Ch 11 - Technology, Production, & Costs

Technology:

the processes a firm uses to turn inputs into outputs of goods/services

Long-Run Average Cost Curve (LRAC):

the lowest cost at which a firm can produce a given quantity of output in the long run with no fixed inputs - In the long run, ATC = AVC

How to Graph Output and MPL:

* Plot L vs Q (# workers vs output) - the curve will rise but at a decreasing rate (concavity) * Plot L vs MPL (# workers vs MPL) - the curve will rise at first and then decrease

4 Steps to Graphing the 4 Cost Curves:

1.) Start by graphing the MC curve 2.) Freehand the AVC curve in a u-shape, making sure it intersects the MC at its lowest point 3.) Draw the AFC curve showing an exponential decrease and a horizontal asymptote 4.) Draw the ATC curve in a u-shape above both the AFC and AVC curves, making sure it intersects MC at its lowest point. Make it eventually converge closer and closer to the AVC MC > AVC (shape & intersect) > AFC (shape, asymptote) > ATC (shape, position, intersect, convergence)

Average Fixed Cost (AFC) and Average Variable Cost (AVC):

AFC = FC / Q and AVC = VC / Q ATC = AFC + AVC As Q increases, average fixed cost (AFC) falls and average variable cost (AVC) follows the ATC in a U-shape. - The MC curve also intersect the AVC curve at the AVC's minimum

Law of Diminishing Marginal Returns:

Adding more a variable input to the same amount of a fixed input will cause diminishing marginal returns

Explicit Costs:

Costs that involve spending money (accounting costs) - inputs, wages, interest payments on loans, electricity/utilities, lease payments

Deriving the LRAC Curve:

Each size of firm has its own average total cost (ATC) curve. Connect the minimum ponts on every ATC curve to derive the LRAC curve

Types of Costs (FC, VC, TC)

Fixed and variable inputs produce fixed and variable costs. Fixed costs are independent of output and include costs such as rent/lease, interest payments on machines, insurance, utilities, etc. TC = FC + VC

Economies of Scale:

For small quantities, the firm's LRAC decreases as Q increases.

Diseconomies of Scale:

LRAC increases as output increases because the firm has grown too big

Implicit Costs:

Non-monetary opportunity costs which are resources in the firm that could have been used for other beneficial purposes - a former salary, lost interest in a saving's account, time, depreciation (decrease in resale value) Economic Cost = Explicit Cost + Implicit Cost

Average Product of Labor (APL) =

Q/L the average of the marginal products of labor, dictated by MPL

Short-Run vs Long-Run:

Short-run: a period of time in which at least one input is fixed (usually capital K) Long-run: no inputs are fixed, all inputs are variable

Cause of increasing average costs in the short and long-run:

Short-run: due to diminishing marginal returns Long-run: due to diseconomies of scale

Average Total Cost (ATC) =

TC / Q ATC forms a U-shaped curve because the ATC falls at first and then begins to climb with increased levels of production (output) - ATC depends on APL (average product of labor)

Minimum Efficient Scale:

The LOWEST level of output at which all economies of scale are exhausted

Relate MC and ATC curves:

The MC curve is U-shaped due to the marginal products of labor (MPL's) which first increase than decrease. The ATC curve is U-shaped because it follows the MC curve. * If MC < ATC, then ATC curve falls * If MC > ATC, then ATC curve rises The MC curve intersects the ATC curve at the ATC's minimum point

Production Function:

The relationship btwn the inputs employed and the maximum output of the firm *Cost is not 0 when Q = 0 due to fixed costs!

The Producer's Problem:

To minimize costs (maximize profits) by choosing a bundle of inputs K and L subject to a given level of cost (budget) (aka: Find the cost-minimizing combination of inputs at a given level of output)

Marginal Cost (MC) =

[delta TC / delta Q] the change in a firm's total cost from producing one more good/service - MC decreases at first, then begins to increase quickly, driving the ATC

Isoquant:

a curve showing all combinations of two inputs that produce the same level of output

Isocost Lines:

all combinations of two inputs with the same total cost

Constant Returns to Scale:

growing larger does not reveal more economies of scale, the LRAC does not change as output Q increases

Slope of an isoquant =

how many units of capital are needed to compensate for one unit of labor (L vs K) = Marginal Rate of Technical Substitution (MRTS) - due to diminishing returns of workers in exchange for capital, MRTS decreases resulting in convex down isoquant curves

Marginal Product of Labor (MPL):

the additional output a firm produces from hiring one more worker -MPL rises at first and then falls w/ additional workers