Econ Quiz 2

Production Process decisions are based off

- the price of input - techniques of production available

production technology

- the quantitative relationship between inputs and outputs - lowest cost technology is the best technology

Long tern firms by looking at short term circumstances

1. firms that earn economic profits 2. firms that suffer economic losses but continue to operate to reduce or minimize those losses 3. firms that decide to shut down and bear losses to equal to fixed costs

Choices of Technology

2 things determine the cost of production: 1. technologies that are available 2. input prices

Production Function/Total Production function

A numerical or mathematical expression of a relationship between inputs and outputs. It shows units of total product as a function of units of inputs.

firm

An organization that comes into existence when a person or a group of people decides to produce a good or service to meet a previeced demand **under perfect conditions, firms are profit maximizing

The Behavior of Profit-Maximizing Firms

Decisions a firm must exhibit in order to qualify as "profit maximizing" 1. How much output to supply 2. Which production technology to use 3. How much of each input to demand

Costs in the SHORT RUN

Fixed Costs Variable Costs Total Costs

total cost

Fixed Costs + Variable Costs

Types of technology

Labor Intensive, Capital Intensive

total, average and marginal product

Marginal and average product curves can be derived from total product curves. Average product is at its maximum at the point of intersection with marginal product. Diminishing Returns kick in when MP begins to fall

a firm operates at

P* = MR = MC

long-term equilibrium

SRMC = SRAC = LRAC - firms make no profits so that P=SRMC=SRAC=LRAC

SRAC

Short run average cost

Average Fixed costs

TFC/Q or ATC - AVC as output increases, AFC declines b/c we are dividing a fixed number by an increasingly larger quantity

Capital Intensive Technology

Technology that relies heavily on capital instead of human labor - usually cost minimizing in places with higher wages

Marginal Cost (MC)

The additional cost incurred from the consumption of the next unit of a good or service **MC measures additional cost of inputs required to produce each successive unit of output T he easiest way to derive MC is to look at the TVC and subtract. as a firm increases input, the demand for inputs increases

shut down point

The point where the price of a good or service is equal to the minimum point on the average variable cost curve. PROFIT = 0

spreading overhead

The process of dividing total fixed costs by more units of output. Average fixed cost declines as quantity rises.

Average Product of Labor

Total Product/Total Units of Labor If marginal product is above average product, the average rises If marginal product is below average product, the average falls

Operating Profit/Loss

Total revenue - Total variable cost ***if a firm has a certain amount of fixed costs it will sustain. And if the firm can offset some fixed costs by making a short term profit, they will Even if (TFC+TVC)>TR (they are making a loss)

variable costs

a cost that depends on the level of production chosen any input that mist be purchased to increase short run production

Intuition

a firm eventually gets less and less new production out of each new input

U-shaped long run average cost curve

a firm exhibiting diseconomies of scale

The bases of decisions

a firm needs to know; 1. The market price of output (determines potential revenues) 2. The techniques of production that are available 3. The prices of inputs

long-run average cost curve

a graph that shows the different scales on which a firm can choose to operate in the long run we want the lowest cost per unit - each scale of operation defines a different short run LRAC

total variable cost curve

a graph that shows the relationship between total variable cost and the level of a firm's output TVC is deprived from production requirements and input prices TVC curve embodies information about both input prices and technologies, it shows the cost of production at each output level given certain input prices

increasing returns to scale (economies of scale)

an increase in a firm's scale of production leads to lower costs per unit produced Long-run average cost is falling LRAC if a firm doubles all inputs, outputs will be more than double ex) technologies

constant returns to scale

an increase in a firms scale of production has no effect on costs per unit produced LRAC is flat if a firm doubles all inputs, outputs double exactly

decreasing returns to scale (diseconomies of scale)

an increase in a firms scale of production leads to higher costs per unit produced LRAD is rising if a firm doubles all inputs, output is less than double

perfect competition

an industry in which; - there are many firms, each small and relative to the industry - each firm produces identical/homogenous products and in which no firm is large enough to have control over any prices - new competitors can freely enter and exit the market

fixed costs (sunk costs)

any cost that is not dependent on the firms level of output incurred even if the firm is not producing anything there are NO fixed costs in the long run firms have no control over fixed costs in the short run AFC x q

if P<AVC

any time the price is below the minimum point on the AVC curve, and the operating profit will be negative at any output level. the firm should shut down in the short run the minimum point of the AVC curve is called the shut-down point

Positive Economic Profit

appears when MC is larger than Average total costs (ATC) Look to see where price is intersecting the marginal cost curve, if it is above the MC curve it is positive profit P=TR-TC

Capital and Labor

are complementary inputs

a fixed factor implies

diminishing returns and limited capacity to produce as the limits are produced the marginal costs rise Declining marginal product = downward trend in slope of MP curve Rising Marginal Costs = upward trend in slope total variable costs always increase with output

if a firm is profit maximizing, a competitive firm(s) will... (Long term)

enter the industry increase supply drive down prices for the industry as a whole in a perfectly competitive firm there are very little barriers to entry

if TR>TVC

excess revenue can be used to offset fixed costs and reduce losses it will pay the firm to keep operating in the short-run

How to see if profit is maximized

higher value under profit column (TR-TC) another way to see MR is to see where MR is >/= MC and producing up the the point until MR=MC

Marginal cost (short run)

in the short run every firm is constrained by some fixed inputs that; a. lead to diminishing returns to variable inputs b. limits its capacity to produce as a firm approaches that capacity, it becomes increasingly costly to produce successively higher levels of input marginal costs ultimately increase with output in the short run in the short run we are discussing fixed-production scales

zero economic profit

indicated by P*= ATC

Profit maximizing level of output

marginal revenue and marginal cost are exactly equal added output means added profit firms will produce an additional unit of output as long as they will get more money from selling it than it cost them to make it

Long-Run any price below P*

means that firms are suffering losses, and firms will exit the industry

Profit maximizing firms will choose the technology that...

minimizes the cost of production given the current market prices will use the lower cost technology over the more expensive/advanced technology

Short-run profits

moves in and out of equilibrium

a profit-maximizing perfectly competitive firm will...

produce up to the point where the price of its output is just equal to short run marginal cost the live of output at which P* (market price)=MR=MC this is the profit maximizing level for all firms where MR=MC **each additional unit increases revenues by more than it costs to product the additional output because P>MC **at any market price, the marginal cost curve shows the output level that maximizes profit

SRMC

short run marginal cost

marginal cost curve

shows total variable cost changes with single-unit increases in total output

Inputs can also be

substituted for one another - if labor becomes too expensive, firms can replace labor with capital

Labor Intensive Technology

technology that relies heavily on human labor instead of capital - usually cost minimizing technology in rural areas and developing countries

Declining Marginal product implies

that marginal cost will eventually rise with output

Marginal Revenue

the additional income from selling one more unit of a good; sometimes equal to price in perfect competition P=MR in a perfect market, the demand curve and marginal revenue curve are identical in a perfectly competitive market they will sell a homogenous product for anything more than Eq. price so MR will also be equal to equilibrium price

marginal product

the additional output that can be produced by adding one more unit of specific input, ceteris paribus

Average Product

the average amount produced by each unit of a variable factor or production

marginal costs

the cost of producing one more unit of a good

if TR<TVC

the firm operating will suffer losses in excess of fixed costs In this case, the firm can maximize its losses by shutting down in the short-run

in the long run if P>AVC

the firm should consider a future permanent shut down b/c total costs are still greater than TR when the firm suffers losses

if market price is intersecting the marginal cost curve anywhere above ATC...

the firm should continue to operate and has positive economic profit

if market price is intersecting the marginal cost curve below ATC and above AVC...

the firm should continue to operate but will continue to incur losses

As long as P>AVC

the firm will gain by operating in the short run rather than shutting down the firm should continue to operate in the short run even if it is suffering losses

is the market price intersects the marginal cost curve at or below AVC...

the firm will shut down and not be able to offset some fixed costs.

average fixed costs

the fixed cost per unit produced

Long Term Decision

the period of time for which; - there are no fixed factors of production, firms can increase or decrease the sales of operation. - new firms can enter and existing firms can exit the industry

short-run decision

the period of time in which; - the firms is operating under a fixed scale of production ( this fixed short run factor is normally capital) - firms can neither enter nor exit the industry

Production

the process by which inputs are combined, transformed, and turned into outputs

optimal method of production

the production method that minimizes cost for a given level of output

Hiring additional labor increases

the productivity of capital - When more workers are hired at a plant that is operating at 50% capacity, previously idle machines become more productive

Additional Capital increases

the productivity of labor - The amount of output produced per worker per hour

optimal scale of plant

the scale of plant that minimizes long-run average cost lowest point on LRAC curve

Breaking Even

the situation in which a firm is earning exactly a normal rate of return TR-TC = 0 MC=ATC on a graph

Total Revenue (TR)

the total money received from the sale of a product Price x Quantity

Total Variable Cost (TVC)

the total of all costs that vary with output in the short run unlike fixed costs, TVC tend to increase as production increases TVC = (K x Pk) + (L x Pl) we assume firms choose the cheapest technology

Long-Run any price above P*

there are profits to be made in the industry and new firms will continue to enter

average total costs

total costs divided by the number of units produced.

Economic Profit

total revenue minus total cost, including both explicit and implicit costs

homogenous products

undifferentiated products; products that are identical to, or indistinguishable from, one another This matters for production because it implies a perfectly elastic demand curve in the short run, which is just a horizontal line at the market equilibrium price

Average Variable costs

variable costs per unit of output

Law of Diminishing Returns

when additional units of a variable input are added to fixed inputs, after a certain point, the marginal product of the variable input declines - every firm will face diminishing returns in the which always apply in the short run Meaning every firm finds it progressively more difficult to increase its output as it produced production capacity

short run losses

where supply and demand intersect for an industry is lower than the breaking even point of a firm P<SRAC, there are economic losses (losses=area of rectangle) some firms will exit the industry - when supply decreases eq. price increases and eq. quantity decreases since P*=SRMC=SRAC=LRAC, the industry is in long-run equilibrium

Long-Run only at P*

will profits be equal to 0, and only at P* will the industry be at eq.

Slope of Total Variable Cost curve

∆TVC/∆q = ∆TVC/I=TVC=MC