product of labor is 50 bagels and the average product of labor is 25 bagels. Which of the following best describes what happens if one more unit of labor is used?
APL increases
What are the total fixed costs?
All costs that DO NOT change when output changes ~constant amount
What are total variable costs
All costs that DO change when output changes
What is the key feature of the long run?
All resources are variable; no fixed resources and the size and capacity of the factory can change
What is the long run ATC curve made up of?
All the different short run ATC curves of various plant sizes
If a firm operates in a perfectly competitive market, what must be true about the firm's efficiency in the short run and the long run?
Allocatively efficient in the short run; both allocatively efficient and productively efficient in the long run Allocative efficiency occurs when a firm produces the quantity where marginal benefit (MB) equals marginal cost (MC). A perfectly competitive firm always produces the allocatively efficient quantity because the good's price reflects its marginal benefit, and a perfectly competitive firm always produces where P=MR=MC. Productive efficiency occurs when a firm produces the quantity where average total cost is minimized, and a perfectly competitive firm produces this quantity in the long run.
The Law of Diminishing Marginal Returns
As variable resources (workers) are added to fixed resources (ovens, machinery, tool, etc.), the additional output produced from each additional worker will eventually fall
How is average product calculated?
Average product= Total product/ Units of labor
Turkey jerky is produced and sold in a perfectly competitive increasing cost industry and buyers consider it a normal good. The incomes of turkey jerky buyers have increased. What happens to each firm's average total cost curve and the price of turkey jerky in the long run?
Average total cost curves increase; the price of turkey jerky increases.
How is marginal product calculated?
Change in total product/ change inputs
Which of the following best describes the shutdown rule?
Choose Q=0 when P<Average variable cost
When Yooko Industries makes 2000 widgets, the cost of producing a typical widget is $5 which includes implicit costs of $2. What is Yooko Industries economic profit (or loss) and accounting profit (or loss) if the price of a widget is $4?
Economic profit= −$2000 (a loss) Accounting profits=$2000
What are some examples of total variable costs?
Examples includes payments for.. ~ materials ~ fuel/power ~ transportation services ~most labor
What is the equation of average fixed cost?
FC/ Q (fixed cost)/ (quantity of output)
Where does the marginal cost curve intersect the average total cost curve?
From below and crosses it at the lowest point
Which of the following is a way to avoid diminishing marginal returns to labor?
Increase the quantity of capital
What happens to the total cost curve as more output is produced?
It becomes steeper due to the diminishing returns
Which of the following is true about a perfectly competitive firm in the long run?
It produces the quantity where marginal benefit equals marginal cost and the average total cost is minimized.
What happens when the marginal cost is below the average?
It pulls the average down
What happens when the marginal cost is above the average?
It pulls the average up
When does the u-average total cost curve fall at low levels of output?
It then rises at higher levels
What is true about marginal product if total product is maximized?
Marginal product equals zero
What is true about the price of a good that leads firms to exit an industry?
P<ATC
If profit is as high as possible and normal economic profits are being earned, which of the following is true?
P=ATC(Q)P= ATC(Q) and MR(Q)=MC(Q)
Which of the following would entice a firm to enter an industry?
P>ATC
What is long run used for?
Planning for firms to identify which size factory results in the lower per unit cost
Which of the following happens in the long run when demand increases in a perfectly competitive constant cost industry?
Price doesn't change.
Which of following best describes a perfectly competitive firm in the short run and the long run?
Short run: allocatively efficient; long run: allocatively efficient and productively efficient
What is the equation for total fixed costs?
TFC= Q x AVC
When and why does TVC increase?
TVC increases as the quantity increases because the firm needs more labor to make more output
What is the equation for TVC?
TVC= Q x AVC
Average product
The amount of outputs that are produced by an average unit of labor
Which of the following best describes what happens in the long run when a firm anticipates that the price of their good will always be less than average total cost (ATC)?
The firm will exit the industry. If price is less than ATC a firm is making a loss. If a firm knew that this would be the situation forever, and it would forever lose money, the firm would exit the industry.
What is the average fixed cost?
The fixed cost per unit of output
What is the total cost?
The sum of the fixed cost and the variable cost of producing that quantity of output
What is the long-run?
The time period in which all inputs can be varied ~Enough time for a firm to change the quantities of all resources employed, including the plant size
What is the short-run?
The time period in which at least one input is fixed ~NOT a set specific amount of time
What is the key feature of the short run?
The time period in which at least one resource is fixed
What is the average total cost?
The total cost divided by quantity of output produced
What is the average variable cost?
The variable cost per unit of output
What is important to know about the "short-run" and the "long-run"
They are not specific amounts of time
How is average total cost calculated?
Total cost/ quantity of output
What is the equation of average variable cost?
VC/ Q (variable cost)/ (quantity of output)
What does a rational firm consider?
all of the costs and benefits of an action, which means it considers both implicit and explicit costs of an action.
fixed input
an input whose quantity is fixed for a period of time and cannot be varied
variable input
an input whose quantity the firm can vary at any time
All of the following are characteristics of perfectly competitive markets EXCEPT
barriers to entry
How do you find the marginal cost?
change in total cost / change in quantity of output ~ change in total cost generated by one additional unit of output
Which of the following best describes what a firm's objective is?
maximize economic profit
Marginal product
the additional output generated my additional inputs
What is the diminishing returns effect?
the larger the output, the greater the amount of variable input required to produce additional units, which leads to higher average variable cost
What is the spreading effect?
the larger the output, the greater the quantity of output over which fixed cost is spread, leading to lower average fixed cost
Total product (Q)
the relationship between the quantity of inputs a firm uses and the output it produces ex: 10 units of output
production function
the relationship between the quantity of inputs a firm uses and the quantity of output it produces
How do you find the total profit?
total revenue - total cost
When does allocative efficiency occur?
when a firm produces the quantity where marginal benefit (MB) equals marginal cost (MC).
What are the three stages of return?
~ Stage 1: Increasing marginal returns ~ Stage 2: Decreasing marginal returns ~ Stage 3: Negative marginal returns
Why does marginal cost curve go down and then up?
~Diminishing marginal returns to labor in the production function ~As output increases, the marginal product of the variable input (labor) declines ~ This implies that more and more labor must be used to produce each additional unit of output ~ Since each unit of labor must be paid for, the additional cost per additional unit of output also rises
What are some examples of total fixed costs
~Include payment for Rent Interest on firm's debt insurance premiums
What are some examples of short-run costs?
~Labor (wages) ~ Raw materials (resources) ~ Any resource used for production in a fixed plant